Determinants of Exchange Rate in India

SSRN Electronic Journal 04/2008; DOI: 10.2139/ssrn.1165602


Appreciation or depreciation of the domestic currency depends on the supply of foreign exchange reserves, liquidity conditions in the economy as determined by money supply, central bank's policy intentions and differences in the interest yield on dated securities of the concerned economies. The present research tests validity of this hypothesis in association with the exchange rate between the Indian rupee and the US dollar. In particular, an attempt is made to investigate the impact of bank rate policy of the Reserve Bank of India (RBI) and interest yield differentials between the India and the US securities. Impact of broad money supply and foreign exchange reserves is also analyzed. A monthly time series from April 1996 to June 2007 is used for the purpose. It is observed that the monetary policy intentions depicted by the bank rate of the RBI, the short-term and long-term domestic interest differentials and interest yield differentials, and the rate of change of foreign exchange reserves have a significant impact on the monthly average of the exchange rate between Indian rupee and the US dollar and quite in line with the economic theory.

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Available from: Mita Suthar, Jul 24, 2014
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    ABSTRACT: The paper attempts to determine the factors affecting the real exchange rate in India. The fundamental determinants considered are productivity differences, government expenditure, foreign institutional investment, openness of the economy, interest rate differentials, inflation differentials, terms of trade, foreign exchange reserves and net foreign assets. The ARDL bounds testing approach confirms the long run relationship between the real exchange rate and these variables for the quarterly data 1993Q1-2011Q4. The error correction term also indicated 76 percent of the convergence towards the long run equilibrium level in the next quarter. The study confirmed the expected theoretical relationship between the variables and the real exchange rate in the long run.