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This article examines whether financial development has 'caused' economic growth in India since 1996. The dynamic interactions between the growth of real Gross Domestic Product and indicators of financial development are investigated using the concept of Granger Causality after testing for cointegration using both the Engle-Granger and Johansen techniques. The ADF * test for cointegration proposed by Gregory and Hansen (1996) reveals that there has been both the level shift and regime shift in the specifications relating economic growth and financial development. The empirical results obtained by the Johansen method and ADF * test suggest the existence of a stable long-run relationship between stock market capitalization, bank credit and growth rate of real GDP. The growth rate of real GDP is also found to be cointegrated with financial depth. However, causality runs from the growth rate of real GDP to stock market capitalization. The sector-wise rates of growth of the industrial and services sectors are found to be cointegrated with the stock market development as well as banking sector development and financial depth. The direction of causality for both the sectors runs from the rate of growth to stock market capitalization. We also observe that financial depth causes industrial growth and causality runs in both directions between bank credit and industrial growth. Furthermore, volatility in stock prices is cointegrated with each growth rate-of GDP, of industrial sector output and of the service sector output. The article establishes that, in an overall sense, economic growth has 'caused' financial development in India.

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This article examines the impact of the developments in the financial sector on economic growth in India in the post-reform period. The model of Mankiw et al. (1992) was extended to establish a relationship between financial development and economic growth. The model was then estimated using quarterly data for the period 1993 to 2005 for India, using the techniques of cointegration and vector error correction method. Cointegration results show that capital-output ratio and rate of growth of human capital have positive effects on real rate of growth of GDP, irrespective of the indicator of stock market development. An increase in the market capitalization dampens economic growth, whereas turnover has no significant effect, and an increase in the money market rate of interest has a positive effect on economic growth. Real wealth, debt burden, real effective exchange rate and the rate of growth of labour have negative effects. Vector error correction method shows that the ECM term relating to market capitalization and inflation help adjust short-run dynamics of economic growth when we use market capitalization as the indicator of the stock market development. The findings lend no support to the theoretical prediction that the stock market development would play an important role in enhancing economic growth in India. On the contrary, reform measures on the market rate of interest that were introduced in the Indian banking system appear to have promoted economic growth significantly. JEL: F43, G21, O16