Financial development and economic growth: Evidence from States of India

Abstract

This paper examines the relationship between financial development and economic growth using unique panel data from states in India, for a 31 year period. Using instrumental variable technique, this study finds strong positive impact of financial development on growth and this result is robust for alternate specifications. Further, this paper examines the effect of economic reforms and inflation on the finance-growth relationship. Using the post 1991 years as the reform years, the results provide evidence of a positive impact of finance on growth only in the periods after the initiation of economic reforms With regard to inflation; the results provide evidence of a strong positive relation between finance and growth when inflation is low. However, at moderate inflation levels, this relationship between financial development and economic growth declines in magnitude as well as in significance and finally becomes insignificant at high levels of inflation