The relationship between macroeconomic indicators, banking sector vulnerabilities and sovereign risk in Pakistan is examined in this article. It evaluates risk spillovers and their effect on financial stability within the framework of dynamic interconnectivity.
The sovereign risk, banking risks which include credit risk, liquidity risk, interest rate risk, risk-taking behavior and bank stability and macroeconomic indicators gross domestic product (GDP), GDP growth inflation rate, unemployment are all examined using a time-varying parameter vector autoregression (TVP-VAR) model. The study looks at the transmission of systemic risk using data from 2008 to 2024.
Debt-to-GDP ratio and inflation rate emerged as transmitters of spillover. There is supposed to be a strong connectedness between GDP and External debt of Pakistan in theory, but results reveal that there is low connectedness between the two as Pakistan increases its nominal GDP, not real GDP, which makes the connectedness relation so weak, while stochastic volatility changes over time as different events and financial situations change. According to the impulse response function (IRF), shocks from government debt impair economic growth and financial stability.
By directly applying TVP-VAR to banking variables, this study offers policymakers and financial organizations insightful information about how financial risk is transmitted in Pakistan. Further, this study provides the details of the impulse response function analysis. On the basis of the results, this study provides crucial policy insights and practical implications.
