Impact of Exchange Rate Volatility on the Foreign Direct Investment in India in the Post Liberalization Period

Abstract

Trade deficits and surpluses are sometimes attributed to intentionally low or high ~change rate levels. The impact of exchange rate levels on trade has been much debated but the large body of existing empirical literature does not suggest an unequivocally clear picture of the trade impacts of changes in exchange rates. Similarly relationship between Real Effective Exchange Rate (REER) and foreign direct investment is not much discussed in the current time. The present study tries to establish a causal relationship between the real effective exchange rate and foreign direct investment in India using a time series data between 1992 and 2013. It tries to understand whether the fluctuation in the exchange rate in turn causes the change in the quantum of foreign direct investments inflows and vice-versa which is of enormous importance in the wake.of unprecedented depreciation of Indian Rupee against US dollar. Under this analysis unit root test and Johenson co-integration test were adopted to show whether the variables under consideration exhibit stationarity and a long run association respectively. The test indicates absence of any long term association between the two variables under consideration. The Vector Auto regression (VAR) model depicts that the coefficients do not have any long run association. To establish the possibility of any short run association Wald test is conducted.