Causal Relationships between Industrial Production, Interest Rate and Exchange Rate: Evidence on India

Abstract

This paper attempts to examine the causal relationships between Industrial Production, Interest Rate and Exchange Rate in India. The study uses Granger's Causality test and Vector Auto Regression technique on monthly IIP (Index of Industrial Production), exchange rate, and interest rate for the period April 1992 to March 2004. The major findings of the study are (a) there exists a unidirectional causality between the exchange rate and interest rate and between the exchange rate return and IIP; (b) there is no Granger's causality between the interest rate and IIP. Through Vector Auto Regression modeling, the study confirms the results obtained from Granger's Causality test. It shows that interest rate and IIP depend on the exchange rate and there is no relationship between interest rate and IIP.