Causality between Exchange Rate and Foreign Exchange Reserves in the Indian Context
Using a time series data of the variables between 1980 and 2010 the present study tries to establish a causal relationship between exchange rate and foreign exchange reserves in the Indian context. Emphasis has been laid on understanding the impact of foreign exchange reserves on the exchange rate. India has accumulated unprecedented foreign exchange reserves and synchronously has been experiencing a large depreciation in its Rupee vies avis US dollar. This trend prompted us to undertake this study to establish some association between the two trends. Our analysis uses Unit Root test, Johansson Co -integration test and Vector Auto Regression (VAR) and concludes that there is no long and short term association between exchange rate (EXR) and foreign exchange reserves (FOREX) in the Indian context. It can be concluded that the accumulation of fore reserves are only in anticipation of overcoming any global financial crisis and maintaining credit rating which in turn could repose faith in the investors and attract large investments in the form of foreign direct investment and portfolio investments. The accumulation of fore reserves may not be used as a tool to tame exchange rate as suggested by some authors.
