Is twin deficit hypothesis a myth or reality in india? evidence using symmetric ARDL model with structural breaks

Recent empirical evidence on twin deficits reveals that the fiscal deficit and current account deficit nexus is subject to structural breaks. With time series data spanning 1970-2018, this study seeks to objectively explore the nexus between gross budget deficit and current account deficit in the Indian context. Using Autoregressive Distributed Lag (ARDL) methodology augmented with structural breaks, our econometric exercise validates the Twin Deficit Hypothesis and repudiates not only the proposition of Ricardian Equivalence but also the hypotheses of two way and reverse causality for the Indian economy. The study also found evidence of a positive statistically significant impact of exchange rate on current account deficit. This finding provides both the necessary and the sufficient condition to validate the hypothesis that fiscal deficits cause current account deficits indirectly via exchange rate appreciation, thereby substantiating the pertinence of Mundell-Fleming framework of twin deficits in the Indian context. The Toda-Yamamoto causality test supports a weak unidirectional causality from fiscal deficit to current account deficit. Thus, to circumvent the problem of mounting current account deficit and maintain currency stability, it is imperative on part of the central bank to pursue a prudent monetary policy that is resilient to the changing realms of fiscal and current account balance.