The Differential Effects of Financial Development on India’s Industrial Performance

The paper aims to investigate the differential impact of increased financial development on
industrial output, across state and industry categories. Using an unbalanced panel of 15
Indian states, 22 industries at the 2-digit level, and an 11-year period spanning 1992-2002,
the paper’s most novel contribution comes from hypothesising and testing for operating
channels though which increased financial depth benefits output. It is concluded that
financial depth facilitates increased use of contract labour by industries, which in turn
mitigates the effects of industrial disputes and increases output. This beneficial impact is
uniformly felt across the country, regardless of state-level labour regulations. However,
financial depth has failed to directly benefit industries with the greatest need for external
financing, i.e. those with moderate and high dependence on external sources of finance.
Overall, increased financial depth alleviated the working capital constraints of firms, but not
their investment constraints. The negative effects of the latter outweigh the positive effects of
the former, and help explain the sharp deceleration of growth across industries categories.
Finally, the paper makes the dual case for comprehensive labour reforms and for policies to
improve quality of intermediation in Indian financial markets.