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This paper is an attempt to re-examine the validity of the Twin Deficit Hypothesis in the Indian economy, which is characterised by mounting inequality and liquidity constraints. The authors augment the econometric analysis with two important mediating variables, exchange rate and trade openness, to analyse their impact on current account deficit.

The authors have used a ground-breaking asymmetric cointegration technique proposed by Shin et al. (2014) to investigate the short-run and long-run asymmetric nexus between gross fiscal deficit and current account deficit. In addition, the study has used asymmetric dynamic multipliers to see the dynamics of nonlinear adjustment from disequilibrium in the short run to equilibrium in the long run. The study has also used generalised impulse response functions to check the robustness of our cointegration results.

Using annual time series data from 1970 to 2018, the empirical exercise validates the presence of asymmetries in the Twin Deficit Hypothesis for the Indian economy. This study's robust findings demonstrate that the two deficits are asymmetrically related in the long run. The authors also found that exchange rate asymmetrically affects current account deficit thus validating the asymmetric J-curve phenomenon. From the causality analysis, the authors infer that there is a weak unidirectional causality running from fiscal deficit to current account deficit.

Fiscal deficit may cause current account deficit via changes in other macroeconomic variables that were not taken care of in this study. Therefore, the estimation techniques used in the present study might suffer from the issue of omitted-variable bias. Further research should include other macroeconomic variables where the twin deficit nexus is also influenced by other relevant variables. This will help in disentangling the indirect transmissions by which fiscal deficit translates into current account deficit.

The results from our econometric exercise strongly suggest that the twin deficits are asymmetrically related. From a policy perspective, the asymmetric twin deficit nexus offers strong policy implications for the development of policies that are flexible enough to respond to shifts in internal and external sector dynamics. While framing the mechanism of fiscal prudence, policymakers in emerging countries like India must take into account the regime-changing behaviour of twin deficits.

The present paper is a significant contribution to the existing body of literature by being the first study in India which has analysed the Twin Deficits phenomenon in a nonlinear framework with the incorporation of asymmetric exchange rate dynamics in the model.

This study attempts to examine the twin deficits hypothesis for Bangladesh. Along with the traditional twin deficits hypothesis associated with the current account and fiscal deficit, the paper also explores the causal relationship between the trade deficit and fiscal deficit.

We start with the investigation of the conventional twin deficit hypothesis employing autoregressive distributed lag (ARDL) bounds testing approach in a multivariate framework. Due to the absence of cointegration between the budget deficit and trade deficit, the study adopts a multivariate vector autoregressive (VAR) model to analyze the nexus.

The study supports the presence of the twin deficits hypothesis in Bangladesh, both in the short run and long run. Unidirectional causation running from the budget deficit to the current account deficit in the long run. The trade model also supports the twin deficit hypothesis, like the aforementioned current account model.

Therefore, the sustainable fiscal deficit is the key to maintain a stable current account deficit and trade deficit in Bangladesh.

The study incorporates the country risk indicators to address the governance issue while analyzing the models' deficit scenarios because good governance is an integral part of explaining the development outcome and failure of a country like Bangladesh.

This study aims to examine the impact of fiscal deficit, exchange rate and trade openness on current account deficit (CAD). The study tried to empirically investigate the ‘twin deficits hypothesis’ and ‘compensation hypothesis’ in the Indian context.

Autoregressive distributed lagARDL) bound test approach was used by taking annual time series data from 1978 to 2021. The estimates confirm a significant long-run and short-run relationship between dependent variables, i.e. CAD and independent variables such as the fiscal deficit, exchange rate and trade openness.

The results show that positive shocks of all explanatory variables significantly affect the CAD. CAD and fiscal deficit are significantly associated, as the coefficient of fiscal deficit is positive and significant. The study also found that exchange rate and trade openness significantly affect the CAD. The coefficients of exchange rate and trade openness are positive and significant. The findings show that an increase in CADs results from liberal trade policies that help domestic industries grow their trade and expansionary fiscal policy, leading to a higher fiscal deficit. The negative and significant error correction term suggests that short-run disequilibrium converges to long-run equilibrium at a speed of 19.2%. The findings validate the ‘twin deficits hypothesis’ and ‘compensation hypothesis’ in the Indian context.

It can be inferred from the study that liberal policy to promote economic growth and trade openness should be designed and promoted judiciously. An excessive liberalised approach may impact other macroeconomic variables such as current account balances. Integrating the domestic market with global markets poses a big challenge for countries like India that aspire to penetrate global markets. Furthermore, the Indian policy makers should rigorously work and promote the policies such as Fiscal Responsibility and Budget Management (FRBM) as reduction in fiscal deficits, trade imbalances will also be reduced.

This study contributes to the existing literature on ‘twin deficit’ and trade openness by giving new evidence on the trilemma between designing sustainable fiscal policy by spending wisely without imperilling the country's global presence and CAD.

This paper aims to scrutinize the asymmetric interactions between current account deficit and gross fiscal deficit in case of a growing and dynamically integrated economy, namely, India featured with high inequality and liquidity constraints. Two additional variables, trade-openness and output growth, are also incorporated into the analysis to assess their likely impact on the current account balance.

The study uses a recently developed non-linear autoregressive distributed lag model given by Shin et al. (2014) in its empirical examination. In addition, non-linear cumulative dynamic multipliers are used to understand the route between disequilibrium position of short-run and subsequent long-run equilibrium of the system.

The study confirms the long-run co-movements of current account deficit and gross fiscal deficit and therefore refutes the Ricardian Equivalence proposition and validates the twin-deficit hypothesis. But instead of a linear relationship of the kind examined in the previous studies, the two variables share asymmetric linkages – both in the short run and in the long run. The asymmetry indicates that positive changes are more influential than their negative counterparts in the short run, whereas in the long run, only the positive changes are found to alter the external balance statistically. The asymmetric impact of fiscal deficits on the current account balance of a country may arise due to its asymmetric impact on aggregate demand through consumption inflexibility (ratchet effect) and the existence of liquidity constraints. The other control variables used in the study are also found to have cointegration with the current account deficit, but the relationship is symmetrical in the long run, even though it is asymmetrical in the short run. The study finally uses the asymmetric cumulative dynamic multipliers to examine the route of asymmetries and adjustments over the course of time. The dynamic multipliers also confirm the results documented in the earlier part and therefore demonstrate their robustness.

The asymmetric results obtained in the study provide strong grounds to devise the policies adaptive to changing arenas in domestic and external sectors. Output growth, export promotion and import substitution, increasing integration and fiscal austerity are seen as helpful in achieving a desired (and growth conducive) external balance together with macroeconomic stability. The need for a prudent fiscal policy and avoidance of profligacy is indicated based on the asymmetric results to ward off any unfavorable impact of fiscal deficits on external account. To conduct a sound fiscal policy, the government needs to cut down unproductive consumption expenditure, raise tax revenues and should pay attention to distribution and trickle-down effects to avoid the adversity of high inequality and liquidity constraints in the economy. Moreover, to ameliorate the current account balance, policies aimed at increasing the real competitiveness through control of domestic price fluctuations and improvement in the quality of tradable goods and services (such as productive investments and technological advancements) should be adopted.

Work reported in the present paper is motivated by the fact that there is no study conducted so far in the Indian context which has analyzed the two deficits in a nonlinear framework. The authors have used a well-articulated nonlinear asymmetric technique to examine the relationship between two deficits when asymmetry is incorporated. This paper will, therefore, enrich the existing literature along the lines of asymmetric linkages. Moreover, the traverse of asymmetries and adjustments over the course of time highlights the inherent dynamism of the relationship.

The purpose of this paper is to contribute further on the twin deficits debate in a developing economy.

The data for Thailand over three decades are used as a case study.

The major findings are: first, a stable, long‐run equilibrium relationship between fiscal deficit, interest rate, exchange rate, and current account was found. Second, the causal relationship between the two deficits runs from fiscal deficit to current account deficit. This evidence is supportive of the twin deficits hypothesis. Further econometric analysis reveals that the two financial variables (interest rate and exchange rate) act as intermediating variables – that is an increased fiscal deficit causes interest rate to rise, and this in turn puts pressure on the exchange rate. The appreciation of the domestic currency causes a current account deficit.

The paper is of value by showing both direct and indirect channels to uncover the twin deficits phenomena. Based on a persistent profile response, it was found that the adjustment process may take as long as a year to complete.

Deficits in fiscal and current account balances in a large number of countries reveal interesting implications of the causal relationship between internal and external imbalances. Empirical evidence about the occurrence of so-called twin deficits or twin surpluses provides crucial information about the validity of an intertemporal approach. However, most recent dynamic cyclical changes during the crisis period revealed many questions about the direct interconnection between macroeconomic performance and twin imbalances. In the paper we observe substantial features of twin imbalances in European transition economies. Event study (identification of large fiscal and current account changes and their parallel occurrence) and vector auto-regression methods will be employed to examine key aspects of twin imbalances. Our results suggest that current account deteriorations were predominately associated with negative public investment and savings balances (fiscal deficits), while current account improvements were predominately associated with positive private investment and savings balances, confirming empirical evidence about twin deficits in European transition economies.

The purpose of this paper is to estimate the relationship between the current account (CA) and fiscal deficit (FD), and the real exchange rate for India, for the managed float period 1996 Q2 to 2015 Q4, after controlling for output growth and oil shocks. It also examines the cyclicality of the CA, the size of each shock, and assesses whether aggregate demand, forward-looking smoothing, or supply shocks dominate outcomes.

The authors use several variants of structural vector autoregression (SVAR), implemented with quarterly Indian data, to control for effects of oil prices, and the output cycle, and then see how FD shocks affect the current account deficit (CAD) and the real exchange rate. For robustness, the authors tried different identifications, changed variable definitions, added new variables, or substituted with other variables. The cyclicality issue is addressed by examining the effect of growth shocks. The relative size of each shock is assessed through co-movement decompositions of the forecast errors. Responses to shocks help identify dominant influences on India’s CAD.

The CAD is found to be countercyclical. A FD shock raises the CAD, but high impact growth shocks and large variance oil shocks lead to overall divergence of the deficits. There is some support for the aggregate demand channel, but it is moderated by supply shocks and compositional effects. Consumption is sticky rather than forward-looking.

The paper contributes to the literature by including supply shocks, compositional effects, cyclicality, real interest and exchange rate in a theoretically and empirically consistent way for the analysis of twin deficits. The large empirical literature on twin deficits in EMs has not yet done this. There is no study using quarterly data in an SVAR allowing the dynamic relationship between the variables to be explored. The extensions bring in the supply side and compositional effects qualify the working of both the channels, with empirical exercises supporting theoretical predictions.

The purpose of this study is to revisit the twin deficit hypothesis (TDH) and provide insights into the transmission mechanism connecting budget deficits and current account deficits for five major South Asian countries, namely, India, Bangladesh, Pakistan Sri Lanka and Nepal for the period 1985-2016.

This study uses a multivariate framework including real interest rate, real exchange rate and real gross domestic product to avoid the possibility of incorrect inferences caused by omission of relevant mediating variables. The long-run relationship and causality are investigated through the autoregressive distributed lag bounds testing approach and Toda Yamamoto approach, respectively, for each individual country. The robustness of the results is assessed with the help of Westerlund’s cointegration test and group mean fully modified ordinary least squares (GM-FMOLS), group mean dynamic ordinary least square (GM-DOLS) and common correlated effect mean group (CCEMG) estimators in the panel framework.

Both time series and panel evidences indicate long-run relationship between budget balance (BB) and current account balance (CAB) together with the mediating variables. The results indicate bi-directional causation between the two balances for India and Bangladesh, TDH for Pakistan and Sri Lanka and the reverse causation from CAB to BB for Nepal. Regarding the transmission mechanism, the results indicate the absence of the causal chain postulated by Mundell–Fleming, which predicts that BB causes CAB via interest rate and exchange rate. A CCEMG estimate of the import demand function reveals a positive government spending elasticity of imports suggesting that BB affects CAB by direct impact through demand.

This study augments the twin deficit literature on South Asian countries by providing insights into the transmission mechanism connecting the BB and CAB. Moreover, the study provides robust evidences on the TDH by using both time series and panel data techniques.

The purpose of this paper is to examine the issue of high current account deficit (CAD) from various perspectives focussing its behaviour, financing pattern and sustainability for India.

To begin with the trends, composition and dynamics of CAD for India are analysed. Next, the influence of capital flows on current account is investigated using Granger non-causality test proposed by Toda and Yamamoto (1995) between current account balance (CAB) to GDP ratio and financial account balance to GDP ratio. Also, the sustainability of India’s current account is examined using different econometrics techniques. In particular, Husted’s (1992), Johansen’s cointegration and vector error correction model (VECM) is applied along with conducting unit root and structural break tests wherever applicable. Further, long-run and short-run determinants of the CAB are estimated using Johansen’s VECM.

The study found that the widening of CAD is due to fall in household financial savings and corporate investments. Also, it was found that a large part of India’s CAD has been financed by FDI and portfolio investments which are partly replaced by short-term volatile flows. The unit root and cointegration tests indicate a sustainable current account for India. Further, econometric analysis reveals that India’s current account is driven by fiscal deficit, terms of trade growth, inflation, real deposit rate, trade openness, relative income growth and the age dependency factor.

Since India’s CAD has widened and is expected to widen primarily due to rise in gold and oil imports, policy makers should focus on achieving phenomenal export growth so that a sustainable current account is maintained. Also, with rising working-age and skilled population, India should focus more on high-value product exports rather than low-value manufactured items. Further, on the structural side it is important to correct fiscal deficit as it is one of the important factors contributing to large CAD.

The paper is an important empirical contribution towards explaining India’s CAD over time using latest and comprehensive data and econometric models.