Causality between stock market development and economic growth: A case study of India

Whether stock market development causes, or is caused by, economic growth is an unsettled issue. It assumes greater relevance for India given tremendous spurt in stock market activities in the last decade. There is limited time-series econometric evidence that documents the link between stock market developments and the Indian economy. Causality tests in the present study are preceded by cointegration testing which provides a more natural setting for causality studies and inferences. Furthermore, the present study tries to overcome the problems encountered by previous research by constructing and using a composite index of stock market developments. Our findings provide evidence of a stable long run equilibrium relationship between stock market developments and economic growth in India. This study suggests that the policies relating to stock market should be directed towards the creation of transparent and mature stock exchanges in which there will be a preponderance of investors who take a long term view rather than catering only to the needs/whims of speculators and day traders.