Research Paper

Optimal Financial Structure and Growth: The Indian Perspective

Pradeepta Sethi(, Brajesh Kumar(

Abstract

Financial structure, an assortment of financial markets, intermediaries and banks, varies over time and across countries. An efficient and well-developed financial structure usually fosters long-run economic growth. This paper builds on the above concept of ‘Optimal Financial Structure’ and examines its association with economic development in the Indian context. Specifically, the present paper intends to: (1) examine the evolving importance of banks and markets during the process of economic development in India; (2) evaluate the sensitivities of economic development towards increases in banks and stock markets development; (3) calculate the optimal financial structure for India and its dynamics with economic development; and (4) assess the impact of deviation from the optimal financial structure on the economic growth.

Using quantile regression, the study finds that the services provided by banks are comparatively more important than those provided by the stock markets in the economic growth process of India during the 1989-2009 periods. The results from the robust regression suggest that the financial structure gap has retarded the growth process, and deviation from the optimal structure has harmful effects on the economy. We observe mismatch between the industrial structure and financial structure which can hold the financial system from performing efficiently. The study result is consistent with the view that as economy grow they require different blend of financial services to operate efficiently.

JEL Classifications: O16; G18; G28

Keywords: Financial development, Financial Structure, Economic growth, Principal component analysis, Quantile regression, Robust regression

I. Introduction

Periodic occurrence of financial crisis has once again brought the finance-growth debate to the forefront of academicians, researchers

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