Financial Sector Reforms and Inflation in India : An Empirical Investigation

Authors

DOI:

https://doi.org/10.17010/aijer/2025/v14i4/175047

Keywords:

inflation, financial development, index, India.
JEL Classification Codes : E310, G21, L11
Publication Chronology: Paper Submission Date : May 5, 2025 ; Paper sent back for Revision : November 20, 2025 ; Paper Acceptance Date : November 30, 2025

Abstract

Purpose : The present study examined how inflation affected India’s financial development from 1990 – 2020. Following economic liberalization, India’s financial sector experienced significant expansion. However, this expansion coincided with rising inflation during the same period. This situation raised an important question regarding whether these developments were interrelated and whether they conflicted with the policy framework in the Indian context.

Methodology : The study constructed a multivariate financial development index using principal component analysis (PCA). The autoregressive distributed lag (ARDL) model proposed by Pesaran et al. (2001) was employed to examine the relationship between financial development and inflation.

Findings : The findings revealed a cointegrated relationship among the variables considered in the study. High inflation hindered India’s financial development in both the short run and the long run. Control variables such as human resources and trade openness enhanced financial development in the long run, whereas economic growth remained insignificant. Furthermore, the results indicated that the constructed index served as an effective proxy for financial development, as the variable selection bias was minimized through the application of PCA.

Policy Implications : The study recommended that enhanced capital formation, entrepreneurship, trade flows, and utilization of human resources, along with an improved financial system, promote growth. Therefore, stable inflation was identified as a prerequisite for India to achieve financial development and benefit from it. The policy framework was suggested to focus on reducing market uncertainty and creating an environment that encouraged investors to undertake new investments. Additionally, the study indicated that trade openness and human resources contributed positively to India’s financial development through knowledge transfer, skill development, technological diffusion from foreign countries, and improvements in efficiency, specialization, and educational investment.

Originality : Although the impact of inflation on financial development was found to be negatively skewed, no consensus existed on this issue. Second, most studies suggested that inflation obstructed economic growth indirectly. Third, the majority of existing research inaccurately represented the multidimensional nature of financial development by relying on a single proxy measure. Moreover, studies focusing on developing economies, particularly India, remained limited. The present study addressed and filled this research gap.

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Published

2025-12-15

How to Cite

Manhas, B., Hajam, R. A., & Shahzeb, S. M. (2025). Financial Sector Reforms and Inflation in India : An Empirical Investigation. Arthshastra Indian Journal of Economics & Research, 14(4), 70–84. https://doi.org/10.17010/aijer/2025/v14i4/175047

Issue

Volume 14, Issue 4, October-December 2025

Section

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