Exchange Rates and International Reserves in India

Abstract

This article aims to study the relationship between real effective exchange rate (REER) and international reserve in India by applying the bivariate and conditional bivariate Granger causality test in frequency domain framework proposed by Breitung and Candelon (2006). The variables that are included to condition the frequency domain are the industrial production index, stock prices and wholesale producer index. Results found the evidence of business cyclical causality running from international reserve to REER for frequencies between 0.01 and 1.63 that corresponds to the 4 months and higher months cycles in India. The results have a strong bearing on the policy implications of India and any country alike it. The study concludes that the Reserve Bank of India should consider exchange rate as a grave determinant to manage appropriate forex reserve.