Capital flow and its impact on exchange rate: A comprehensive study of exchange rate fluctuation during Global Financial Crisis and Fed Tapering

Abstract

Sharp exchange rate fluctuations severely impact the trade relations and deter investors’ sentiment to invest in any country. Two events in last one decade- Global Financial Crisis (GFC) in 2008 and Fed Tapering in 2013 impacted exchange rate across many developed country and India was no exception. India being a developing country with its underdeveloped financial markets and susceptible to capital flows has always been a curious case for study. This paper contends that India’s response to Financial crises studies both the financial crises and Fed tapering with respect to the volatility of capital flows and its impact on exchange rate can be analyzed based on its vulnerability with respect to macroeconomic indicators on one hand and viability of policy responses in a globalized world on other. The authors suggest putting in place a broad- based risk weighted policy which focusses more on increasing cushion on external reserves and shielding capital volatility by augmenting long term flows (FDI), local bonds while abstaining from short term flows (FII).