  This study investigates whether a uni-directional or bi-directional causal
relationship exists between financial development and international trade for
Indian economy, during the time period from 1980 to 2019. The empirical
analysis utilizes three measures of financial development created by IMF,
namely, financial institutional development index, financial market development
index and a composite index of financial development, encompassing dimensions
of financial access, depth and efficiency. Johansen cointegration, vector error
correction model and vector auto regressive model are estimated to examine the
long run relationship and short run dynamics among the variables of interest.
The econometric results indicate that there is indeed a long run causal
relationship between the composite index of financial development and trade
openness. Cointegration is also found to exist between trade openness and index
of financial market development. However, there is no evidence of cointegration
between financial institutional development and trade openness. Granger
causality test results indicate the presence of uni-directional causality
running from composite index of financial development to trade openness.
Financial market development is also found to Granger cause trade openness. In
contrast, trade openness is found to promote financial institutional
development in the short run. Empirical evidence thus underlines the importance
of formulating policies which recognize the role of well-developed financial
markets in accelerating international trade of Indian economy.
