Intertemporal budget constraint and current account sustainability: Evidence from a large emerging economy

Abstract

This paper examines the sustainability of the current account deficit (CAD) and validity of the intertemporal budget constraint of India for the period of 1980 to 2019. The cointegration results show that exports and imports are not cointegrated and the current account (CA) series is not mean reverting during the study period. Therefore, the results refute the sustainability of CAD and the validity of the intertemporal budget constraint in the Indian context. Furthermore, the study also emphasised the testing of the disaggregated CA and found that while the goods account is not sustainable, the services account found to be sustainable in the long run. Our findings thus indicate the potential for aggregation bias to have an impact on the overall CA sustainability results. Therefore, policies that help in achieving self‐sufficiency on the one hand and export promotion in goods on the other may eventually contribute to CA sustainability.