Academic journal article Contemporary Economic Policy

Nonlinear Autoregressive Distributed Lag Approach and Bilateral J-Curve: India versus Her Trading Partners

Academic journal article Contemporary Economic Policy

Nonlinear Autoregressive Distributed Lag Approach and Bilateral J-Curve: India versus Her Trading Partners

Article excerpt

The J-curve studies related to India have mostly either used aggregate trade flows of India with the rest of the world or between India and its trading partners. They have all assumed exchange rate changes have symmetric effects on Indian trade balance. In this article, we use partial sum concept combined with the nonlinear auto regressive distributed lag approach of Shin et al. to show that indeed in some instances, there are evidences of asymmetry effects of currency depreciation. This new nonlinear approach provides more support for the J-curve than the previous linear approaches. (JEL F31)

I. INTRODUCTION

In an effort to gain international competitiveness and export more for the purpose of creating jobs at home or generating foreign exchange to finance imports, a country adheres to currency devaluation under fixed exchange rate system or depreciation under flexible exchange rate system. However, there is now abundant evidence that the short-run effects of devaluation or depreciation on net exports or the trade balance could be different than its long-run effects. Indeed, in the short run due to currency contracts and adjustment lags, the trade balance deteriorates first and improves later, hence the J-curve pattern (Magee 1973). (1)

The literature on the J-curve was reviewed by Bahmani-Oskooee and Ratha (2004) and recently by Bahmani-Oskooee and Hegerty (2010) and it appears to be so vast that each country now has its own literature and India is no exception. Studies that have included India in their sample of countries are: Bahmani-Oskooee (1985, 1989, 1991), Bahmani-Oskooee and Alse (1994), Bahmani-Oskooee and Malixi (1992), Buluswar, Thompson, and Upadhyaya (1996), Himarios (1989), Ratha (2010), and Suri and Shome (2013) who have mostly found not much evidence of the J-curve in the short run and no significant relation between the value of rupee and Indian trade balance in the long run. Indeed, findings by some of these studies could be considered to be spurious since they did not account for integrating properties of variables or for cointegrating properties between the variables (e.g., Bahmani-Oskooee and Malixi 1992 and Himarios 1989).

The above studies are said to suffer from aggregation bias because they have used trade flows of India with the rest of the world. Indeed, this was the criticism against U.S.-related studies by Rose and Yellen (1989) who advocated disaggregating the U.S. trade flows by her trading partners and estimating bilateral trade balance models. They not only recommended disaggregation but also introduced a new definition of the J-curve within error-correction and cointegration modeling approach, that is, short-run deterioration combined with long-run improvement. Two studies have followed this path and estimated bilateral trade balance models between India and her major trading partners. The first is by Arora, Bahmani-Oskooee, and Goswami (2003) who considered the bilateral trade balance of India with her seven major trading partners that included Australia, France, Germany, Italy, Japan, the United Kingdom, and the United States. Arora, Bahmani-Oskooee, and Goswami (2003) were able to provide empirical support for the new definition of the J-curve in the trade balance between India and Australia, Germany, Italy, and Japan. The second study is by Dash (2013) who considered India's bilateral trade balances with four partners. The study found evidence of the J-curve in the models of India-Japan and India-Germany but not in the models of India-United States and India-United Kingdom, a result similar to Arora, Bahmani-Oskooee, and Goswami (2003).

A common feature of the above studies is that they have all assumed that the effects of exchange rate changes on India's aggregate or bilateral trade balances are symmetric, that is, if depreciations of the rupee improve the trade balance, appreciations should worsen it. However, as argued by Bahmani-Oskooee and Fariditavana (2015, 2016), since expectation of traders could be different to depreciations as compared to appreciations, they could react differently to depreciations versus appreciations which implies that exchange rate changes could have asymmetric effects on the trade balance not just in direction of change but also in magnitude. …

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