Transmission of real exchange rate changes to the manufacturing sector performance

Abstract

We explore the impact of Real Exchange Rate changes on the performance of Indian manufacturing firms over the period 2000-2012. Our empirical analysis shows that real exchange rate movements have a significant impact on Indian firms' performance through the import cost channel but not the export competitiveness channel. The impact depends upon the degree of market power as reflected in the industry specific Herfindahl index. Further, appreciation and depreciation affect firms' performance differently. Overall, our results point towards the need for an effective reserve management policy to deal with sudden movements in exchange rate in the short run while maintaining a competitive exchange rate in the long run.