The IUP Journal of Applied Economics
Causal Relationship Between Changes in Indian Financial Structure and Economic Growth

Article Details
Pub. Date : Oct, 2020
Product Name : The IUP Journal of Applied Economics
Product Type : Article
Product Code : IJAE11020
Author Name : Gautam Negi
Availability : YES
Subject/Domain : Economics
Download Format : PDF Format
No. of Pages : 25



Empirical studies show that as economies progress, the structure of the financial system also changes. The aim of this study, covering the period 1991 to 2019, in the context of India, is to analyze the structural changes in the financial system and its relationship with economic growth. Real Gross Domestic Product (GDP) at factor cost is taken as the proxy for economic growth. Credit extended by banks is taken as a variable for bank-based financial development. For market-based financial development, four variables are considered, namely, Bombay Stock Exchange (BSE) market cap, BSE equity turnover, Assets Under Management (AUM) of mutual funds and funds mobilized through Initial Public Offers (IPO). In addition, four control variables are considered: government expenditure, exports, call rate and World GDP (WGDP) growth rate. Six Autoregressive Distributed Lag (ARDL) models are estimated for capturing the short- and long-run relationships. The findings of the study reveal both short- and long-run association of economic growth with market capitalization, government expenditure, call rate and world growth rate. Bank credit has a long-run causal relationship with economic growth. The findings highlight the role of bank credit and of financial development in the long-run economic growth.


Financial system enables wealth creation by linking savings with investments. The efficiency of this linkage determines how optimally capital is allocated to various productive activities and thus is important for the growth and general welfare of the economy (Allen and Carletti, 2012). The financial system comprises two segments, namely, financial institutions and financial markets. These two channels enable the movement of funds from households and firms to the final borrowers (Cecchetti et al., 2011; and Hubbard and O'Brien, 2012). The financial system of a country could be market-based or bank dominated depending on which segment plays a more important role in channelizing savings, credit and investment allocation and offering risk management services. Japan and Germany are examples of bank-based financial system, while UK and US characterize market-based financial system. The structure of the financial system changes at different stages of economic development with the financial system becoming market-based as economies progress (Arestis et al., 2004; and Beck, 2011). According to Arestis et al. (2004) with economic growth, the market-based financial system removes the inefficiencies associated with banks and thus hastens economic welfare.

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