The question whether increased openness on trade account creates a favorable atmosphere for inflation reduction has been examined in the present study. The empirical results employing quarterly data over the 21-year period from 1984-85 to 2004-05, indicate that while trade openness has significantly contributed to the disinflation process, the decline in the world inflation rate has also been a significant environmental factor for this decline. The study also finds that the relationship has grown stronger, in terms of structural break, since 1989, when the trade liberalization started showing macroeconomic effects.

Inflation rate in India has declined considerably in the past decade. The decline was brought about by several factors. Better monetary management and supply management have undoubtedly played a major role in this achievement. The period was also characterized by several policy changes in the economic arena and favorable international environment. The world inflation itself declined significantly during this period, providing on the one hand an opportunity in terms of lower cost of imports, and on the other hand, posing a challenge in terms of losing competitiveness to other countries, if India failed to reign in the inflation. Opening up of capital account also posed a challenge to manage the impact of excess inflows on the money supply.

While these long-term favorable movements were taking place, the crude oil prices have been exerting significant pressure on inflation since 2003. While the crude oil prices continued to rule high in the international market, the policy of the Indian government to practically return to the administered prices for the consumer fuels like petrol, diesel, LPG and kerosene moderated the pressure to some extent on the inflation faced by the public. The inflation decline in the past decade poses a few interesting questions: Whether the increased external sector liberalization has contributed to the decline of inflation or the decline has nothing to do with openness? In particular, whether the trade openness has contributed to reduction in inflation rate? The present paper seeks to address this particular issue.

Monetary Economics Journal, Trade Openness, External Sector Liberalization, Supply Management, Monetary Management, International Market, Wholesale Price Index Basket, Economic Reforms Program, Export Promotion System, Gross Domestic Product, GDP, Globalization.