External Determinants of Inflation: The India Experience

This study investigates the role of external factors in determining inflation levels in India from 2000:01 to 2016:12 in a time-varying parameter approach of structural vector autoregressive (TVP-VAR) model. Our analysis of time-variations in the impact of foreign determinants of inflation in India is based on a time-varying parameter approach of structural vector autoregressive (TVP-VAR) model. This model allows for time-variations in both the coefficients and the variance-covariance matrix of theinnovations. We build five TVP-VAR models for each of the five foreign factors to be investigated. These models contain the same set of domestic macroeconomic variables. The foreign factors enter the system of domestic variables, one by one. The structural identification in this TVP-VAR model has been done in the following order. The foreign factors have been ordered as the most exogenous variables in all the models, owing to the small size of the Indian economy as compared to the global factors. We find oil price, commodity price, US monetary policy and global liquidity to be significant in explaining the inflation level in India. Further, we also find their impact to be time-varying which may be impacted by a host of factors.