Empirical Evidence on Causality between Financial Inclusion and Economic Growth in India Using Vector Error Correction Model

Bhawna Rajput¹ , Anupama Rajput²

1. Department of Commerce, Aditi Mahavidyalaya, University of Delhi, India.
2. Department of Commerce, Janki Devi Memorial College, University of Delhi, India.

Section:Research Paper, Product Type: Journal-Paper
Vol.4 , Issue.1 , pp.28-41, Jan-2018

Online published on Jan 31, 2018

Copyright © Bhawna Rajput, Anupama Rajput . This is an open access article distributed under the Creative Commons Attribution License, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited.
 

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Abstract :
Financial inclusion enhances access of financial services and provides a positive impact on people’s lives particularly poor people. Financial inclusion is an important aspect of inclusive and sustained economic growth. The improved and easy access of formal financial system helps to unlock the economic potential of the population. This paper attempts to examine the status of financial inclusion and the impact of economic growth and other macroeconomic variables on financial inclusion of India using annual time series data of 37 years and covers the period from 1980 to 2016. The study uses Vector Autoregressive (VAR) method consisting Johansen and Juselius multivariate approach of co integration, Vector Error Correction Model (VECM) in combination with innovation of accounting (Impulse Response Function (IRF), and Variance Decomposition (VDC) to provide empirical evidence on short-term and long-term dynamic relationship between financial inclusion and economic growth. Further, the causal relationship between financial inclusion and economic growth in India for the sample period has been analyzed using Granger causality through cointegrated Vector Autoregression methods. The analysis was carried out using multidimensional financial inclusion index based on factors such as access to financial services, penetration of the financial services and the utilization of the services. To capture the effect of the financial reform policy initiated in 1991, the shift dummy variable in 1991 is included in the cointegration test and VECM equation.The results of trace statistics of Johansen cointegrating equation indicate the existence of positive long run equilibrium relationship between economic growth and measure of financial inclusion, inflation and trade openness. In the estimation of VECM, the error correction term indicates that the system corrects its previous disequilibrium at a speed of 22.21 percent p.a. The IRF and VDC analysis shows that financial inclusion has a significant positive impact on economic growth in the long run, meaning that inclusive financial systems leads to higher economic growth. VECM Granger causality results indicate that financial inclusion causes economic growth in India. The causality runs from financial inclusion to economic growth i.e. the supply leading hypothesis is predominant in India. Financial inclusion and institutional financial reforms should be enhanced in order to promote economic growth process in India.

Key-Words / Index Term :
Financial Inclusion, Economic Growth, Vector Autoregressive (VAR) Method, Vector Error Correction Model (VECM), Granger Causality, Phillips-Perron (PP) Test

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