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The Indian Foreign Exchange Market and the Equilibrium Real Exchange Rate of the Rupee

Author

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  • Ila Patnaik

    (NCAER)

  • Peter Pauly

    (University of Toronto)

Abstract

This article seeks to analyze changes in the forex market in India and to explain the behaviour of the rupee in the nineties when India moved from a fixed to a f loating exchange rate. The analysis attempts to identify the underlying economic forces that are submerged under an interventionist market structure. The exchange rate is determined in the more slowly adjusting output markets in the long run and in volatile asset markets in the short run. The long run equilibrium exchange rate is seen to be determined by a version of the purchasing power parity condition. In the short run, the real exchange rate deviates from that determined by real interest parity due to risk. As long as pressures are not extreme, the Reserve Bank of India (RBI) is able to intervene effectively to influence the exchange rate. Its policy of 'keeping the rupee in line with fundamentals' has usually amounted to preventing a nominal appreciation of the rupee so that it does not effectively turn into a real appreciation. Other than attempting to keep exports competitive, the Reserve Bank has intervened to reduce volatility in forex markets. More recently, indirect intervention using interest rates has also played an increasingly important role in the RBI's foreign exchange policy.

Suggested Citation

  • Ila Patnaik & Peter Pauly, 2001. "The Indian Foreign Exchange Market and the Equilibrium Real Exchange Rate of the Rupee," Global Business Review, International Management Institute, vol. 2(2), pages 195-212, August.
    • Handle: RePEc:sae:globus:v:2:y:2001:i:2:p:195-212
    DOI: 10.1177/097215090100200204
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    References listed on IDEAS

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    3. Strauss, Jack, 1999. "Productivity differentials, the relative price of non-tradables and real exchange rates," Journal of International Money and Finance, Elsevier, vol. 18(3), pages 383-409.
    4. Frankel, Jeffrey A. & Rose, Andrew K., 1995. "Empirical research on nominal exchange rates," Handbook of International Economics, in: G. M. Grossman & K. Rogoff (ed.), Handbook of International Economics, edition 1, volume 3, chapter 33, pages 1689-1729, Elsevier.
    5. Isard,Peter, 1995. "Exchange Rate Economics," Cambridge Books, Cambridge University Press, number 9780521466004, September.
    6. Bela Balassa, 1964. "The Purchasing-Power Parity Doctrine: A Reappraisal," Journal of Political Economy, University of Chicago Press, vol. 72(6), pages 584-584.
    7. Isard,Peter, 1995. "Exchange Rate Economics," Cambridge Books, Cambridge University Press, number 9780521460477, September.
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    Cited by:

    1. Ila Patnaik, 2003. "India's policy stance on reserves and the currency," Indian Council for Research on International Economic Relations, New Delhi Working Papers 108, Indian Council for Research on International Economic Relations, New Delhi, India.
    2. Hüseyin Şen & Ayşe Kaya & Savaş Kaptan & Metehan Cömert, 2019. "Interest rates, inflation, and exchange rates in fragile EMEs: A fresh look at the long-run interrelationships," Working Papers halshs-02095652, HAL.
    3. Cheng, Fuzhi & Orden, David, 2005. "Exchange rate misalignment and its effects on agricultural producer support estimates," MTID discussion papers 81, International Food Policy Research Institute (IFPRI).

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