While anecdotal evidence for India suggests increased linkages with the world, the systematic evidence on this is limited. In this paper, we use output and trade data on India and the rest of the world to investigate two questions:
1.Has there been a change in business cycle synchronisation over time between India and the rest of the world
2.Does India have particularly strong linkages with the US, or is the comovement stronger with a broad set of industrial countries
It can be seen that these questions are only of correlation and not causation. In the context that there is no consensus in the literature on the impact of increasing trade and financial liberalisation on business cycle integration, establishing or rejecting the synchronisation hypothesis is in itself an important element in the debate.
Over the past two decades, India has seen several economic and institutional changes, including in its exchange rate regime, monetary policy framework, financial regulatory framework and trade policy structure. Given this institutional environment, the case for trend-cycle interaction is strengthened, and we do not detrend the data to isolate the business cycle. Rather, we study the trend-cyclical component of seasonally adjusted data. In order to address the classical expansion faced by the emerging markets, where all measures of output have been on a steady increase over the past decade or so, we modify this approach to study cyclical fluctuations in annualised point-on-point growth rates of output. Effectively, we are studying growth rate cycles.
The literature on business cycles in India uses monthly data for industrial production as a proxy for output, for practical as well as conceptual reasons. The dataset that we create runs from August 1992 till December 2008. We seasonally adjust the data using X-12 ARIMA, and to examine the increase in integration, we cut the sample period into three roughly equal sub-samples. The break-points chosen are August 1997 and August 2003. We source all domestic data from the Centre for Monitoring Indian Economy. We use the Conference Board coincident indicator for the United Statesa composite of the Index of Industrial Prodution, non-farm payroll employment, personal disposable income excluding transfers and retail manufacturing and sales. For advanced economies, we use a weighted index of non-seasonally adjusted industrial production for 22 countries classified as industrial by the International Monetary Fund.
To look at some preliminary empirical evidence about whether business cycles in India have been coupled or decoupled with those in industrial countries, we look back towards the last US business cycle as defined by the NBER (starting in March 2001 and ending in November 2001). Figure 1 shows data for India during that period. This shows that the growth of exports and industrial production fell to very low levels. Similar results are also seen when examining changes in corporate revenues and corporate profits.
To test this more formally, we use the index of concordance (HP Index) as developed by economist Donald Harding and Adrian Pagan as a means to test increasing business cycle synchronisation across our three sample periods. This measures the proportion of the time that two variables are in the same state.
Assuming two variables x and y over N time periods, the index of concordance between them would be:
xy = #[Sxt=1, Syt=1] + #[Sxt=0, Syt=0]
The value of the HP index ranges between 0 and 1. An index value of close to 1 would indicate perfect procyclicality while an index value of 0 would indicate perfect counter-cyclicality. We correct for serial correlation and data skewness by reporting Heteroskedasticity-Autocorrelation (HAC) corrected t-statistics, and also by reporting the correlation coefficicent Sx and Sy and I xy, an indicator that has symmetric statistical properties to the index of concordance.
The main results of the Harding-Pagan analysis on the data and three sub-samples are reported in Table 1. We report the index of concordance and the cross-correlations of the state variables as two measures of concordance. The results support the hypothesis that there is business cycle synchronisation between India and the rest of the world, and that synchronisation has been increasing with time.
For the full sample (1992-2008) the index of concordance suggests that Indian and US business cycles are in the same phase for a statistically significant 63.9% of the sample period, while cycles of industrial production in India and advanced economies are in the same phase for 74.3% of the sample. The most recent sample (2003-2008) shows stronger synchronisation. The index rose to 0.781 with the US coincident indicator, and as high as 0.984 against advanced countries.
In Period 1 (1992-1997), both the US coincident indicator and IIP for advanced economies were negatively correlated with Indian industrial production, suggesting that the Indian business cycle was weakly counter-cyclical to the world during this time. However, this was a high volatility period due to structural adjustment to reforms and revival from the balance-of-payments crisis of 1991. Hence, it can be viewed as a transition period in the Indian economy, a possible explanatory factor for this result.
Also, across all samples, it can be seen that the Adv. Ec. IIP is more strongly correlated with Indian IIP, suggesting that the Indian synchronisation with industrial economies as a whole is stronger than the synchronisation with the US. In fact, for the last period 2003-2008, the index of concordance against Adv. Ec.
IIP is as high as 0.984, and it has a t-statistic of 43.5.
We check the robustness of our main results to three sets of sensitivity teststhe redefinition of sample periods, detrending the data and redefining key variables. We also check the results with two other methodologiescross-correlation analysis and spectral analysis. We find that our results broadly hold across all methodologies and robustness checks.
In this paper, we find that the Indian business cycle is synchronised with that of the US and other industrial economies.
We also find that this synchronisation has increased across time in the period 1992-2008, i.e. the period that saw a significiant rise in Indias trade and capital flows.
Finally, the linkages of the Indian economy are stronger when measured against a broad set of industrial countries as opposed to just the US.
This paper was written in March 2009 under the aegis of the SPF Financial and Monetary Policy Reform Project at the National Institute for Public Finance and Policy, New Delhi. The views expressed are personal and do not represent those of the Institute.
The full paper is available at the Institutes website