Testing the Stability of India’s Import Demand Function: A Cointegration Approach

The persistent current account deficit leads to a loss of opportunity of industrialisation, resulting in a loss of jobs and foreign exchange. Since the opening up of the Indian economy to international trade, the current account has been in deficit for the maximum time period. Given this scenario, the present study examines India’s import demand function in order to infer the dynamics of domestic shocks in the external sector and determine if this deficit leads to long-run violations of budget constraints. In this context, the present study has used quarterly data from 1996Q1 to 2019Q2 and applied multivariate cointegration and error correction models. From the results, the import demand function appears stable in the long run as there is an equilibrating relation between imports and their determinants, which indicates that the country is not violating its international budget constraint in the long run. The current account deficit is due to poor export performance and a lack of domestic import substitutes. Further, the error correction mechanism (ECM) results conclude that macroeconomic policy frameworks are ineffective for ensuring equilibrium in the short run. JEL Codes: F14, F19