Relationship between Foreign Institutional Investment, Exchange Rate and Foreign Exchange Reserves: The Case of India using ARDL Bounds Testing Approach

Abstract

Foreign institutional investment (FII) is believed to affect real economy of a country through its impact on factors such as exchange rates and foreign exchange reserves. Similarly, exchange rate movements are also believed to affect the FII coming to the country and foreign exchange reserves of the country. In the light of recent volatility in the movements of these variables, we examine the long-run and short-run relationship between these three variables. Using monthly data for the period September 1993 to July 2013, this paper employs the more recent and robust auto-regressive distributed lag (ARDL) bounds testing approach to study the relationship among these three variables. The results indicate strong evidence of a long-run relationship between FII as dependent variable and exchange rate and foreign exchange reserves as independent variables. We also find exchange rate to be a significant determinant of FII movements.