Financial Development and Economic Growth: A Case of Indian Economy

Long run high growth of an economy requires mobilization of large amount of savings and then its allocation to the highest return assets/projects. For such efficiency, a well-developed financial system has always been a requirement. An Attempt in the present study has been made to examine if the financial sector development in Indian economy since 1981 has contributed to long run economic growth of the economy. For this purpose, a financial development index has been formulated using principal component analysis, using the variables from banking sector as well as the stock market, capturing almost the entire financial system. The study makes use of the data spanning from 1981-2011 including the break during 1991 when Indian financial system went through crucial financial reforms. GDP at constant US dollars has been used as a proxy variable for economic growth of the country. Two variable Engle-Granger approach has been used to find out long run equilibrium relationship between financial development and economic growth in the context of the Indian economy. Study confirms the long run co-movements between financial development and economic growth in India. However, Error Correction Model (ECM) does not support short run relation