An Analysis of Determinants of Balance of Trade in India

Abstract

In the era of globalization, global macroeconomic crises and the changes in the international trade pattern have accentuated the need for clearer understanding of the factors underlying a country's balance of trade position.  In this onset, this article attempts to examine the role of various determinants like real effective exchange rate, domestic consumption, FDI and foreign income on balance of trade in determining short-and-long-run trade balance behavior for India over the period,1972-73 to 2010-11. More precisely, the aim is to examine whether the trade balance is affected by exchange rates, FDI and household consumption and foreign incomes etc.Several econometric techniques and tools like Augmented Dickey Fuller test, Johansen Cointegration test and VECM , OLS have been used to observe long run as well as short run causality among different macro- economic variables under consideration of our study. The result suggests that long run as well as short run causality existed among different macro economic variables like real effective exchange rate, FDI, domestic consumption and foreign income and foreign direct investment and foreign income have significant positive impact on balance of trade whereas domestic consumption and real effective exchange rate impacted negatively on balance of trade in India.

Keywords: Balance of trade, real effective exchange rate, domestic consumption, FDI, foreign income, India.