Purchasing power parity, in the presence of foreign exchange black markets: The case of India

The empirical validity of PPP as a long-run constraint between India and the US is examined in the presence of foreign exchange black markets. In a trivariate model, the official exchange rate is found to be cointegrated with both the price ratio and the black market exchange rate. Both the official exchange rate and price ratio respond to correct short-run departures from PPP. Also, both the official and the black market exchange rates respond to correct departures from their own equilibrium relation. The two sources of endogeneity in the official rate follow as Indian authorities aimed to stabilize domestic prices and reduce uncertainty about the dollar price of rupees.