Seminar: Determinants of India’s Real Exchange Rate: An ARDL Approach
Speaker: Rucha R. Ranadive
Abstract: The study analyses determinants of the exchange rate in India. The real and monetary variables affecting the real exchange rate have been empirically analysed. 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 analysis has been carried out using auto-regressive distributed lag (ARDL) bounds testing approach that enables studying the short run and long run relationship among the variables of interest during 1993-94 to 2012-13 using quarterly data. The ARDL bounds testing approach confirmed a cointegration relationship between the real exchange rate and its determinants implying a long run relationship among these variables in India. The error correction terms introduced in these methods affirmed the convergence of the real exchange rate towards its long run equilibrium level in the next periods. Government expenditure, openness of the economy and inflation differentials correctly depreciate whereas long run interest differential and terms of trade appreciate the real exchange rate in the long and short run. Productivity differential is insignificant in the long run and short run; however, pose an opposite sign to the expected theoretical relationship. Nevertheless, a permanent long run effect indicates that it tends to appreciate the real exchange rate. As expected, the FII appreciates the real exchange rate in the long and short run with mixed results at various lags. The short run interest differential and net foreign assets show negative relationship in the long and short run. However, net foreign assets appreciate the real exchange rate in line with the theory. Higher foreign exchange reserves are found to appreciate the real exchange rate in India. Thus, it has been deduced that the determinants established a logical relationship with the real exchange rate in the case of India.