Assessing the Role of Digital Finance on Shadow Economy and Financial Instability: An Empirical Analysis of Selected South Asian Countries

Abstract

The advancement in fintech technological development in emerging countries has accelerated the role of digital finance in economic development. Digital finance assists in financial inclusion; however, it may also increase the chances of financial instability due to systematic risks. Emerging countries are also in the clutches of shadow economic growth, which reduces taxable income revenue and creates pressure on financial inclusion prospects. The current study attempts to measure the impact of digital finance on the shadow economic growth and financial stability among the selected South Asian emerging countries. We have used the CUP-FM and CUP-BC estimation methods to measure the above relationship on two model frameworks from 2004 to 2018, with the former measuring the influence of digital finance on the shadow economy and the latter examining the relationship between digital finance and financial stability. In addition, the second-generation unit root test, and the Westerlund cointegration analysis are also employed to confirm the stationarity and cointegration among the variables. The result of the Westerlund’s cointegration confirms a long cointegration between the explanatory and outcome variables. Furthermore, the long-run estimation results conclude that an increase in digital finance helps in reducing the growth of the shadow economy among the selected sample countries. However, it also increases the likelihood of systematic risks and increases financial instability. The study also reveals that the control variables like unemployment and industrial productivity also have a significant influence on financial stability and the shadow economy. The findings will assist readers in comprehending how digital finance influences the shadow economy and promotes financial inclusion and stability in emerging nations.