A Note on the Link between Regional Market Integration and Financial Development in Rural India

Abstract: Promoting financial development has been a long-prevailing goal for Indian policymakers. However, across the Indian regions, significant variation in the level of financial development is observed. By understanding the factors underlying this variation in financial development, policymakers will be better equipped to design policies that promote development of the financial system. The purpose of this Master's thesis is to contribute to our understanding of the factors underlying the regional variation in financial development in rural India. Theories of economics of trade and the historical-empirical evidence of Indian financial market development suggest that the level of market integration can be an important factor in determining the level of financial development. In this study, the hypothesis that higher market integration leads to higher financial development is tested. The results suggest a negative empirical relationship between regional market integration, measured by the average regional share of non-homegrown consumption in total consumption, and the marginal interest rate a household pays on its loans (an inverse measure of financial development). This is consistent with higher market integration leading to higher financial development.