Recent devaluation of Chinese yuan has threatened the stability of global financial system and has invited unwarranted currency war. China is India’s largest goods trading partner and India has a whopping trade deficit (US$49 bn in FY15) with China on account of rising imports and dismal exports. The recent devaluation of yuan (around 4% in two days, August 11-12, 2015) would make Chinese exports more competitive than that of India, which in turn would have a negative impact on India’s exports. Depreciation of Indian rupee by virtue of its global integration though has nullified the devaluation effect of yuan, but the growing trade deficit of India with China is still a concern. This study aims to provide empirical insights on whether real depreciation of Indian rupee is an effective way of improving the trade deficit with China. Using annual data from World Bank and UN Comtrade from 1987 to 2014, the paper validates Marshall-Lerner condition and J-Curve effect for India. Bounds test to cointegration approach based on Autoregressive Distributed Lag (ARDL) model and error correction of ARDL model are employed in the study. The bounds test result shows evidence of long-run relationship between trade balance, domestic income, foreign income and real exchange rate. Moreover, the estimated long-run ARDL model rejects the validity of Marshall-Lerner condition for Indian economy. Finally, short-term dynamics obtained from the estimation of error correction model show that there is no J-curve effect for India. Hence, depreciation of rupee is not expected to yield the desired result in correcting the trade deficit with China.

The recent devaluation of Chinese renminbi (yuan) has resulted in a sharp volatility in the currency and financial markets worldwide. The main purpose of devaluation was to boost the export competitiveness of Chinese goods in the international market in a sluggish demand scenario. Though yuan was officially de-pegged from US dollar in 2005, the recent adjustment of almost 4% was the biggest decline. In the virtue of global integration, Indian Rupee (INR) almost lost more than 4% against US dollar in successive trading sessions. China is India’s largest trading partner and India had a whopping trade deficit of US$49 bn in FY15 with China on account of the rising imports and dismal exports. The recent devaluation of yuan (around 4% in two days, August 11-12, 2015) would make Chinese exports more competitive than that of India, and this in turn would have a negative impact on India’s exports.

In such a scenario, it is very urgent to address the issue with policy initiatives. Re-pricing the traded commodities (both export and import) through manipulation in the currency market is one of the important tools used by many countries to correct the deficit. But for India, whether currency depreciation is going to work as a panacea to correct the trade imbalances, is the major objective of the present study.

Applied Economics Journal, Indian Rupee (INR), India-China, Gross Domestic Product (GDP), World Development Indicators (WDI), India-China Trade Relations, Marshall-Lerner, J-Curve, Hypothesis.