Relationships of Foreign Exchange Rates With Macroeconomic Variables, Economic Crisis, and Trade Volumes: An Empirical Study From India

Abstract

Volatility in foreign exchange rates is an indicator of economic performance particularly for emerging market economies like India. This study tries to re-examine the relationship between exchange rates and macroeconomic variables for Indian economy. It addresses three issues, namely Volatility in exchange rates (USD/INR; EUR/INR and GBP/INR); Effect of Economic crisis represented by global financial crisis (GFC) and macroeconomic variables mainly Inflation and Yield of 10yearsGovt. Securities on above mentioned three exchange rates; and Relationship between exchange rates volatility and foreign trade (both export and import). Daily data for three exchange rates are taken for the period of January 3 rd , 2000 to March 26 th 2019, whereas for other two objectives, monthly average exchange rates are used along with monthly data for select macroeconomic variables for the period of Jan 2000 to Dec 2018. Volatility is represented by Standard Deviation and Causality is checked through Granger Causality Test. The findings suggest that volatility is highest for EUR/ INR followed by GBP/INR and USD/INR. The average annual volatility for all three exchange rates indicates the minimum value in 2001 whereas maximum value for 2013. It is also observed that volatility is higher during crisis period compared to pre and post crisis periods for all three exchange rates. Granger Causality test suggests that out of 10 pairs of testing for causality only unidirectional cause effect relationships stating GBP granger causes yield on 10 years Government securities. The study further finds that USD/ INR exchange rate granger cause imports of India. These findings will help the market players at the time of taking their strategic decisions whereas to regulators during their policy decision process. For academicians and researchers, it provides an opportunity to explore the conditions with more macroeconomic variables and with the use of advanced econometric tools.