Financial Openness Causes Economic Growth in India : An Evidence from Co-integration

Abstract

The paper attempts to test empirically the hypothesis of finance-led growth in India. For this it traces the relationship between growth rate of GDP and the M3/GDP ratio, well researched indicator of financial deepening for the period of 41 years (i.e, 1971-2012) with the help of recently developed time-series techniques (i.e., Unit roots, Johansen's, co-integration test and granger causality). Unit roots were checked in the data with the help of ADF test and Phillips Perron Process. Two variables of interest i.e., GDP growth rate and M3/GDP are integrated at first difference level and significant at 5 per cent level. Co-integration results obtained with the help of co-integration technique developed by Johansen and Juselius (1991) confirm one co-integrating vector which tells about long-term equilibrium in the data. Granger Causality results showing that M3/GDP is causing economic growth in India f.e., F-test value is coming more than 4 (4.5). Our results support the view that finance is a leading sector in the process of economic development. We find considerable evidence of causality (i.e. causality runs from finance to growth) in India. In other words, Indian financial system follows ''Supply Leading Hypothesis. " The policy of increasing the level of financial deepening will serve as major determinant to the growth rate in India. Therefore, this study concludes that policy measures for infrastructure improvements should be taken into account to make financial sectors more vibrant to invigorate economic growth.