The Concurrent Effect of Financial Development and Trade Openness on Private Investment in India

Abstract

This article examines the role of financial development and trade openness in promoting private investment in India. We use data (1960– 2013) from the World Development Indicators database. After checking the time series properties of the data, we employ auto-regressive distributed lag (ARDL) estimation technique to investigate the impact of the concurrent existence of financial development and trade openness on private investment and whether the effect of financial development is dependent on the level of openness. The results show that, independently, financial development and trade openness have significant positive effects on India’s private sector investment, in both the long run and the short run. However, the effect of the interaction between financial development and trade openness on private investment is significantly negative, suggesting that the effect of financial development on private investment depends on the level of openness. Therefore, we conclude that care should be taken in the design of policies that allow for the coexistence of financial development and trade openness if India aims at promoting private sector capital formation for job creation. JEL Classification: E22, E44, F10, F60