The Dynamic Linkage between Financial Depth, Economic Growth and Savings in India

Nayak, J M and Rath, Badri Narayan (2014) The Dynamic Linkage between Financial Depth, Economic Growth and Savings in India. Masters thesis, Indian Institute of Technology, Hyderabad.

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Abstract

The importance of the relationship between economic growth and financial depth has been well recognized and received serious attention in the literature. The theoretical and empirical studies although substantially advanced in this area but they provide ambiguity on the direction among this relationship. The ambiguity arises primarily because of missing control variables like savings, investment, and trade openness are so far missing in the literature. By keeping the omission of control variable problem, present study examines empirical relationship between financial development and economic growth by taking saving as a control variable. It is new for Indian case because none of the earlier studies taken into consideration of the role of total saving as well as private saving. The study examines the long-run relationship among these variables by employing cointegration and error-correction techniques. The result indicates the existence of long-run cointegrating relationship between financial development, economic growth and savings. The short-run causality results reveals that economic growth Granger causes financial development as well as financial depth but there is no causal flow from financial development and financial depth to economic growth. Economic growth Granger causes the savings but the savings does not cause economic growth. Unidirectional causal flow from financial development to total savings and from financial development to private savings, but the reverse is not happening in Indian context. Hence the aforementioned results from both cointegration and VEC models conclude that though there exists a long-run relationship between financial depth, economic growth and savings, but in the short-run, we did not find any bi-directional causality among these variables. This finding indicates that even if the savings (particularly the household savings) has increased in India, people are still following the traditional patterns of savings rather than opening any account in the bank or putting their savings in the capital markets. Therefore, reform plan should have the aim of constructing new institutions both in private and public sector.

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