Exchange rate volatility and export growth in India: An ARDL bounds testing approach

P Srinivasan,M Kalaivani

doi:10.5267/j.dsl.2013.04.002

Abstract

Article history: Received March 2, 2012 Received in Revised Format April 1, 2013 Accepted April 2, 2013 Available online April 4 2013 This paper empirically investigates the impact of exchange rate volatility on the real exports in India using the ARDL bounds testing procedure proposed by Pesaran et al. (2001). Using annual time series data, the empirical analyses has been carried out for the period 1970 to 2011. The study results confirm that real exports are cointegrated with exchange rate volatility, real exchange rate, gross domestic product and foreign economic activity. Our findings indicate that the exchange rate volatility has significant negative impact on real exports both in the short-run and long-run, implying that higher exchange rate fluctuation tends to reduce real exports in India. Besides, the real exchange rate has negative short-run and positive long-run effects on real exports. The empirical results reveal that GDP has a positive and significant impact on India’s real exports in the long-run, but the impact turns out to be insignificant in the short-run. In addition, the foreign economic activity exerts significant negative and positive impact on real exports in the short-run and long-run, respectively. © 2013 Growing Science Ltd. All rights reserved.

Highlights

Exchange rate volatility is a crucial element that needs to be considered for developing countries that depend extensively on trade – the case of India
This paper empirically investigates the impact of exchange rate volatility on the real exports in India using the Autoregressive Distributed Lag (ARDL) bounds testing procedure proposed by Pesaran et al (2001)
The study results confirm that real exports are cointegrated with exchange rate volatility, real exchange rate, gross domestic product and foreign economic activity

Summary

Introduction

Exchange rate volatility is often treated as a risk and an increase in volatility would raise cost for risk-averse traders and depress trade (Ethier, 1973). Cote (1994) stressed that the assumption of risk aversion does not necessarily lead to a conclusion that exchange rate volatility diminishes the amount of trade. His argument is based on the consideration that an increase in risk (exchange rate volatility) has two effects, namely a substitution effect and an income effect, which work in opposite directions. Broll and Eckwert (1999) and Franke, (1991) have argued for an ‘option’ framework where a firm’s engaging in export trade is viewed as an option The ‘option view’ indicates that exchange rate volatility will increase the value of the export option, thereby stimulating a firm’s production and international trade activity if the degree of relative risk-aversion is less than unity

Methods

Results

Conclusion