Lets Make India Great Again: The Effect of China’s Currency Manipulation on India’s Balance of Payments

During the 1980’s, India experienced a sudden decline in its Balance of Payments (BOP), which led the country to increase its national debt. The growing fiscal debt led to a decline in foreign investments in India, as the country was soon on the brink of a financial crisis. India experienced a severe depreciation during the 1991 financial crisis. Our study examines China’s foreign exchange intervention during the period 1980-2000, as we suspect that the People’s Bank of China’s (PBoC) currency manipulation coupled with the growing fiscal debt triggered the 1991 financial crisis. In our study we hypothesize that China’s currency manipulation had a negative effect on India’s BOP. In order to examine the BOP, we individualize the effect on the Capital and Current account. According to theory, the BOP should always equal zero, however, we are analyzing the Current and Capital account portions of the BOP, without taking into account the official reserves settlement account that balances out any surplus or deficit. We derive the Mundell-Fleming IS-LM model in order to theorize China’s currency manipulation. The five empirical articles that we analyze and evaluate help us derive our conceptual and operational model. Since we utilize a time series data set, we test for unit roots, and other tests such as multicollinearity, serial correlation and heteroskedasticity. The results of our empirical testing indicate that China’s currency manipulation had a significant effect on India’s Capital account only. Therefore, we prove our hypothesis, but with weak results