The Role of Macroeconomic Indicators in Shaping the Informal Economy: A Panel data analysis of five South Asian Countries

This paper aims to estimate the impacts of macroeconomic indicators on the formation of the shadow economy across five South Asian countries- Bangladesh, India, Pakistan, Sri Lanka and Nepal throughout 1991 to 2015. This study employs a panel data analysis by extracting data from IMF and World Bank data sources. The Fixed Effect (FE) regression model and the Random Effect (RE) model have been used. To increase the robustness of the model and to address potential heteroskedasticity and autocorrelation issues, Driscoll-Kraay standard error was applied. The findings show that increased openness in trade and higher revenue of the government are associated with a higher size of the shadow economy. On the other hand, the shadow economy of a country reduces when the credit distribution through the commercial banks increases. The study also found that when inflation increases, the amount of shadow economy also increases and while GDP per capita increases, the size of the shadow economy decreases. All these findings suggest that financial development and effective regulatory governance are necessary in curbing the size of the shadow economy.