Financial sector development, Foreign direct investment and economic growth in India: An empirical analysis

The paper examines the causal relationship between Financial Sector Development, Foreign Direct Investment and Economic Growth in India during the period 1996–2014, the period where major changes have taken place in the Indian Financial System, in the magnitude of FDI coming to India and its economic growth. Using Granger Causality test based on unrestricted vector auto regression (VAR), we found support for “demand-leading” hypothesis of relationship between financial sector development and economic growth. Our results also lend support to FDI led Growth hypothesis in context of India. Among the financial development and foreign direct investment, result reveals that while inward FDI causes banking sector development (ratio of total bank deposit liabilities), improvement in stock market capitalization may lead to larger inflows of foreign investment.