Exploring the Linkage between Financial Development and Ecological Footprint in Egypt: Evidence from AVECM Analysis

Abstract

This study examines the dynamic relationship between financial development and environmental sustainability in Egypt using a Vector Error Correction Model (VECM) and Granger causality tests. The research focuses on key indicators of financial development, namely Domestic Credit to the Private Sector (DCPS) and Foreign Direct Investment (FDI), and their impact on CO2 emissions. The VECM results highlight a long-term equilibrium relationship, where both FDI and DCPS have significant impacts on CO2 emissions, reflecting the environmental implications of financial growth. Specifically, FDI is associated with increased environmental degradation, while the effect of DCPS is positive but less pronounced. The Granger causality test reveals a bidirectional causal relationship between DCPS and CO2 emissions, indicating interdependence between financial development and environmental degradation. Furthermore, there is evidence of unidirectional causality from CO2 emissions to FDI, suggesting that environmental conditions may influence foreign investment decisions. These findings underscore the importance of implementing sustainable financial policies to mitigate the environmental impact of financial development in Egypt.