Dynamic Effects of Islamic Finance and Corruption on Environmental Quality in Malaysia

Hengchao Zhang^a, Riasat Amin Imon^b, Rafia Afroz^b

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^aSchool of Graduate and Professional Studies, INCEIF University, Malaysia. (Email: zhang@inceif.edu.my)

^bDepartment of Economics, Faculty of Economics and Management Sciences, International Islamic University Malaysia

15th International Conference on Islamic Economics and Finance (15th ICIEF)

20^th -22^nd February 2024, Sasana Kijang, Kuala Lumpur

Executive Summary

INTRODUCTION

• Financial Development (FD) is a double-edged sword:
• (+) promotes a nation's prosperity: facilitating efficient resource allocation and investment strategies.
• (-) increases energy consumption and carbon emissions: fueling demands on energy-intensive commodities.
• (✔) value-concerned FD stimulate eco-friendly investments on developing and adopting efficient technology and sustainable practices.
• Does rapid Islamic Financial Development (IFD) promote Environmental Quality?
• Important but complex to answer
• Complexity: a) heterogenous IF practices, b) diverse environmental quality, c) legislation
• Malaysia Context:
• Malaysia's Halal economy contributes around 7.5% to its GDP in 2020.
• The 12th Malaysia Plan (2021-2025) aims to enhance the competitiveness of the halal industry, and the halal industry to GDP is targeted to grow to 8.1%
• However, Malaysia's recent environmental performance has been less favorable:

-2^nd highest per capital CO2 emitter in ASEAN

-temperature increased nearly 0.2 °C every decade since 1970.

-29% of trees coverage (8.67 million hectares) loss since 2000.

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Malaysia: CO2 Emissions Over the Time

LITERATURE REVIEW

• Researchers and policymakers often use the Environmental Kuznet Curve (EKC) theory and Stochastic Regression Impacts on Population, Affluence and Technology (STIRPAT) framework to study the impact of economic development on environmental degradation (Manocha, 2023; Yu et al., 2023).
• The EKC theory suggests an initial “+” correlation between economic growth and environmental degradation, followed by a “-” relationship after reaching a certain development level (Grossman and Krueger, 1995) .
• The STIRPAT framework extend beyond EKC’s concern solely on the economic factor by augmenting the impact of population, urbanization, and technology on environmental quality (Pantaleone, 2020).

LITERATURE REVIEW

METHODOLOGY

METHODOLOGY

TABLE 1

Description of Variables

EMPIRICAL RESULTS

UNIT ROOT TEST

• Prerequisite for ARDL-Bound Test: Dependent Variable lnCO2 =I (1) & Indep Var cannot be I(2) (Jordan & Philips, 2018)
• Both ADF & PP test are used.
• Lag structure selected based on minimized values of Bayesian information criterion (BIC), which is believed to be more suitable for small sample size (Ivanov & Kilian, 2005).
• General-to-Specific approach to remove the insignificant lags for ADF test to ensure the reliability of the results (Hall, 1994)
• Findings: lnCO2 is I(1), and all the regressors are either I(0) or I(1) 🡺 suitable for ARDL-bound test

COINTEGRATION

DIAGNOSTIC TESTS

DYNAMIC ARDL ESTIMATION

• Income (Y): 1% percentage increase in Y will enhance pollution but insignificantly by 8.87% in the long run and reduce pollution but insignificantly by 0.35% in the short run (Ang , 2008; Azlina & Mustapha,2012).
• It implies that, the likelihood of achieving environmental sustainability concurrently with the robust economic growth is limited within the context of Malaysia.
• IFD: 1% increase in IFD results in a corresponding long-term increase of 5.88% in CO2 emissions (Abduh, 2022), despite its short-run modest effects at -0.08%.
• This implies that IFD exhibits promising potential in promoting development and concurrently mitigating CO2 emissions. However, over the long-run such advantage has dashed out.
• Empirical evidence contradicts with theoretical belief on the environmental value-embedment of IF.
• Corruption Perception Index (CPI): Significant positive association between the CPI and CO2 emissions, both in the short (0.75%) and long term(24.15%)
• General anti-corruption initiatives less favorable for countries with relatively low level of corruption (CPI ≤ 52.47) (Balsalobre-Lorente et al.,2019).
• Instead, policymaker shall institute a reward-mechanism to incentivize stakeholders to align their undertaking with green, renewable, and sustainable development initiatives (Balsalobre-Lorente et al., 2019; Perwithosuci et al., 2023).
• Urbanised Population (U): 1% increase in urbanised population has insignificant increase CO2 emission in the LR, while yielded significant effect in the short run (Lin et al., 2017 & Mukhopadhyay, 2016).
• Urbanized population requires higher fossil energy consumption, including electricity and gasoline-powered transportation, leading to increased carbon emissions and more significant environmental damage.
• Insignificant of U for Malaysia can be attributed to Malaysia’s decreasing rate of urbanization, declined fertility rate and rapid ageing population between 2015-2020 (Peng, 2020).

IMPULSE RESPONSE ANALYSIS

Dynamic Effects of ±2% Shock in lnU on lnCO2

Dynamic Effect of ±2% Shock in lnCPI on lnCO2

Dynamic Effect of ±2% Shock in IFD on lnCO2

CONCLUSION & IMPLICATIONS

Objective: To examine how IFD, corruption (CPI), economic growth (Y), and urbanization (U) affect CO2 emissions in Malaysia using the STIRPAT framework and DYARDL analysis on data from 1997 to 2022.

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Findings:

• LR: significant effect of CPI and IFD on increment of CO2 emissions
• SR: IFD reduces CO2 emissions, U increases CO2 emissions

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Implications:

• A reward-mechanism to incentivize stakeholders to commit to environmental initiatives.
• Islamic finance institutes (IFIs) shall align their operational undertakings with the Value-based Intermediation (VBI) framework, gradually shift to future-benefits-oriented and actively facilitate financing for environmental-friendly projects.
• The diminishing effect of urbanization over the long-run underscores the importance of environmental awareness training among the elderly to ensure the environmental narratives are attainable.

Thank you �for your time

Dr. Hengchao, Zhang (Ali)

INCEIF University, Malaysia

zhang@inceif.org