India's 'twin Deficits': Are they Identical Twins or the Warring Cousins

Abstract

This study tests the presence and behavior of the 'twin deficits'-a shorthand term referring to the trade and budget deficits-in India's economy between 1995 and 2010. Although each deficit is thought to have its own unique set of triggers, theoretical analyses and empirical studies have attempted to document and analyze the extent to which, and how, they act as 'twins' (i.e. move together over time). The period of analysis in this study provides an interesting case study because it is fully situated in India's period of 'liberalization,' after a balance of payments (BOP) crisis in the early 1990s catalyzed a set of reforms designed to improve the government and trade budgets. Our approach employs regression models and causality tests to find that while there is evidence of twin deficits in India over the time period in question, the direction of the causal relationship between these deficits stems from the trade deficit to the budget deficit, which is contrary to the direction that standard theory would predict.