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1.Introduction
This study aims to explore the dynamics, factors influencing and effects of
fluctuations in the exchange rate of Indian Rupee. Exchange rates play a vital role
in a country's level of trade, which is critical to almost every free market economy
in the world. Therefore, exchange rates are among the most monitored, analyzed
and governmentally manipulated economic measures. Exchange rate matters on a
smaller scale as well: it impacts the real return of an investor's portfolio,
profitability of firms, growth of specific sectors amongst various other
determinants of the economy.
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http://www.iioa.org/pdf/17th
%20Conf/Papers/4743149_090505_155551_INPUT_OUTPUT_MODELING_OF_IMPACT
_OF_EXCHANGE_RATE_FLUCTUATIONS_ON_INDIAN_ECONOMY.[1].PDF
The normality tests on the daily exchange rate returns for the last one-decade or
so indicate the need to explore the application of non-linear modeling techniques
while understanding exchange rate behavior. But we come to see that the results
from the persistence tests are split. The Variance Ratio results show that in the 3,
6 months and 2 years lag, the ratio has been greater than 1 that indicates the
persistence or a trend reinforcing tendency in exchange rate returns. However, the
3 months period shows a very close case of Random Walk. In the lag periods of 15
days, 30 days, 1 year and 5
Years the same is between 0 to 1 indicating mean reversion tendency or antipersistent. However, the R/S analysis does give indications of long-term memory
but with noise. In either case, analysis shows that the movement of exchange rate
does not follow a random movement. However, a more rigid analysis needs to be
performed, maybe by using Los modified R/S Analysis. Also, for a foolproof
analysis, the data used should be for a period longer than just one decade.
http://golak.tripod.com/icfai_ex_rate.pdf
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5. Objectives
This is conceptual study based on Rupee Dollar relationship in terms of Rupee
appreciation that is dollar depreciation and rupee depreciation that is dollar
appreciation. It provides valuable insights into impact of changes in currency
relations on various sectors of economy keeping in focus economy in general and
Indian economy in particular. Pros and Cons of currency appreciation and
depreciation are studied as boon and bane for the economic growth. It also provides
suggestions or steps needed to control as well as to overcome ill-effects of
excessive fluctuations between rupee and dollar keeping in view current trends.
http://zenithresearch.org.in/images/stories/pdf/2012/March/ZIJBEMR/22_ZIJBEMR_MA
RCH12_VOL2_ISSUE3.pdf
5. Hypotheses
There are several factors affecting the exchange rate like the inflation, interest
rates, current account deficits, public debt, terms of trade, economic and political
factors FDI, FII, etc. From these factors we have identified three independent
variables:
1) Interest Rates
2) Inflation
3) Current Account Deficit
So, we have constructed following 3 Null hypotheses:
1st Ho : Interest rates do not have any effect on the exchange rate of Indian Rupee
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2nd Ho : Inflation rates do not have any effect on the exchange rate of Indian Rupee
3rd Ho : Current Account Deficit does not have any effect on the exchange rate of
Indian Rupee
The corresponding Alternate Hypothesis are illustrated below ( We have used prior
knowledge to devise the alternate hypothesis in a manner which reflects the real
world scenario to be tested) :
1st H1 : Rise in interest rates would increase the value of the Rupee with respect to
other currencies.
2nd H1 : Higher inflation will lower the Rupee value.
3rd H1 : Higher the current account deficit, lower the Rupee value.
6. Research Methodology
Yearly data for the 3 Independent variables mentioned in previous section was
considered for the period 1991 -2011. Also data for the dependant variable Rupee
Exchange Rate with Dollar was considered for the same period (Source:
http://www.indiastat.com)
We performed Regression analysis on this data to observe correlation of the
dependant variable with the independent variables. Contribution of each
independent variable individually and their collective impact on the dependant
variable was observed.
Below are the values we have used for the analysis of the problem :
Year
Exchange rate US
Dollar
Inflation
rate
Interest
Rates
1990
17.4992
16.5
1991
22.689
13.9
17.875
1992
25.9206
11.8
18.916666
67
1993
31.4439
6.4
16.25
1994
31.3742
10.2
14.75
CAD
3.3279
7
2.2106
5
2.2668
8
3.8370
8
2.3625
1
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1995
32.4198
10.2
1996
35.428
15.458333
33
15.958333
33
1997
36.3195
7.2
13.833333
33
1998
41.2665
13.2
13.541666
67
1999
43.0552
4.7
12.541666
67
2000
44.9401
12.291666
67
2001
47.1857
3.7
12.083333
33
2002
48.5993
4.4
11.916666
67
2003
46.5818
3.8
11.458333
33
2004
45.3165
3.8
10.916666
67
2005
44.1
4.2
10.75
2006
45.307
6.1
11.1875
2007
41.3485
6.4
13.020833
33
2008
43.5049
8.4
13.3125
2009
48.4049
10.9
12.1875
2010
45.7262
12
8.33335
2011
46.6723
8.9
10.166666
67
2.1431
1.9839
2.7421
9
3.2459
6
3.2420
3
3.7597
5
4.2867
9
4.5915
6
3.3752
1
3.2000
4
3.1778
8
2.2429
0.4706
2
4.8702
1
5.4187
3.6432
3.6821
5
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9.
Findings
Correlation coefficient R of 0.89 clearly explains the relationship between the
actual values of three independent variables of inflation, interest rates, current
account deficit and the dependent variable exchange rate if India Rupee with the
US Dollar.
Also, the Coefficient of determination R Square of 0.79 explains how well the
independent variables - inflation, interest rates, current account deficit explain the
fluctuations in the Exchange rate.
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Below is the Exchange rate graph. We can observe that the rates are fluctuating
but post the reforms
of 1991, the Exchange rate has been more or less stable between 45 Indian
Rupees to 55 Indian Rupees for 1 US Dollar.
10. Recommendations/Suggestions
1. Measures by RBI:
a. Using Forex Reserves: RBI can sell forex reserves and buy Indian Rupees
leading to demand for rupee. But using forex reserves poses risk also, as using
them up in large quantities to prevent depreciation may result in a deterioration of
confidence in the economy's ability to meet even its short-term external
obligations. And not using reserves to prevent currency depreciation poses the risk
that the exchange rate will spiral out of control. Since both outcomes are
undesirable, the appropriate policy response is to find a balance. Recent data
shows that RBI had indeed intervened by selling forex reserves selectively to
support Rupee.
Source:RBI
b. Raising Interest Rates: The rationale is to prevent sudden capital outflows
and ultimately lead to higher capital inflows. But Indias interest rates are already
higher than most countries. This was done to tame inflationary expectations. So
further raising interest rates would lead to lower growth levels.
c. Make Investments Attractive- Easing Capital Controls: RBI can take steps to
increase the supply of foreign currency by expanding market participation to
support Rupee. RBI can increase the FII limit on investment in government and
corporate debt instruments. It can invite long term FDI debt funds in infrastructure
sector. The ceiling for External Commercial Borrowings can be enhanced to allow
more ECB borrowings.
2. Measures by Government: Government should take some measures to bring
FDI and create a healthy environment for economic growth. Key policy reforms that
should be initiated includes rolling of Goods and Services Tax (GST), Direct Tax
Code (DTC), FDI in aviation and retail, Companies Bill and diesel decontrol. Efforts
should be made to invite FDI but much more needs to be done especially after the
holdback of retail FDI and recent criticisms of policy paralysis. The government
took steps recently to loosen rules for portfolio investment in the Indian market,
indicating its desire to sustain external inflows. The measure to increase External
Commercial Borrowings (ECB) to $10bn will help in borrowing in dollar at a less
cost. It may take similar steps to encourage FDI as well, helping sustain external
funding.
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11. Conclusions
The initial success story of India was clearly based on factor driven economy based
on labour arbitrage that is providing low cost labour in comparison to another
country. At this stage development is sensitive to global business cycle and
exchange rate fluctuation. We need to move towards being investment driven
economy that is efficiency driven in the form of infrastructure development,
improving skill of work force and make that investment which translate into tangible
productivity across the board. Final stage which can make India to be developed
economy is to be innovation driven economy that can create unique value of India
at global economy level. We need to accelerate reform process that would make
economy resistant to external shocks and changes in economy cycles and currency
fluctuations. The bottom line is our policy should concentrate on enhancing our
capability in manufacturing, promote entrepreneurship and provide incentive for
innovations. We need to remember that the challenge which we are facing is not
only about currency risk but it is about moving to growth and development.
The Indian Rupee has depreciated significantly against the US Dollar marking a new
risk for Indian economy. Grim global economic outlook along with high inflation,
widening current account deficit and FII outflows have contributed to this fall. RBI
has responded with timely interventions by selling dollars intermittently. But in
times of global uncertainty, investors prefer USD as a safe haven. To attract
investments, RBI can ease capital controls by increasing the FII limit on investment
in government and corporate debt instruments and introduce higher ceilings in
ECBs. Government can create a stable political and economic environment.
However, a lot depends on the Global economic outlook and the future of Eurozone
which will determine the future of INR.
13. Acknowledgments
Factors affecting the fluctuations in exchange rate of the Indian Rupee
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14. References
15.
http://www.iioa.org/pdf/17th
%20Conf/Papers/4743149_090505_155551_INPUT_OUTPUT_MODELING_OF_IMPA
CT_OF_EXCHANGE_RATE_FLUCTUATIONS_ON_INDIAN_ECONOMY.[1].PDF
http://www.quandl.com/WORLDBANK-World-Bank/IND_NY_GDP_MKTP_CN-IndiaGDP-current-LCU
http://www.quandl.com/WORLDBANK-World-Bank/IND_BN_CAB_XOKA_GD_ZSIndia-Current-account-balance-of-GDP
http://www.quandl.com/WORLDBANK-World-Bank/IND_FR_INR_LEND-IndiaLending-interest-rate
http://www.quandl.com/WORLDBANK-World-Bank/IND_NY_GDP_DEFL_KD_ZGIndia-Inflation-GDP-deflator-annual
http://golak.tripod.com/icfai_ex_rate.pdf
http://zenithresearch.org.in/images/stories/pdf/2012/March/ZIJBEMR/22_ZIJBEMR_
MARCH12_VOL2_ISSUE3.pdf
http://www.indiastat.com
http://www.rbi.org.in
http://www.tradingeconomics.com
Appendix/Annexure
Assumptions:
1. We have assumed that all the other factors that influence rupee fluctuation
besides Interest Rates, Inflation, and Current Account Deficit (CAD) are held
constant.
2. We have considered the period since when India has opened for
Liberalization, Privatization and Globalization (LPG) i.e., 1991 onwards.
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We are attaching the graphs of the three dependant variables in the following pages
to give a better picture of how these variables have been fluctuating in the recent
past.
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