Dynamic Relationship Between Rupee-Dollar Exchange Rate and Major Economic Indicators

Abstract

It is very likely that dollar to rupee exchange rate has an influence on the major economic indicators of India like the GDP of India, the NIFTY 50 index, gold prices in India, import prices in India, and crude oil prices in India. The quarterly time series data of the seven variables have been used. The time considered for the study is 2016 Quarter 1 to 2022 Quarter 3 and dummy variables to adjust drastic changes during the Automobile industry crash in India and other global uncertainties (2018-Q3 to 2019-Q3) and covid (2019-Q4 to 2021-Q2) for all variables have been used. Unit Root test, Bound test, Johansen-Juselius multivariate cointegration test, and generalized forecast error variance decomposition have been used to analyze the data and it was found that there exists a relationship in the short run, although there does not seem to be a long-run equilibrium relationship between economic variables and changes in the exchange rates. This probably reflects the increasing disparity in economic, monetary, and hedging uses between these indicators and exchange rates. It may also imply that those economic indicators may not be sensitive to common macroeconomic factors in the long run. There is only rather weak evidence of a long-run relationship, investors may benefit from diversification into gold in the long run. Similarly, exporters may benefit from expanding their exports (if possible) if reserves are available, thereby diversifying the risk of price fluctuations in the long run. However, there is evidence that spot prices and exchange rates may be closely linked in the short-run aftershocks occur. Changes in the nominal price of oil have basically no information to provide to monetary authorities on changes in the exchange rate behavior and the opposite holds as well.