Exchange rate variation and impact on trade: an Indian perspective

Abstract

Since 19992-93, exchange rate in India has been floating freely although with regular RBI interventions. RBI, on its part, publishes six-currency as well as 36 currency indices of NEER/REER in its monthly Bulletin. Because of the intricate relationship between exchange rates and trade, lots of alternative indices/measures have been proposed. This study provides a brief of the literature. Since, none of the existing measures are able to explain the inter-linkage between exchange rates and trade, a new index has been proposed for a better understanding of the relationship. The model has been then, refined further to be suitably applied at sector level. The results have been very satisfactory. Broadly, the model successfully explains the trend in trade and when combined with the impact of Government policies and other macroeconomic variables, it provides for a good relationship measure. The study also argues or constructions of such indices at the sector level for not only a better understanding but also so that participants in the market are able to take appropriate steps. RBI chooses the countries in its index based on the following broad criteria: (i) the share in India s exports and trade,(ii)regional representation and (iii) the regular availability of data on exchange rates and prices on a monthly basis. This study argues that an important of equal, if not more importance is the inclusion of countries with whom we compete for our exports. Finally, the major implications of the study have been discussed towards the end.