Determination of Exchange Rate under Flexible Exchange Rate Regime in India: An Analysis Using ARDL Model

Abstract

Since March 1993, the Indian economy has accepted the flexible exchange rate regime in which the rates are determined by the market. In this flexible exchange rate regime, the degree of volatility has been observed to be comparatively high, and it affects the economy in many different ways. The present paper is an attempt to examine and explain these variations in exchange rate through the theory of purchasing power parity. The primary purpose of this study is to develop an empirical framework to estimate the determinants of exchange rate by employing a time series data of exchange rate and gross domestic product measured at purchasing power parity, and for this, the data used have been for the period 1994 to 2013. In the present paper, the statistical tools such as Pair wise Granger Causality Tests, Breakpoint Unit Root Test, Cointegration Test and finally ARDL model have been applied to develop a viable relationship between regressor and regressand. The result of this endeavor has revealed that there is a definite causal relationship between exchange rate and gross domestic product expressed at purchasing power parity, but the larger variation in the exchange rate is explained by the lag value exchange rate.