INDIAN ECONOMY. Empirical Analysis on Monetary and Financial Issues in India. Indian Economy Downloaded from

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1 INDIAN ECONOMY Empirical Analysis on Monetary and Financial Issues in India

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3 INDIAN ECONOMY Empirical Analysis on Monetary and Financial Issues in India Takeshi Inoue Nanzan University, Japan Shigeyuki Hamori Kobe University, Japan World Scientific NEW JERSEY LONDON SINGAPORE BEIJING SHANGHAI HONG KONG TAIPEI CHENNAI

4 Published by World Scientific Publishing Co. Pte. Ltd. 5 Toh Tuck Link, Singapore USA office: 27 Warren Street, Suite , Hackensack, NJ UK office: 57 Shelton Street, Covent Garden, London WC2H 9HE Library of Congress Cataloging-in-Publication Data Inoue, Takeshi, 1973 Indian economy : empirical analysis on monetary and financial issues in India / by Inoue Takeshi & Shigeyuki Hamori. pages cm Includes bibliographical references and index. ISBN Monetary policy--india. 2. Finance--India. 3. Economic development--india. I. Hamori, Shigeyuki, 1959 II. Title. HG1235.I dc British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library. Copyright 2015 by World Scientific Publishing Co. Pte. Ltd. All rights reserved. This book, or parts thereof, may not be reproduced in any form or by any means, electronic or mechanical, including photocopying, recording or any information storage and retrieval system now known or to be invented, without written permission from the publisher. For photocopying of material in this volume, please pay a copying fee through the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, USA. In this case permission to photocopy is not required from the publisher. In-House Editors: Lum Pui Yee/Dipasri Sardar Typeset by Stallion Press enquiries@stallionpress.com Printed in Singapore

5 To Tadashi, Chieko, Sumiko, and Hideo To Hitoshi, Makoto, and Naoko

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7 Contents About the Authors List of Figures List of Tables List of Abbreviations List of First Appearances xi xiii xv xvii xix Introduction 1 Part 1 Monetary Policy in India 7 Chapter 1. An EmpiricalAnalysis of the Money Demand Function in India Introduction Literature Review Models Data Empirical Results Monthly data Annual data Concluding Remarks References Chapter 2. Financial Variables as Policy Indicators: Empirical Evidence from India Introduction Literature Review vii

8 viii Contents 2.3 Empirical Technique Data Empirical Results Concluding Remarks References Chapter 3. Is India Ready to Adopt a Policy Framework Targeting Inflation? Introduction Literature Review Models Data Empirical Techniques Empirical Results Simple Taylor rule Open economy Taylor rule Concluding Remarks References Part 2 Financial Markets in India 51 Chapter 4. Causal Relationships in Mean and Variance between Stock Returns and Foreign Institutional Investment in India Introduction Literature Review Empirical Technique Data Empirical Results Causality test based on the LA-VAR Causality test based on the CCF approach Concluding Remarks References... 72

9 Contents ix Chapter 5. Market Efficiency of Commodity Futures in India Introduction Literature Review Model Empirical Techniques Data Empirical Results Full-sample analysis Sub-sample analysis Concluding Remarks References Chapter 6. What are the Sources of Real and Nominal Exchange Rate Fluctuations? Evidence from SVAR Analysis for India Introduction Data Empirical Technique Empirical Results Results for India and the United States Results for India and the euro area Concluding Remarks References Part 3 Financial Development and Poverty Alleviation in India 99 Chapter 7. How Has Financial Deepening Affected Poverty Reduction in India? Introduction Literature Review Data Models Empirical Results

10 x Contents Results for the whole country Results for the urban areas Results for the rural areas Summary Concluding Remarks References Chapter 8. Financial Inclusion and Poverty Alleviation in India Introduction A History of Financial Inclusion in India Financial Inclusion and Poverty Conditions Literature Review Models and Data Empirical Results Concluding Remarks References Chapter 9. Concluding Remarks: Monetary Policy and Financial Sector for Sustainable Economic Growth and Poverty Reduction 147 Index 153

11 About the Authors Takeshi INOUE is an Associate Professor of Policy Studies at Nanzan University in Japan. He received his PhD from Kobe University. He previously worked as Research Fellow at Institute of Developing Economies (IDE-JETRO). His research interests include empirical analysis of Indian macroeconomy and finance-poverty nexus in developing countries. Shigeyuki HAMORI is a Professor of Economics at Kobe University in Japan. He received his PhD from Duke University and has published many papers in refereed journals. He is the author or co-author of An Empirical Investigation of Stock Markets: the CCF Approach (Kluwer Academic Publishers, 2003), Hidden Markov Models: Applications to Financial Economics (Springer, 2004), Empirical Techniques in Finance (Springer, 2005), and Introduction of the Euro and the Monetary Policy of the European Central Bank (World Scientific, 2009). He is also the co-editor of Global Linkages and Economic Rebalancing in East Asia (World Scientific, 2013) and Financial Globalization and Regionalism in East Asia (Routledge, 2014). xi

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13 List of Figures 3.1 Output Gap Cumulative Net FII and Stock Price Index Cumulative Net FII and Stock Price Index in Real Terms Total Value of Commodities and Stocks in India (Rs. Billion) The Movements of Commodity Price Indices The Movements of the Effective Exchange Rates Population Group-wise Distribution of Commercial Bank Branches (Number) Population Group-wise Distribution of Credit Accounts (Accounts in Thousands) Population Group-wise Distribution of Deposit Accounts (Accounts in Thousands) Population Group-wise Distribution of Percentage of Population below the Poverty Line (% of Persons) xiii

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15 List of Tables 1.1 Cointegration Tests (M1, Monthly Data) DOLS (M1, Monthly Data, Model 1) DOLS (M1, Monthly Data, Model 2) Cointegration Tests (M2, Monthly Data) DOLS (M2, Monthly Data, Model 1) DOLS (M2, Monthly Data, Model 2) Cointegration Tests (M3, Monthly Data) Cointegration Tests (M1, Annual Data) DOLS (M1, Annual Data, Model 1) DOLS (M1, Annual Data, Model 2) Cointegration Tests (M2, Annual Data) DOLS (M2, Annual Data, Model 1) DOLS (M2, Annual Data, Model 2) Cointegration Tests (M3, Annual Data) Causality During the MIA Period (April 1998 to June 2009) Causality During the Monetary Targeting Period (April 1985 to March 1998) Causality During the MIA Period (April 1998 to June 2009) Causality During the Monetary Targeting Period (April 1985 to March 1998) Cointegration Tests (Simple Taylor Rule) Cointegrating Regression (Simple Taylor Rule) Cointegration Tests (Open Economy Taylor Rule) xv

16 xvi List of Tables 3.4 Cointegrating Regression (Open Economy Taylor Rule) Causality from LA-VAR (d max = 1) Causality from LA-VAR (d max = 2) Empirical Results of the AR-EGARCH Model (January 1, 1999 to April 30, 2003) Empirical Results of the AR-EGARCH Model (May 1, 2003 to March 31, 2008) Causality in the Mean between FII Flows and Stock Returns Causality in the Variance between FII Flows and Stock Returns Unit Root Tests Cointegration Tests Cointegration Estimation Results (Full-sample Analysis) Cointegration Estimation Results (Sub-sample Analysis) Forecast Error Variance Decomposition (India and the United States) Forecast Error Variance Decomposition (India and the Euro Area) Summary of Literature on the Finance- Poverty Nexus Definition and Sources of Each Variable Financial Deepening and Poverty: Whole Country Financial Deepening and Poverty: Urban Areas Financial Deepening and Poverty: Rural Areas Summary of Empirical Results Number of Indebted Households (Number in Lakhs) Outstanding Household Debt (Amount in Rs. Crores) Definition and Sources of Each Variable Empirical Results

17 List of Abbreviations ADF AIC AIDIS AR-EGARCH BSE CCF CRR DOLS EGARCH FII FMC FMOLS GARCH GDP GMM GOI IMF IPI KCCs LAF LA-VAR MCX MIA MOCAFPD augmented Dickey Fuller Akaike Information Criterion All India Debt and Investment Survey AR-exponential GARCH Bombay Stock Exchange cross-correlation function cash reserve ratio dynamic OLS exponential GARCH foreign institutional investment Forward Markets Commission fully modified OLS Generalized Autoregressive Conditional Heteroscedasticity gross domestic product generalized method of moments Government of India International Monetary Fund industrial production index Kisan Credit Cards liquidity adjustment facility lag-augmented vector autoregression Multi Commodity Exchange of India multiple indicator approach Ministry of Consumer Affairs, Food and Public Distribution xvii

18 xviii List of Abbreviations MOSPI MSF NCDEX NEER NSDP NSSO OLS RBI REER RRB(s) SBIC SBLP SEBI SLR SVAR VAR VMA WPI Ministry of Statistics and Programme Implementation marginal standing facility National Commodity and Derivatives Exchange nominal effective exchange rate Net State Domestic Product National Sample Survey Organization ordinary least squares Reserve Bank of India real effective exchange rate Regional Rural Bank(s) Schwarz Bayesian Information Criterion Self-Help Group (SHG)-Bank Linkage Program Securities and Exchange Board of India statutory liquidity ratio structural vector autoregression vector autoregression vector moving average wholesale price index

19 List of First Appearances Chapter 1 Inoue, T., Hamori, S., An empirical analysis of the money demand function in India. Economics Bulletin 29(2), Chapter 4 Inoue, T., The causal relationships in mean and variance between stock returns and foreign institutional investment in India. Margin: The Journal of Applied Economic Research 3(4), (Originally published in Margin The Journal of Applied Economic Research, Vol. 3, No. 4. Copyright 2009 National Council of Applied Economic Research, New Delhi. All rights reserved. Reproduced with the permission of the copyright holders and the publishers, SAGE Publications India Pvt. Ltd, New Delhi.) Chapter 5 Inoue, T., Hamori, S., Market efficiency of commodity futures in India. Applied Economics Letters 21(8), (Reprinted by permission of the publisher (Taylor & Francis Ltd, Chapter 6 Inoue, T., Hamori, S., What explains real and nominal exchange rate fluctuations?: Evidence from SVAR analysis for India. Economics Bulletin 29(4), xix

20 xx List of First Appearances Chapter 7 Inoue, T., Hamori, S., How has financial deepening affected poverty reduction in India? Applied Financial Economics 22(5), (Reprinted by permission of the publisher (Taylor & Francis Ltd, Chapter 8 Inoue, T., Financial inclusion and poverty alleviation in India: An empirical analysis using state-wise data, in: Hirashima, S., Oda, H., Tsujita, Y. (Eds.), Inclusiveness in India: A Strategy for Growth and Equality. Palgrave Macmillan, Basingstoke and NewYork, pp