Financial Markets, Financial Institutions and International Trade Nexus: The Case of India

This study examines the causal links between financial development and international trade for Indian economy, during the time period from 1980 to 2020. Our study utilizes the new measure of financial development constructed by the International Monetary Fund, namely, the broad-based financial development index and its two sub-indices, the financial market development index and the financial institutional development index; encompassing dimensions of financial access, depth and efficiency. Johansen Cointegration, Vector Error Correction model, and Vector Auto-Regressive model are estimated to examine the nature of long run relationship and short run dynamics among these variables. Econometric results indicate the existence of cointegration between the broad-based index of financial development and trade openness. Cointegration is also found to exist between trade openness and financial market development index. However, there is no evidence of cointegration between financial institutional development index and trade openness. Granger causality test results point towards the presence of uni-directional causality running from the composite index of financial development to trade openness. Financial market development is also found to Granger cause trade openness. Empirical evidence thus underlines the importance of formulating policies that recognize the role of well-developed financial markets in accelerating trade openness of Indian economy.