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

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.