Impact of Inflation on Financial Development: Evidence from India

Abstract

Financial development is considered an important driver of economic growth, but high level of inflation impedes the ability of the financial sector to allocate resources effectively. This paper examines the impact of inflation on financial development in Indian economy for the period of 1970-2012. To test for stationarity, the study uses Ng- Perron unit root tests. The long- and short-run dynamics are obtained by using auto-regressive distributed lag (ARDL) approach to co-integration and Granger causality is used to examine the direction of the causal link among the variables. The empirical evidence indicates that there is a significant, and negative relationship between inflation and both banking sector development indicator both in the short and long run. The empirical findings reveal that high trends of inflation impede the performance of financial markets. The degree of trade openness promotes development of the financial sector.