The Dynamics of Cointegration Between Economic Growth and Financial Development in Emerging Asian Economy: Evidence from India

Abstract

The present article examines the relationship between economic growth and financial development in the context of Indian economy over the period of 15 years from June 2003 to February 2018. The study employs cointegration test, involving Johansen Juselius Cointegration and autoregressive distributed lag (ARDL) Bounds test approach to ascertain the long-run relationship between financial development and economic growth. The study further employs fully modified ordinary least squares—OLS—(FMOLS), dynamic OLS (DOLS) and canonical cointegration regression (CCR) models to ascertain the sensitivity and robustness of the estimates derived from ARDL Bounds test approach. The stability of the models employed in the study are further confirmed by rolling window analysis and the cumulative sum (CUSUM) and cumulative sum of squares (CUSUMSQ) tests. The outcome of the article reports the existence of long-run equilibrium relationship between economic growth represented by Index of Industrial Production and Financial Development represented by the Bombay Stock Exchange (BSE) Index and BSE Volume of Trade. The article also involves consumer price index as proxy for inflation, exchange rate, ratio of export to import and weighted average call rate as control variable to also examine their impact on the Indian economic growth. The study confirms the existence of Supply Leading Hypothesis, that is, existence of unidirectional causality running from financial development to economic growth in the Indian economic scenario. The outcome of the article indicates the positive and significant influence of development of financial markets represented by stock market on the economic growth.