Does Exchange Rate Influence External Trade?

Abstract

External sector reforms, such as trade liberalisation, exchange rate reforms, etc. are vital elements in the economic reforms agenda of any liberalising economy. Does devaluation/depreciation act as an effective instrument in curing the ills of external payment account? This study essentially attempts to investigate the impact of depreciation/devaluation on Indian trade accounts. The study employs monthly data on trade and effective exchange rate series, culled out from IMF and RBI statistics, for the period spanning 1984 to 1998, in effect capturing both pre and postreform period. An examination of different individual series relating to India's external accounts, such as import, export, balance of trade, nominal effective exchange rate and real effective exchange rate based both on trade and export-based weights were undertaken. It shows that all the external account series are trend-stationary. Subsequently, results emerging from regression analysis reveal that export does not seem to have positively responded to devaluation/depreciation measures as well as other exchange rate policy changes. Trends in import appear to have accelerated in the post-reform period. Therefore, it is suggested that singular and undue importance on the exchange rate management as a policy instrument may not give the desired results.