MBA Department of Vidyasagar University organised a two days International Seminar during 25-26 January,2017 on Recent Innovations in Management,Accounting Business and Entrepreneurship.
I have presented a paper on "Behaviour and Determinants of Real Effective Exchange Rate of India"The details of the paper is given below.
In this paper,author endeavours to establish the patterns
and trends of Real Effective Exchange Rate of India during 1970-2015 and tries
to show the determinants of REER eg,growth rate,current account deficit as per
cent of GDP,per cent of openness, foreign direct investment inflows, and
foreign exchange reserves excluding gold.The author used semi-log,double log
linear and exponential model,autoregession,ARIMA ,GARCH models for trends and
volatility.Bai-Perron (2003) model was applied to show structural breaks and
Hodrick-Prescott (1997 ) model was applied for smoothness of cyclical
trend.Johansen (1988, 1991, 1996) models were used to fit cointegration test
and vector error correctons.Residual tests were done to verify
autocorrelations, normality and impulse response functions were found to show
stability and convergence.
The paper concludes that REER has been declining at the rate 0.4085 per
cent per year which is insignificant at 5% level during 1970-2015 but it is
exponentially declining at the rate of 0.2028 per cent which is
significant.AR(1) of REER is convergent,stationary and significant but AR(2) is
convergent ,nonstationary and insignificant.Even ARIMA(1,1,1) is nonstationary
because AR(1) is stationary but MA(1) is nonstationary.GARCH(1,1) showed
insignificant.Thus the series REER is highly volatile.This series contains five
significant structural breaks in 1976,1986,1992,(downward)2004 and
2010(upward).It’s pattern is cyclical which was turned to smooth cycle.Trace
statistic showed three cointegrating vectors and Max-Eigen Statistic showed two
cointegrating vectors that verify cointegration in the order one.Vector Error
Correction model is stable because all roots lie in the unit root circle but it
is nonstationary because impulse response functions are diverging and error
corrections are significant only in degree
of openness and FDI inflows in relating REER during 1970-2015 with one period
lag.Residuals test of VECM confirmed non normality and autocorrelations.
Only
sound fiscal and monetary policy can control upward movement of REER so that
significant relationships can be achieved with those selected determinants that
would spur the growth of international trade.
Key
words---Real Effective Exchange Rate, stationary,structural breaks, causality, cointegration,vector
error correction
JEL-F15,F31,F32,F36,F43,O13,O24,O54
Behaviour and determinants of Real
Effective Exchange Rate of India
I.Introduction
Real Effective Exchange Rate is an important tool in
managing international trade and finance and macroeconomic stability in an open
economy. It influenced export and import prices and trade volumes. Appreciation
and depreciation of REER determined terms of trade, openness, foreign exchange
reserves of an economy to at great extent.FDI inflows and current account
balance are largely depend on the REER because in the liberalized and globalised
world the adjustment in balance of payments is largely correlated with the
movement of REER.The REER is closely related with the nominal and real rate by
definition when it is trade weighted or export weighted with group of
countries. Exchange rate policy whether it is nominal or real controls national
inflation and influenced international inflation in which interest rate differential
is the crucial and key variable. Today, under globalization REER is closely
related with the growth rate also since volatility of REER is the barrier of
high growth in which volume of trade affects. According to Balassa-Samuelson
effect,volatility of REER influenced export competitiveness and productivity.In
calculating REER based with export or trade weighted 36 countries,RBI did not
consider productivity.Even,India have not long run data on REER,and NEER.
However,India could not predict well the nature of capital account
convertibility,the productivity changes and terms of trade changes in relating
to REER. Therefore, the task before RBI is crucial because policy of exchange
rate also related with monetary and fiscal policies as well.
II.Objective
of the study
This paper endeavours to study the behavior patterns
of REER and its determinants in India during 1970-2015 where the author assumed
that the basic determinants of REER are growth rate,current account deficit as
per cent of GDP,openness of the economy,foreign direct investment
inflows,foreign exchange reserves excluding gold and so on .The relation were
calculated through cointegration and vector error correction models.The
policies of REER and limitations of the paper are also the aims of this study.
VIII.Conclusion
REER of India during 1970-2015 is significantly decreasing exponentially
at the rate of0.2028% per year.AR(2),ARIMA(1,1,1) are non stationary,
GARCH(1,1) is exstremely volatile.REER has five structural breaks in
1976,1986,1992,2004 and 2010 ,it follows random walk, REER has bidirectional
causality with growth rate,current account balance,FDI inflows but
unidirectional causality with openness and foreign exchange reserves.
Johansen unrestricted cointegration rank test among REER ,growth
rate,current account deficit,trade openness,FDI inflows and foreign exchange
reserves assured that Trace Statistic contains three cointegrating equations
and Max Eigen Statistic contains two cointegrating equations which determined
they are cointegrated in the order one, All the estimated equations of VECM are
not good fit except Δx3t and Δx4t where error correction
processes are significant and even the changes of variables are not related
with previous period significantly.
TOT,NEER are not included,model could be explained in pre reform and post
reform period and in different exchange rate regime.It is necessary to reduce
inflation,to rise foreign exchange reserves,to increase trade surplus and to
rise productivity which will lower cost that may decrease price level and REER.
More the protection the less is the REER volatility,so avoid capital
account liberalization. Again,the higher the foreign exchange reserves the
lower is the commodity TOT shock to REER which tends to lower volatility of
REER. RBI is trying to resist volatility of REER and formulates [i] to develop
skill in dealing spot and foreward market,[ii] to compete with FED rate by
reducing interest rate,[iii] to increase in outflow of port folio which will
call for new exchange rate and monetary policy,[iv] to allow alternative
exchange rate policy to check appreciation of REER which enhance capital
inflows,[v] to monitor excessive exchange rate depreciation which follows loss
of foreign exchange reserves during macro economic shocks ,[vi] thus Rajan said
India needs macroeconomic stability.
