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Oil price shocks on Indian economy: evidence from Toda Yamamoto and Markov regime-switching VAR

The study investigates the dynamic impact of linear and non-linear specifications of oil price shocks on macroeconomic fundamentals for an oil-importing emerging economy – India – during the period March 1991 to January 2009. The paper deploys extended vector autoregressive (VAR) model of possibly integrated processes proposed by Toda and Yamamoto, which has its advantage of application irrespective of the variables being stationary or cointegrated. The study further estimates two-state Markov regime-switch VAR model to examine regime shift behaviour of the underlying variables and its relationship. The study finds that inflation and foreign exchange reserve are greatly impacted by oil price shocks. The study also confirms that the movement in oil price is exogenous with respect to the movement of India’s macroeconomic variables and the impact of oil price shocks are asymmetric in nature with negative price shocks having more pronounced effect than positive shocks.