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Rajan Goyal, Director Department of Economic and Policy Research Reserve Bank of India

This report examines the behavior of exchange rate and its impact on trade flows in India. It analyzes the volatility of the exchange rate, the sensitivity of trade flows to exchange rate movements, and the overall trade performance of India. The report also provides key messages and insights on the relationship between exchange rate and trade flows.

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Rajan Goyal, Director Department of Economic and Policy Research Reserve Bank of India

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  1. Rajan Goyal, Director Department of Economic and Policy Research Reserve Bank of India World Trade Organisation, Geneva March 27, 2012 Exchange Rate and Trade Flows – Indian Experience

  2. India’s trade volumes have grown much faster than the world growth in the recent years.

  3. Exchange Rate and Trade FlowsStructure • Exchange Rate Behaviour • Sensitivity of Trade Flows • Trade Performance

  4. Exchange Rate and Trade Flows Exchange Rate Behaviour

  5. Exchange Rate BehaviourRupee in nominal terms steadily depreciated over the years.

  6. Exchange Rate BehaviourSince 1993, Rupee in real terms has largely remained range bound

  7. Exchange Rate Behaviour Current Account Balance doesn’t explain the volatility in exchange rate

  8. Exchange Rate Behaviour Significant co-movement between capital flows and exchange rate

  9. Capital flows are potent factor explaining x rate volatility Exchange Rate Behaviour

  10. Behaviour of Exchange Rate • Rupee was overvalued and administratively pegged prior to 1993. • Since 1993, movement in nominal exchange rate are largely reflective of inflation differential. • Accordingly, real effective exchange rate has remained close to base level and movements have been largely range bound. • Large variations in capital flows tend to cause exchange rate volatility. • Movements in exchange rate are reflective of market conditions. • Reserve Bank doesn’t have an exchange rate target or a band.

  11. Exchange Rate BehaviourWhether Exchange Rate is fairly valued? 3 Methodologies: • Real Effective Exchange Rate • Sustainable level of CAD • Macro Balance Approach • Growth differential • Demography • Oil balance • Stage of development • Fiscal deficit • No clear message. • IMF analysis (2010) showed Rupee is fairly valued.

  12. Exchange Rate and Trade Flows Sensitivity of Trade Flows

  13. Sensitivity of Trade FlowsSensitivity of Trade Flows to Exchange Rate

  14. Sensitivity of Trade Flows • Elasticity has risen over the period • Exchange rate pass through • Response to export – import prices • Import sensitivity • Gold and Oil • Non oil and non gold imports • Marshall-Lerner condition trade balance is negatively related to exchange rate movement

  15. Sensitivity of Trade Flows Given two way movement in exchange rate, sustained rise in trade volumes can’t be explained solely in terms of exchange rate variations

  16. Sensitivity of Trade Flows Trade Flows and Exchange Rate Volatility • Impact on export and import prices and profitability of the trade sector

  17. Exchange Rate and Trade Flows Trade Performance

  18. Trade PerformanceIndia’s exports and imports grew faster than growth world trade after reforms

  19. Trade Performance Opening up of India’s External Sector • Liberalized trade regime from the early 1990s • Integrated Policy Framework to improve overall productivity and efficiency • Move towards unified market determined exchange rate system • Lowering down of tariffs rates • Withdrawal of quantitative restrictions • Phasing out of the system of licensing

  20. Trade Performance

  21. Trade Performance Indian exports steadily diversified towards developing and emerging market economies

  22. Trade Performance Indian exports slowly moving up the value chain imparting resilience.

  23. Trade Performance Share of developing economies in total imports rising, largely on account of China

  24. Trade Performance There is sharp upward movement in the share of crude oil and petroleum products

  25. Exchange Rate and Trade Flows Key Messages • Rupee in real terms has generally remained stable and close to its base level. • Volatility in rupee is largely explained by the movement in capital flows caused by global events. • Apart from level of exchange rate, exchange rate volatility also impact trade volumes. • Reserve Bank intervenes only to stem the volatility in exchange rate without any target or band. • World demand and growing openness of Indian economy are the key factors explaining steep rise in export volumes. • Given that exchange rate has moved both ways, it doesn’t explain the sustained rise in export and import volumes.

  26. Exchange Rate and Trade Flows Thanks

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