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Financial inclusion and economic growth in India amid demonetization: A case study based on panel cointegration and causality

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  • Singh, Vinay Kumar
  • Ghosh, Sajal

Abstract

Does financial inclusion through opening of bank accounts catalyze economic activity? We use the case study of a large-scale financial inclusion programme in India called Pradhan Mantri Jan Dhan Yojana (PMJDY) to investigate this question. We deploy a panel cointegration and causality framework on a sub-national dataset. Firstly, we establish that financial inclusion and economic activity share a long-term link. The variables move together and are in a long-run equilibrium relationship. Secondly, we find that the relationship between financial inclusion and economic activity experiences structural breaks clustered around the month in which demonetization of Indian currency was announced. Further, our analysis of causality directions shows that in the period before demonetization, an increase in economic activity causes an increase in the use of banking. Post-demonetization, the direction of the causal relationship between economic activity and banking reverses. An increase in banking transactions now causes a positive impact on economic growth. We discuss the likely channels through which causality operates and the possible reasons for reversal in the causality direction. We contend that financial inclusion through access to savings accounts does not impact economic growth in the short-term. Access to an account does not appear to be a sufficient condition. Post account openings, policies to encourage its usage have an important role to play in improving economic activity. To encourage account usage, policy makers could explore introducing incentives for a limited number of initial transactions, develop innovative savings products based on account usage patterns, and also use tax-breaks to encourage employers to pay salaries and wages to the bank account of employees.

Suggested Citation

  • Singh, Vinay Kumar & Ghosh, Sajal, 2021. "Financial inclusion and economic growth in India amid demonetization: A case study based on panel cointegration and causality," Economic Analysis and Policy, Elsevier, vol. 71(C), pages 674-693.
    • Handle: RePEc:eee:ecanpo:v:71:y:2021:i:c:p:674-693
    DOI: 10.1016/j.eap.2021.07.005
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    More about this item

    Keywords

    Financial inclusion; Economic growth; Panel cointegration; Endogenous structural breaks; Panel causality; Demonetization in India;
    All these keywords.

    JEL classification:

    • C5 - Mathematical and Quantitative Methods - - Econometric Modeling
    • D14 - Microeconomics - - Household Behavior - - - Household Saving; Personal Finance
    • E65 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Studies of Particular Policy Episodes
    • G20 - Financial Economics - - Financial Institutions and Services - - - General
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • O16 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment; Corporate Finance and Governance

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