Discussion paper 31/09 Financial development and economic growth in Malaysia: Cointegration and Co-feature analysis

This study seeks to explore the relationship between financial development and economic growth in Malaysia over the period of 1980 to 2008 using the Kuala Lumpur Composite Index (KLCI) and the Index of Industrial Production (IIP). Focusing on long term relationship, this investigation is carried out within the Granger causality and vector error correction model (VECM). The empirical results data suggest the existence of the long-run equilibrium relationship between financial development and economic growth in Malaysia. The causality between economic growth and stock market was found to mutually causal, that is the causality is bi-directional. This finding suggests that a strong stock market is a good channel to foster economic growth of the country. At the same time, strong growth of economy helps to promote the development of the stock market in Malaysia. Therefore it is vital for the Malaysian government to formulate policy that will enhance the efficiency of the financial system to stimulate the stock market and further boost up the growth of economy