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Exchange rate misalignment and economic growth in India

Vaseem Akram (Indian Institute of Technology Hyderabad, Hyderabad, India)
Badri Narayan Rath (Indian Institute of Technology Hyderabad, Hyderabad, India)

Journal of Financial Economic Policy

ISSN: 1757-6385

Article publication date: 6 November 2017

Abstract

Purpose

The purpose of the paper is to examine the impact of exchange rate misalignment on economic growth in India using annual data from 1980 to 2014.

Design/methodology/approach

First, misalignment is measured, which is defined as the deviations of the actual real exchange rate (RER) from its equilibrium level. The equilibrium real exchange rate (ERER) is estimated using the auto-regressive distributed lag (ARDL) model by considering key macroeconomic fundamentals of the determinants of RER. Zivot and Andrews’ unit root with structural break is used to test the stationarity property of data. The impact of exchange rate misalignment on economic growth has been examined using ARDL and variance decomposition techniques.

Findings

Our results find an overvaluation of the exchange rate till 2000, and thereafter, an undervaluation of the exchange rate prevails in India. Further, the result indicates that an increase in exchange rate misalignment leads to a decrease in economic growth and vice versa. Moreover, a positive misalignment (overvaluation) hurts the economic growth and a negative misalignment (undervaluation) promotes the economic growth.

Research limitations/implications

From the policy perspective, the results highlight that India needs to maintain an appropriate exchange rate which can reduce the RER misalignment. It is better for the Reserve Bank of India (RBI)’s intervention to smoothen the fluctuations of the exchange rate to avoid the inefficiency in the allocation of resources. However, to minimize the RER misalignment, the intervention should be conducted only in the short run.

Originality/value

The study contributes to the existing literature by estimating the exchange rate misalignment for India and its impact on economic growth.

Keywords

Acknowledgements

The authors gratefully acknowledge the suggestions of the anonymous referee on an earlier draft of this paper. The usual disclaimer applies.

Citation

Akram, V. and Rath, B.N. (2017), "Exchange rate misalignment and economic growth in India", Journal of Financial Economic Policy, Vol. 9 No. 4, pp. 414-434. https://doi.org/10.1108/JFEP-12-2016-0093

Publisher

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Emerald Publishing Limited

Copyright © 2017, Emerald Publishing Limited