Real Exchange Rate Variations in India in the Liberalized Regime: Implicating the Role of Openness,Trade Balance,and Money Supply

Abstract

This article examines the dynamics of the real exchange rate in India under the market-based exchange rate management regime from 1996Q1 to 2024Q1. It moderates the role of openness, trade balance, money supply, and inflation rate differential in the real exchange rate variations. The results reveal that the real effective exchange rate (RER) and variations in the rupee/dollar real rate (RS) are associated with several specifications of trade openness, trade balance, export and import penetrations, money supply, and the inflation rate differential between India and its major trading partners. Trade openness, trade balance, and export penetration lead to the appreciation of RERs and RS. Besides, a significant depreciating effect of the domestic money supply on the RS is observed. However, it does not seem to affect the RER. The impact of the inflation rate differential between India and its major trading partners is ambiguous. The findings underscore the pivotal role of external sector management in monitoring exchange rates in India.

JEL Classification F31, F14, F41, C32

Keywords

Real exchange rate trade balance trade liberalization trade openness export penetration import penetration

Get full access to this article

View all access options for this article.

References

Abid

, & Rault

(2021). On the exchange rates volatility and economic policy uncertainty nexus: A panel VAR approach for emerging markets. Journal of Quantitative Economics , 19(3), 403−425.

Balassa

(1975). Reforming the system of incentives in developing countries. World Development , 3(6), 365–382.

Calvo

G. A.

, Izquierdo

, & Mejia

L. F.

(2004). On the empirics of sudden stops: The relevance of balance-sheet effects [Working Paper No. 10520]. Inter-American Development Bank. https://doi.org/10.3386/w10520

Cavallo

E. A.

, & Frankel

J. A.

(2008). Does openness to trade make countries more vulnerable to sudden stops, or less? Using gravity to establish causality. Journal of International Money and Finance , 27(8), 1430–1452.

Chowdhury

(2012). Modeling the dynamics, structural breaks, and the determinants of the real exchange rate of Australia. Journal of International Financial Markets, Institutions and Money , 22(8), 343–358.

Corsetti

(2006). Openness and the case for flexible exchange rates. Research in Economics , 60(1), 1−21.

Cuestas

J. C.

, Monfort

, & Shimbov

(2022). Has the relationship between the real exchange rate and its fundamentals changed over time? Baltic Journal of Economics , 22(2), 68–89.

Dumrongrittikul

, & Anderson

H. M.

(2016). How do shocks to domestic factors affect real exchange rates of Asian developing countries? Journal of Development Economics , 119, 67–85.

Edmond

, Midrigan

, & Xu

D. Y.

(2015). Competition, markups, and the gains from international trade. American Economic Review , 105(10), 3183−3221.

10.

Edwards

(1989a). Exchange rate misalignment in developing countries. The World Bank Research Observer , 4(1), 3–21.

11.

Edwards

(1989b). Real exchange rates in the developing countries: Concepts and measurement [NBER Working Paper 2950]. National Bureau of Economic Research. https://doi.org/10.3386/w2950

12.

Fidora

, Giordano

, & Schmitz

(2021). Real exchange rate misalignments in the euro area. Open Economies Review , 32(1), 71–107.

13.

Gali

, & Monacelli

(2005). Monetary policy and exchange rate volatility in a small open economy. The Review of Economic Studies , 72(3), 707–734.

14.

Gantman

E. R.

, & Dabós

M. P.

(2018). Does trade openness influence the real effective exchange rate? New evidence from panel time-series. SERIES , 9(1), 91–113.

15.

Glick

, & Hutchison

(2011). The elusive quest: Do international capital controls contribute to currency stability? International Review of Economics & Finance , 20(1), 59−70.

16.

Iyke

B. N.

, & Odhiambo

N. M.

(2015). The determinants of long-run real exchange rate in South Africa: A fundamental equilibrium approach. Global Economy Journal , 15(3), 319−336.

17.

Johansen

(1991). Estimation and hypothesis testing of cointegration vectors in Gaussian vector autoregressive models. Econometrica , 55(6), 1551–1580.

18.

Johansen

(1995). A statistical analysis of cointegration for I(2) variables. Econometric Theory , 11(1), 25–59.

19.

Khan

M. K.

, Teng

J. Z.

, & Khan

M. I.

(2019). Cointegration between macroeconomic factors and the exchange rate USD/CNY. Financial Innovation , 5(1), 1–15.

20.

Kumar

(2010). Determinants of real exchange rate in India: An ARDL approach. Reserve Bank of India Occasional Papers , 31(1), 33–64.

21.

Lien

N. T. K.

, Doan

T. T. T.

, & Bui

T. N.

(2022). Trade openness and real effective exchange rate volatility: The case of Vietnam. Banks and Bank Systems , 17(1), 150–160.

22.

Maitra

(2020). Exploring import–led growth in India: Evidence from the post-reform period. South Asian Journal of Macroeconomics and Public Finance , 9(1), 87–113.

23.

Maitra

, & Ganguli

(2024). Fiscal policy and real exchange rate variations in India. Eurasian Economic Review , 14(3), 619–640.

24.

Maitra

, & Ganguli

(2025). Impacts of foreign and domestic investment on real exchange rates in India. The Journal of International Trade & Economic Development , 34(8), 1984–2002.

25.

Ranadive

R. R.

, & Burange

L. G.

(2013). The determinants of India’s real exchange rate: An ARDL approach. The Indian Economic Journal , 61(3), 407–428.

26.

Reserve Bank of India. (2021). Effective exchange rate indices of the Indian rupee. RBI Bulletin , LXXV(1), 35–41. https://www.rbi.org.in/Scripts/BS_ViewBulletin.aspx?Id=20020

27.

Romelli

, Terra

, & Vasconcelos

(2018). Current account and real exchange rate changes: The impact of trade openness. European Economic Review , 105, 135–158.

28.

Seraj

, & Coskuner

(2021). Real exchange rate effect on economic growth: Comparison of fundamental equilibrium exchange rate and Balassa–Samuelson based Rodrik approach. Journal of Applied Economics , 24(1), 541−554.

29.

Yang

, & Peng

(2024). Openness and real exchange rate volatility: Evidence from China. Open Economies Review , 35(1), 121–158.

Supplementary Material

Please find the following supplemental material available below.

For Open Access articles published under a Creative Commons License, all supplemental material carries the same license as the article it is associated with.

For non-Open Access articles published, all supplemental material carries a non-exclusive license, and permission requests for re-use of supplemental material or any part of supplemental material shall be sent directly to the copyright owner as specified in the copyright notice associated with the article.

0.00 MB

0.31 MB