Does regional financial development matter for growth? Evidence from Indian states

Abstract

The paper investigates finance–growth relationship across 26 Indian states over the period 1981–2012 in a panel setting. We use four indicators of financial development: credit-GSDP ratio, deposit-GSDP ratio, credit-deposit ratio and branch density and apply panel generalized method of moments (GMM) techniques. We observe positive and significant effect of financial development on economic growth and our findings are robust across alternate indicators of financial development and model specifications. Our findings highlight pivotal role played by financial intermediaries in fostering savings mobilization and financing investment activities across states through channels of deposit mobilization, expansion of credit and greater branch expansion in unbanked locations and consequent reduction of transactions costs. These findings are consistent with observations that much of India’s superior growth performance is attributed to high level of domestic savings. The paper also takes care of issues of bias and precision of various GMM estimators arising out of small sample typically prevalent in empirical growth models like ours.