Analyzing the Dynamic Relationship between Physical Infrastructure, Financial Development and Economic Growth in India

The paper investigates dynamic relationship between physical infrastructure, financial development and economic growth in the case of India, using an Autoregressive Distributed Lag (ARDL) and Toda-Yamamoto (T-Y) causality approach for the period 1980 to 2016. Physical infrastructure index and financial development index are constructed using Principal Component Analysis method. Empirical results suggest that physical infrastructure has a positive effect on economic growth both in the long-run and short-run, whereas financial development, though significant, has a weak impact on economic growth. The causality test supports a bi-directional causal relationship between infrastructure development and economic growth, while it finds a unidirectional causation running from economic growth to financial development. It also finds that gross investment and employment have a positive, and inflation has an adverse effect on economic growth. As India is aiming for higher growth for a sustained period, our results suggest that there is a need for Government intervention in expanding the physical infrastructure and this, in turn, could lead to the growth of the financial sector in the country.