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

Vinay Kumar Singh and Sajal Ghosh

Economic Analysis and Policy, 2021, vol. 71, issue C, 674-693

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.

Keywords: Financial inclusion; Economic growth; Panel cointegration; Endogenous structural breaks; Panel causality; Demonetization in India (search for similar items in EconPapers)
JEL-codes: C5 D14 E65 G20 G21 O16 (search for similar items in EconPapers)
Date: 2021
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (9)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecanpo:v:71:y:2021:i:c:p:674-693

DOI: 10.1016/j.eap.2021.07.005

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