ARDL Co-Integration Approach to the External and Internal Sector Equilibrium of India

The disequilibrium in the Indian economy as reflected by the growing deficits of the Central government of India both on the internal as well as external fronts have been the cause for concern over the last couple of decades. Such an unwarranted trend not only poses a challenge to the policy makers but also most importantly destabilizes the economy internally as well as externally. Thus, if India's objective is to achieve higher sable growth (which it is already achieving), the issue of both the government deficits and trade deficits must be addressed considerably and appropriate policy decisions need to be undertaken before it goes out of hand. The purpose of this study was to examine the v alidity of the Keynesian and the Ricardian views regarding the impact of GFD (as a measure of budget deficit) on the TD (or current account deficit) for India from 1971 to 2010. In order to examine the relationship between budget deficit and current account deficit in India, this stu dy used the ARDL model and a new co-integration test called the bounds test to estimate the long-run dynamics between budget deficit and current account deficit. The empirical results support the Keynesian view that there is a strong linkage between budget deficit and the current account deficit in the case of India during the study period. It also shows that the direction of causality is unidirectional running from budget deficit to current account deficit. Thus, a higher budget deficit leads to a higher current account deficit. Therefore, the empirical results in this study suggest that any policy measures to reduce the budget deficit could assist in reducing the current account deficit in India.