An Econometric Analysis Pertaining to Exchange Rate Dynamics in India

The volatile exchange rate has created ripples in economies across the world more so in emerging market economies( EME's). Almost all the EME's have witnessed deep depreciation of their respective currencies and India is not an exception to this trend. The current depreciation of Indian Rupee vis a vis U.S Dollar which created lots of concerns had a cascading effect on the economy. A developing country like India, which overwhelmingly relies on imports, which in turn is sensitive to the depreciating mode of exchange rate tends to splurge the production costs and thereby triggers an overall inflation in the economy. Also the level of interest rates prevailing in the economy tends to promote or curb the investments.

The current paper tries to empirically investigate the co rrelation between the exchange rate inflation, interest rate using a time series data between 1990 and 2010.The Regression analysis shows that the model is suitable as the data is moderately fitted. The Unit ischolar_main Test suggests that the data is not stationary at Level and thereby the VAR analysis is undertaken. It shows that both the inflation and interest rates do not exhibit any long run association with the exchange rates and therefore cannot independently influence the exchange rate. But in a short run both the interest rates and inflation jointly influences the exchange rates as substianted by Wald test.