Paradox of external finance in the Indian manufacturing sector

This paper aims to examine how financial development affects the growth of industries that are more dependent on external finance, demystifying the roles played by the banks, stock and bond markets.

The authors apply panel fixed-effects and dynamic panel generalized methods of moments on disaggregated industry-level data of the Indian manufacturing sector for the period of 2001-2015 to examine the relationship between financial development, banking market structure and economic growth.

The study finds that financial development has a significant impact on the growth process by reducing cost of external finance. Among the three sources of finance, the study finds that while the banking sector has been the most preferred source of external finance, increasing concentration and selective disbursement of credit have continued to dent the prospects of the industry. This paradoxical result explains the dismal performance of the Indian manufacturing sector.

The effect of financial development (encompassing banking market structure) on economic growth has received sparing attention. Related literature is unclear regarding the impact of banking market structure on the growth process in the context of emerging economies. The authors attempt to fill this important gap in the literature. Moreover, they add novelty to the literature by calculating the external dependence at the firm level, diverging from using US industry as a proxy for calculation of external dependence.