The Effect of Foreign Shocks on the Indian Economy

The Indian economy has been increasingly exposed to external shocks with growing financial and trade integration. We examine the effects of four key international shocks: shocks to US monetary policy, oil supply, global economic policy uncertainty, and geopolitical risk. Using the external instruments strategy with Local Projections and Structural Vector Autoregression methods, we document the dynamic causal effects of these shocks on the Indian economy. We find significant effects of these foreign shocks on both macroeconomic and financial variables. Combined, these shocks explain about 15 to 35 percent of the variation in inflation, output, and financial variables at two- to four-year horizons. However, the magnitude of effects on output is lower relative to both global output and output of peer developing countries. While the oil shock behaves like a traditional supply shock, the US monetary policy and economic policy uncertainty shocks look more like domestic demand shocks. We discuss the implications for stabilization policy.