Objective: The study attempts to show the causality between ‘economic development’ and ‘financial development’ in India considering ‘demand-following’ and ‘supply-leading’ approaches along with ‘structuralist’ and ‘repressions’ views on financial development.
Methods/ Statistical Analysis: To examine the interlink between financial development and economic development in India, from 1990-91 (when the financial sector started liberalization process on larger scale) to 2014-15 is chosen. Technique of correlation and regression analysis are used to examine the interlink and the causality between both variables. We have used two regression equations for testing our data viz. GDP = a + b TFC highlights on supply-leading approach and TFC = a + b GDP highlights on demand-following approach.
Findings: From our data, we estimate the correlation coefficient between GDP (economic development) and TFC (financial development) is very high, indicating that both economic development and financial development go hand in hand. This show that there is an interlink between both. From our regression analysis, we examined two approaches (Supply-leading Approach and Demand-following Approach) and how change in GDP brings change in TFC. We can see that causality works both the ways i.e. financial development to economic development and vice versa. But the causality from economic development to financial development is more dominant than the other way. It also implies that the influence of supply-leading approach is more dominant than demand-following approach in India. This study’s humble attempt is to show that both approaches have equal role to play in economic development, unlike other studies where they have stressed on importance of any one approach. At the same time, this study also shows the direction of causality from economic development to financial development is more dominant. The direction of causality in other studies was generally shown from financial development to economic development.
Application/ Improvements: To achieve rapid balanced and sustained rate of economic development, efforts are directed towards the creation of condition for a faster development of productive resources. Equal improvement is required about knowledge (financial literacy) to access finance or financial schemes provided by financial institutions.