TESTING THE CAUSALITY AND COINTEGRATION BETWEEN EXPORTS, IMPORTS, AND EXCHANGE RATES: EVIDENCE FROM INDIA

Abstract

The aim of this paper is to investigate the dynamic causality and cointegration between the exports, imports, and the USD exchange rate in India. The quarterly time series data from 2002:Q1 to 2018:Q3 are used. Stationarity of the variables are diagnosed using the Ng-Perron unit root test, and the long-run equilibrium relationship vetween the variables is tested using the Johansen’s cointegration test. In addition, the direction of causality and the short and long-run relationships between the variables are investigated using the Vector Error Correction Model (VECM). The findings indicate the existence of a long-run cointegrating relationship between the exports, imports, and the USD exchange rate. In the long-run, exchange rate is positively related to the exports and negatively related to the imports. The VECM results suggest that there are unidirectional Granger causalities running from exchange rate to exports and from exchange rate to imports. In addition, there is a feedback relationship between exports and imports. The existence of cointegration suggests that the macroeconomic policies have been effective in bringing exports and imports in long-run equilibrium, and thus, India is not in violation of her international budget constraint. These findings may have important implications for decision-making by national policymakers.

Keywords

• Exchange Rate
• Export
• Import
• Granger Causality
• International Budget Constraints