Abstract
Exchange rate reflects the fundamentals of an economy in terms of relative export price and indicators of external stability. Volatility in nominal exchange rate spills over to the real sectors of the economy affecting output, employment and price stability. From this point of view, an assessment of exchange rate volatility assumes importance in studies on monetary and macroeconomics. This paper contains econometric analyses of the movements in INR-USD bilateral exchange rate in the post-floating period covering period from 1993 to 2009. Results of the GARCH, VAR and cointegrating VECM models confirm the existence of substantial volatility in the nominal INR-USD exchange rate evolving unilaterally and jointly with INR exchange rates against other international currencies such as EUR, JPY and CNY. Prima facie, this amounts to justify the relevance of managed float regimes for India as an intermediate solution to curb excessive volatility in nominal exchange rate.
Highlights
“Instability of exchange rates is a symptom of instability in the underlying economic structure....A flexible exchange rate need not be an unstable exchange rate
Despite repeated recourse to intervention as a disciplining tool for restoring stability in the exchange rate, the Reserve Bank of India (RBI) has reiterated its commitment to the market-based exchange rate system which is in place since March 1993
As per the RBI, the managed floating regime has emerged successful in managing volatility and ensuring price stability over the past decade
Summary
“Instability of exchange rates is a symptom of instability in the underlying economic structure....A flexible exchange rate need not be an unstable exchange rate. India adopted a de facto managed floating exchange rate regime in 1993 with unification of the two dual rates. Both nominal INR-USD exchange rate and reserves show erratic volatility in the post-floating period. Large oscillations were observed in the first eight years after introduction of the managed float regime It continued to exacerbate in subsequent years, the volatility cycles trimmed in the latter period. These volatility peaks are prominently illustrated in return series of the bilateral INR exchange rates. All the bilateral INR exchange rates exhibit substantial volatility in the INR-USD, INR-GBP and INR-JPY rates in the post-floating period (Fig. 2 through Fig. 4).
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