Do terms of trade affect economic growth? Robust evidence from India

Abstract

This study extends the previous empirics and conducts a comprehensive analysis of the effects of terms of trade (TOT) on economic growth in the large and emerging market economy, India, which experienced tremendous transformation from a persistently low-growth economy in the 1950s–1970s to a moderate-growth economy in the 1980s and then to a high-growth economy, following the onset of inclusive economic reforms from the beginning 1990s. The TOT remained unfavourable during the 1950s, witnessed boom during the mid-1960s to the mid-1970s, showed sharp downturn during the mid-1970s to the mid-1980s, and then displayed deteriorations again from the late 1990s to 2017–2018. The model estimated in one-regime setting with no structural break and in a sample-split setting with multiple structural breaks—over both “long” and “short” time periods—supports the presence of cointegration among variables and suggests the positive and significant long-run effects of TOT on economic growth. The diversification of trade, the continual improvements in the quality of export products, and the development of high value-added industries are essentially crucial to induce long-term improvements in TOT. The improvements in TOT need to be accompanied by the development of financial sector, expansion of external trade, and acceleration of domestic investment.