Exchange Rate and Trade Balance Relationship in India: An Application of Marshall Lerner Condition

At present, most Developing Countries have been facing persistent trade deficits in the regime of exchange rate liberalization that most of countries are practicing. The value of domestic currency in terms of foreign currency in the liberalized foreign exchange market is determined through market forces. International Economics is based on the assumption that a real devaluation of a nation's currency against foreign currency improves the trade balance and its current account. A decline in a nation's currency value in terms of foreign currency is likely to make export commodities relatively cheaper in the world market thus, increasing the volume of exports. Imports of the currency depreciating country turns costlier and hence, the volume of imports should reduce in response to devaluation. However, the Marshall Lerner condition states that devaluation of currency improves the balance of trade only if the sum of the price elasticities of demand for exports and for imports is greater than one. The objective of the study is to identify the relationship between Trade Balance and the exchange rate. Here, Trade Balance is defined as the ratio of exports to imports. In order to test results, the Augmented Dickey-Fuller (ADF), Phillips-Perron (PP) stationary tests are used to check for the presence of a unit ischolar_main for the individual variable and first differences among variables. The results indicated that Marshall Lerner condition is applicable in Indian context for the period of 1996 to 2011.