Oil prices and trade balance: A frequency domain analysis for India

This paper studies the lead–lag relationship between oil prices and trade balance for India by using monthly data covering the period from January 1980 to December 2011 and the post current account convertibility era (from August 1994 to December 2011). To analyse the issue, we adopt the approach proposed by Breitung and Candelon (2006) along with the traditional VAR-based conditional Granger causality. The results of VAR-based conditional Granger causality provide evidence of a bidirectional causal relationship in both study periods. Impulse response analysis shows a positive response of the oil price to one standard deviation shock in the trade balance, whereas the trade balance shows a negative response to one standard deviation shock in the oil price. However, frequency domain analysis also provides evidence of a bidirectional causal relationship, which holds for dissimilar frequencies in the short and medium run in the full sample. Moreover, greater strength and a high degree of cyclicality are found when causality runs from the oil price to the trade balance. Interestingly, the results of the post current account convertibility era provide evidence of frequency domain causality running from the oil price to the trade balance in the short, medium and long run, not otherwise. Hence, our study shows that the oil price has become a leading indicator of the Indian trade balance for the short, medium and long horizons.