The Differential Effects of Financial Development on India's Industrial Performance

Abstract

The paper aims to investigate the differential impact of increased financial development on industrial output, across state and industry categories. Using an unbalanced panel of 15 Indian states, 22 industries at the 2-digit level, and an 11-year period spanning 1992- 2002, the paper�s most novel contribution comes from hypothesising and testing for operating channels though which increased financial depth benefits output. It is concluded that financial depth facilitates increased use of contract labour by industries, which in turn mitigates the effects of industrial disputes and increases output. This beneficial impact is uniformly felt across the country, regardless of state-level labour regulations. However, financial depth has failed to directly benefit industries with the greatest need for external financing. Overall, industries benefited through the indirect operating channel of contract labour use, but did not gain anything through the direct operating channel of alleviating financing constraints. The negative effects of the latter outweigh the positive effects of the former, and help explain the sharp deceleration of growth in industries with moderate and high dependence on external finance. Finally, the paper makes the dual case for comprehensive labour reforms and for policies to improve quality of intermediation in Indian financial markets. Show more