Sustainability of current account deficits in India: an intertemporal perspective

Abstract

This study examines the sustainability of current account deficits (CADs) and the validity of intertemporal budget constraint (IBC) in India. The long-run model is estimated on annual data for the period 1950–1951 to 2009–2010. The optimal single-equation and maximum-likelihood (ML) system estimates of the model provide a consistent support for the long-run relationship between imports and exports. The OLSGH estimates provide no support and that ML system estimates a consistent support for cointegration in both the models estimated with one and two structural breaks in level. The new cointegration breakdown tests generally suggest that the cointegration prevails from 1951 to 2010. The evidence supporting the cointegration between imports and exports overwhelms the evidence providing a mixed or no support for cointegration. The estimates of slope parameter above zero and the dominant support for cointegration between imports and exports vindicate the validity of IBC and the sustainability of CADs. The short-term management strategies need to be accompanied by long-term improvements in productivity to reduce inflation, lever up the competitiveness of exports and ensure the sustainability of the external value of domestic currency.