CHAPTER - III
FOREIGN TRADE AND ECONOMIC GROWTH IN INDIA
A REVIEW OF TRADE LITERATURE AND POLICIES
The external sector has come to occupy an important place in the growth
and development process of the Indian economy. Traditionally, India had been a low
import and low export-oriented country. Throughout the 60's and 70's, India's policy of
encouraging self-reliance has given a relatively closed model of development. Due to
the change in policies in 1977-78 and onwards, trade share in the GDP has been
gradually mounting. Infact, India's trade, trade policy and experience of economic
performance have a story of fluctuating fortunes during four and half decades of planned
development. The past resulted changes and reversals of economic performance through
the trade are here onwards assessed and analysed. In this chapter two aspects are
covered. Firstly, the empirical literatures that are connected with India's trade and growth
are reviewed. This review is to know the way in which earlier writings placed the trade
in India's economic growth. Subsequently, the macro level trade policies adopted in the
past four and half decades are reviewed and its consequences are evaluated.
3.1 TRADE AND ECONOMIC GROWTH IN INDIA : A LITERATURE REVIEW
Inspite of the mounting importance of trade in the post-Independence growth
of the Indian economy, the study of the trade and growth has received less attention.
To review the earlier literature, one can distinguish all the studies into three categories
on the basis of the methodology they adopted viz., 1) the study based on Bivariate and
Multivariate Regression analysis, 2) Causality analysis and 3) Inter-industrial analysis.
B. V. Gupta (1973) initiated a systematic discussion on the trade and growth
in his Ph.D. thesis titled. "Export in Developing Economy - A case study of India"
He adopted correlation and regression methods to assess the relation between export
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and growth for the period of 1951-52 to 1970-71. The study concluded that Indian
Export had positive impact on its economic development by enabling India to more
developmental import. However, for developing nations the study viewed that, unstable
character of export has failed to stimulate the economy. The study results are
self-contradictory and outdated. Though substantial literature came in 70's and 80 s
on trade policy regime, they have not dealt with the relationship between trade and
economic growth. These literature includes books written by Bhagwati and Srinivasan
(1975), Bhagwati and Desai (1978) and Wolf (1982). All these tracts have supported
for the policy of export promotion and import liberalisation in promoting growth and
development. In the book " Export and Growth" D.N.Tripathi (1985) ran regression
for the period of 1948-49 to 1981-82 at disaggregated level and obtained dependence of
national income on export. He supported Chenery's two-gap model by declaring that
export is beneficial to India's growth as it permits higher import. The main limitation of
all the above study is that they ignored the import.
Recently, a number of studies have inducted import into the discussion of
growth. Mainly they are Siddharthan (1989), Sunil Mani (1991), Sunanda Sen and
Hiranya Mukhopadhyay (1994). They observed a phenomenon of higher import
intensity in Indian industry and economy over the period. All these studies except the
last one, have treated total import as leakage to economic growth. The last study has
measured structural linkages among GDP, export and import by formulating its own
macro model with the data for the period of 1973-1990. The study result indicates that
one per cent rise in real import raises nearly 0.5 per cent of growth rate. They also find
that both of export and import are essential inputs for the growth. A.I.Rashid (1995)
has developed four equation model for 1977 to 1989 to assess inter-dependency
between trade and development. She concluded that trade is an important factor in
economic development. V.N. Attri (1992) and Metwally (1993) measured dynamic
effects of export on the rest of the economy. They found that scale mechanism is
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operated through manufactured export in India. Using modified Koyak type lagged
simultaneous equations model, Metwally concludes that India has enjoyed a short-run
spread effect of export. However, study has not considered the problem of auto
correlation in the analysis.
The above studies have made an elementary exercise and have
forwarded the very broader and generalised conclusions. Regression and Correlation
analyses do not take care of causal relationship that exists between trade and
economic growth.
The first study is carried out by Jung and Marshall on causal relations
between export and growth by using Granger test. They found that there is no
support for the causal hypothesis that export growth causes output growth and vice-
versa, in case of India for the period 1960-1979. Subsequent writers noticed that Jung
and Marshall did not make use of any analytical procedure in determining
optimal lag length. Nandi and Biswas (1991) and Nandi and Basu (1993) in a cross
country study, arrived at the conclusion that the study of export growth causes growth
of income using the Sim's test of causation. It is irony that the study of Jung and
Marshall and the later two studies with the two different techniques have arrived at the
contrary conclusions on the causal relationship between export and growth T his
questions the validity of Granger and Sim's techniques to assess the relationship
between trade and growth.
In a significant study, S.K.Mallick (1994) has employed Granger, Sim's
and modified Sim's (Geweke - Meese-Dent) test with improved optimal lags selection
to measure the causal relationship between export and growth for the period of
1950-51 to 1991-92. The result reject the null hypothesis that economic growth does
not cause export growth and vice-versa. The study also demonstrates the
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validity of its finding with the use of Geweke test even after extending bivariate
system to a trivariate one by introducing import as a linkage variable. By and large, the
study concludes that there is a feed back causal linkage between income growth and
export growth without and with link variable. The main drawback of the study is it
ignores the structural break in the series. G.R.Ramkrishna (1994) in his Ph D thesis
confirmed uni-directional relationship from export to growth in India for the period of
1960-61 by using Granger test. One of the major shortcomings of all the above studies
is that, they have not tested stationary conditions of time series while applying causality
test.
Recently Sham Bhat (1995) has applied Granger test after testing
cointegration of export with GNP. The results revealed that there is a bi-directional
causal relationship between export and economic growth in India during the period of
1950-51 to 1993-94. In a significant study, Dipendra Sinha and Tapen Sinha (1996)
examined the relationship between volume trade and economic growth using time
series data. They adopted cointegration technique and found that there is a long run
relationship between real GDP and trade openness. They also observed that two way
causality exists between real GNP and trade openness. Thus it is evident that there is
a bi-directional relationship between export and economic growth in India
During the last decade a number of studies have measured inter-industrial
effect of trade on Indian economy by using yard stick of input-output technique. The
main studies conducted in this regard are Siddarthan (1989), Atul Sharma and Kewal
Ram (1989), Sathe Dhanmanjari (1990), Dholakia (R-H), Dholakia (B.H.) and Kumar
(1992), Dhawan Sangeetha (1993). J.K.Mallick (1994) and S.P.Sharma and K.K Saxena
(1994). The above studies have acknowledged that import intensity of economy and
industries in India have been increased over a period of time. All the studies have
employed different input-output tables of Indian economy. Sathe in his study used all
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input-output tables from 1951-52 to 1982-83 and he observed that the income effect of
export has been almost halved and the import intensity has been doubled during the
period under study. Dholakia (R.H.) Dholakia (B.H.) and Kumar used input-output
table of 1983-84 and observed the phenomena of growth-led export rather than export-
led growth. The major drawback in the above said studies is that they have treated
import as a leakage to the economic growth. This defect is removed by Sharma and
Saxena, who divided import into complementary and competitive in their studies By
analysing the import effect for 1979-80 and 1984-85, they concluded that the use of
import for intermediate consumption has gone down over the years. However the author’s
compartmentisation of the total import as competitive and complementary is purely
subjective. In addition to this chosenjsample period is too small.
A severe attack comes on the issues of trade in documentation of
pro-marxist's thought by R.S.Nambiar and Gopal Tadas (1994). By assessing the
output and employment in 33 manufacturing industries from 1973 to 1991, they stated
that trade is deindustrialising India. Using input-output framework, the study
attributed all the gains of development to internal factors and all loss in output and
employment to trade. However, the method they adopted for distinguish period as
industrialising and deindustrialising, is a misleading one. The study is bias and treared
all import as a leakage to growth. The study itself quoted many of its limitations
substantiates biasness in its result. By and large, all the above studies only measured
Static inter-industrial effect and ignored both of causal and dynamic relationship
between trade and growth. Indian experience in planning and policy making has
underlined the great need for a comprehensive study on trade and economic growth
The above said review provides a wide variety of combating results
Different numerical and methodological exercises have arrived at different
results. Not a single study has provided long run, historical consistent.
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structural and dynamic analysis on the role of total trade in the process of India's
economic growth. Ignorance of structural and policy shifts while choosing sampling
period in many studies have limited the validity of its results. Not a single study
addressed the issues raised in the second chapter. Trade is a singled out as either export
as a stimulant or import as a leakage in all the above static and partial empirical studies.
Everything has been said and done in India, but not properly assessed and analysed.
Indian experience in planning and policy making have underlined the great need for a
comprehensive study on trade and economic growth.
3.2 TRADE POLICY AND GROWTH IN INDIA : REVIEW OF POLICY AND
EVIDENCE
India has faced a dilemma in choosing her trade strategy between IS and
EP as a strategy to economic development during the planning era in the past
The trade policies adopted in India have often been widely at variance with those that
are derived from the models of either protection or free trade. India has been
experimenting with the combination of import substitution and export promotion
strategies in varying degrees during the last four and half decades. However, India is
recognised as being one with the heavily inward-oriented developing countries
But there is a clear cut shift in the trade policies during the period 1955-56 to
1995-96. Considering policy shift and structural shift in Indian economy, one can
divide the policy period into three categories (1) Heavy protection period (1955-56 to
197-6-77), (2) Semi-liberalised period (1977-78 to 1990-91) (3) Trade liberalisation
period (1990-91 onwards). During heavy protection period, trade system in India
is progressively more restrict and complex and protection was total. After 1976-77 the
import sector has been gradually liberalised and measures for export promotion have
been increased. After 1990-91 India has initiated bunches of trade liberalisation
measures in the form of liberalisation of import and promotion of export led-growth
economy. The policy shifts recognized above have been authenticated and
75
documented in most of the studies including World Bank studies. The policies that
are undertaken in the broad trade strategies are discussed below.
3.2.1 Heavy Protection Period
India had not specified her trade strategy for development during the First
Plan Period (1951-56). Import regime was quite liberal. From the Second Plan
(1956-61) period, the country adopted highly intensive import substitution strategy to
achieve industrialisation-led development. During the Second Plan, priority was given
to the development of manufacturing and capital goods sector. In early stages of
development, India had to import capital goods. Thus emphasis was on replacing these
capital goods with the domestic production. The factors like promotion of infant and
key industry, change of composition of trade and GDP, export pessimism, spirit of
nationalism and socialism have enforced India to promote import competing industry
To minimise trade distortions and to promote principle of self-reliance in production,
India had injected heavy dose of IS policies by enforcing all types of physical and
non-physical interventionist policies. This includes import and industrial licencing
system with high level tariffs.
The import-export gap had been widened, during the latter half of the
Second Plan due to neutral response of the export sector to IS policy. Therefore export-
promotion was inducted along with heavy IS regime in trade policy during the third
plan (1961-66) and it continued in the subsequent three annual plan periods
A new dimensions of export promotion efforts was added in the form of creating a
number of organisation and providing export incentives and other services to exporters
Cash Compensatory Support (CCS), Duty Drawbacks (DD), Replenishment and
Import licences are the main components in the basket of export incentives India
devalued her currency at the rate of 57.5 per cent against Dollars in 1966 to promote
export. As a result of these, export has been picked up during the fourth plan
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(1969-74). Along with incentive measures, export controls and export taxes are also
levied on certain commodities to safeguard the interest of the nation.
Meanwhile, a number of committees and Task Forces were set up by
Government of India and Reserve Bank of India (RBI) during 1975-85 to study the
functioning of existing trade policies and to suggest remedial measures to make it more
effective in promoting trade-led development. Among them, the most important
committees were Dr.Aiexander Committee (1978), Tandon Committee (1980) and Abid
Hussain Committee (1984). These committees reviewed the operation of various
policies and its implications on trade as well as development and recommended a
number of innovative measures to rationalise the trade policies. They also urged the
Government of India to take action to promote export and to liberalise import policy.
3.2.2 Semi-liberalised Period
Export promotion acquired a new urgency during late 70's due to the
increased demand for import, stagnant export earnings and industrial stagnation
Government of India has been forced to mitigate the negative effects of high
protection and to reduce anti-export bias. Therefore, Government of India initiated
a new approach of liberalisation in IS regime with more export promotion measures
The important policy changes related to import sector since 1978, are expansions of
OGL lists, shift in goods from more to less restrictive list, swifter and less restrictive,
administrative judgements, concessional duties and reduction in scope of canalisation
There has been greater degree of simplifying and intermediate import. But import of
consumer goods are continued to be banned. A number of direct incentives were given
to export sector in the form of simplified export procedure, reduction in export taxes,
more advanced and special licence for import, promotion of export-oriented industries
and Foreign Trade Zones, concessional finance, tax rebate and unified exchange rate
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Due to change in the policy measures, there has been a steady increase in
the number of capital goods in the OGL lists from 79 in 1976 to 1170 in April 1988
The process of import liberalisation has gathered considerable momentum following
the introduction of the long term import-export (EXIM) policies covering the period
1985-86 to 1990-91. Import of raw materials and technical know-how required by
manufacturing sector were almost made free from licencing formalities. The licence
issued to registered exporters out of total licences was 26.6 per cent in 1981 which was
increased to 68.4 per cent in 1991. As a result of this, there exists an import-led export
growth in India.
The sorrowful story in external sector starts from 1987. Though export
growth during the period was not bad, export did not pick up at the level of import
The current account of the balance of payment has been deteriorated in late 80's
A continuous increase in budgetary and fiscal deficit from mid 80's created more
pressure on external payment. Along with the frequent depreciation of Rupees in late
80's, tariff levels were increased which pushed up the cost push inflation and downed
the export. India's historically low inflation exceeded to 17 per cent in August 1991
At the USA Dollar of 10 billions in 1991 (3.5 per cent of GDP), the current account
deficit of balance of payment (BOP) was unsustainable. This long run failure of macro
economic management provoked by Gulf crisis of 1990-91, ended with crisis of foreign
exchange in 1991. At the time, India had reserves for just a week import. This has put
down industrial growth at the negative level followed by the burst of import. So India
has shifted her policy towards EP or Outward-oriented strategy after 1990-91
3.2.3 Trade Liberalisation Period
The wake of grave crisis in 1990-91, India has been initiating macro
structural reforms which includes a bunch of reforms in external sector. The trade
liberalisation measures are initiated in the form of import liberalisation and export
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led-growth. The task of liberalisation is frequently described in catchy words of
Privatisation, Liberalisation and Globalisation. New EXIM Policy (1977-2002) and
liberalised exchange rate system envisage a leading role for trade or export in the
economic growth of India.
The external sector reforms constitute three main elements viz. exchange
rate adjustment, fiscal correction and structural reforms. Liberalised exchange rate
(Floating) management system (LERMS) with 22 per cent heavy devaluation of money
against foreign currency was adopted to boost export and invisible receipts Current
account of trade is made fully convertible in 1993-94. This conversion will be
extended to capital account in the near future. A series of fiscal measure launched to
restore viability in external payment account. The reduction in tax rate and
unproductive public expenditure are the main elements of fiscal reforms India has
launched extensive structural reforms to promote trade led-development. In July 1991,
the new industrial policy was announced by the Government, to promote
export by making goods internationally competitiveness via exposing foreign
technology and industries. A number of items required of industrial licencing are
reduced to 15. Automatic approval of foreign investment proposal upto 51 per cent of
equity and even above in the case of export-oriented industries is allowed. Introduction of
EXIM policy 1992-97 has come with bunches of trade liberalisation reforms.
Import licencing mechanism has radically altered. The duty free import
licence, advanced import licence and special import licence now constitute
important vehicle of trade policy to promote export growth. Import and export licencing
and procedure are substantially reduced. Except for the negative list of import all items
are freely importable. The EXIM policy reduced a number of items subjected to export
controls from 439 to 215 and so on. An open general licence (OGL) has been extended
to include more than 1000 items. Out of 5021 tariff lines more than 300 tariff lines
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cover capital goods, and inputs that are made free of import licencing requirements
Simultaneously, the Cash Compensatory Support (CCS) were abolished and
Replenishment licence were replaced by EXIM scrips. Scrips also disappeared and
Export Promotion Capital Goods (EPCG) scheme is insisted. Tariffs are made uniform
by merging revenue duty under basic duty. Tariff rates were reduced from 350 per cent
to very low level. It comes to the level of 40 per cent in 1997-98 Budget. The 199"-98
budget aims at getting the average tariff rate down to Asian Level by 2000 It also
proposed a modest reduction in duty on capital goods from 25 per cent to 20 per cent.
Simultaneously, for the first time after Independence consumer goods import were
allowed in the latest budget. Despite the above reforms, direct incentives are extended
to exporters in the form of tax concessions, subsidised export finances and otner
concessions.
In 1992 the Government of India constituted the high level comminee
(Rangarajan 1992) to look into the implications of the reforms initiated upon
the Balance of payment problem. The recommendations of the committee which came
out in 1993 lent further support to the measures of liberalisation in external sector
It also suggested the opening up of the current and capital accounts for full
convertibility of the rupee. This has been already initiated by the Government. The
Government of India also prepared ground for globalise its economy into world
economy by joining World Trade Organisation (WTO).
The new EXIM policy was introduced on 31st March 199”7 by the
Commerce Ministry for 1997 to 2002, which has made further commitment towards
the export led-growth approach. The new policy focuses on liberalisation, openness
transparency and globalisation. The policy was encouraged by 14 per cent growth n
export during the 8th plan. This policy,cut down the list of quantitative restnctions on
import, simplified the procedures, reduced the multiplicity of schemes as in the case of
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duty exemption, provided a special incentive for agro and allied sectors, high-tech
export and small scale sector products and encouraged domestic sourcing of input
Significantly, the policy has shifted 542 items out of the restricted list. The Commerce
Ministry appears to be roughly on target in dismantling quantitative restrictions by
2002. By removing the controversial value based advance licence scheme (vabal) and
pass book scheme, it introduced a new duty of entitlement pass book scheme (DEPS)
Though the EXIM policy does not have a long run perspective, it paved the way for
further import liberalisation and export promotion.
Indian trade regime has been comprehensively analysed by a number of
studies during the last three decades. Major of them are descriptive and unpublished
monographs. The pioneering work of Bhagwati and Srinivasan (1975) and Panchamukhi
(1978), basically covered the experience of trade policies of 1960's. These studies
concluded that the IS policy has hampered growth and export competitiveness
The elaborated study conducted by Wolf (1982) focussed only export sector
The experience of 70's and early 80’s was studied in an unpublished Ph D. thesis by
Rao (1985). The description of trade regime of the 1980’s is given mainly in recent two
World Bank working papers by M. Ataman - Aksoy (1989) and Aksoy and Tang ( 1992)
The results of above mentioned studies, clearly indicates that the trade regimes were
complex and very restrictive and they harmed the growth of the economy and the export
in India . Sensitiveness of the economy with trade and exchange rate is also identified
by the above said study. The complexities of trade regime and non-availabilities of
updated statistics, have limited the above studies to quantify the scope and extent of
restrictions of tariff structure and magnitude of export incentives and their implications
on Indian economy. Thus one can't visualize the failure of IS trade policy in India only
on the basis of the above studies.
Recently a number of studies have made an attempt to measure the
81
impact of import liberalisation and trade reforms on Indian economy and export
sector. They include Atul Sharma and Keval Ram (1989). Sunil Mani (1991), Aksoy
and Tang (1992), Dholakia and Dholakia and Kumar (1992), D. Sing (1994), J K.Mallick
(1994). These studies used various empirical methods and came to the conclusion that
import liberalisation has led to the high level import intensive industrialisation and
export promotion in India. Basically most of these studies are concluded as above on
the basis of experience of the economy during the period of 1977 to 1991 In a recent
study, Sarkar (1996) assessed the impact of on going trade liberalisation by using trend
and regression method for the period 1991-96. He concluded that data does not shows
that export have picked up and balances of trade has improved since 1991. Thus results
of most of the studies have revealed that import liberalisation leads in increasing import
intensity of economy and export sector and rise in external payment gap.
A review of trade policy of the Government of India pertaining to the
period 1955-56 to 1995-96 revealed that trade policy lacked consistency both in terms
of time and principles. India practiced the highest degree of protection where
multiple rate of tariff widely fluctuated between 125 to 350 per cent during the last four
and half decades of planned development. Numerous changes are made in the import
and export policy documents from time to time by public notice because of which it is
difficult to ascertain the scope and the extent of the quantitative restrictions
India adopted IS strategy as a short run measure to stabilise the BOP current account
deficit rather than as a development strategy. Exchange rate adjustment mechanism are
over emphasised and physical factors are not considered while adopting trade policy
(Manjappa and Ishwar Hegde 1995). The policy variables such as high degree of tariff
quantitative restriction, complicated import and export procedure along with less com
mitted bureaucracy set up, have minimised the role of trade in the development The
share of import and export in the world trade has been declined from 1.9 and 18 per
cent in 1950 to 0.6 per cent and 0.5 per cent in 1995-96 respectively. Even share of
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total trade in GDP is almost stagnant around 13 to 14 per cent during 1950 to 1991
This had led the planners and others to view that trade has no positive role in
economic growth and development of India.
Export promotion measures were rendered by complex licence a.nd
regulated system. The discriminatory protectionism has led to costlier domestic
output and has reduced the competitiveness of export goods. Thus IS policy was over
emphasised by the philosophy of self-reliance rather than building international
competitive spirits in industrial and non-industrial sectors.
The experience of past trade policy of India indicates that the stagnation of
export sector has caused imbalance in the balance of payment. Though the response of
economy and export sector to latest reforms has been generally positive, macro
economic stresses raised by reforms posed a new challenges for the future reform
process. During the last one and half years, effect of liberalisation is not so optimistic
for the economy. There is a dear sign of decceleration in growth of import, export,
industrial output and net invisible receipts. Hence, these issues required urgent
empirical verification.
India has achieved commendable achievements in certain fields through
trade policies. Nevertheless, the policy environment did enable India to develop into a
large manufacturing sector. Its share of GDP has been increased from 11.5 per cent on
1950-51 to 17.4 per cent in 1994-95. The positive change in composition of import,
export and GDP over the period is largely due to the IS policy. It is also noticed that
India could sustain her economy from external shocks fairly better than other
developing countries, specially during oil crisis (Joshi and Little 1994) A rapid
development of technology and industrialisation is the distinct contribution of IS policy
for the Indian economy. Thus resultants and reversals of the trade policy of India reveal
83
that India could achieve further higher development if policies were rationally
implemented. Therefore, any failure of trade policy rises out of wTong notions and
isolation of economy from the external sector.
The structural transformation in Indian economy during the period of last
four and half decades has provided enough experience to make it possible to
assess the relative role of trade in the process of economic growth. Underlining the
above observations, the present study is makes an attempt to measure the long term link
between trade and economic growth. While quantifying trade and growth
relationship, effect of policy shifts are recognised. In adopting time series techniques
trade liberalisation period is included in the semi-liberalised period as techniques
require sufficient number of observations. Thus present study mainly considered two
policy period 1) Heavy protection period (1955-56 to 1976-77), 2) Semi-liberalised
period (1977-78 to 1995-96). However, Trade liberalisation period (1991-96) is
separately considered wherever the methodology permits.
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