Srusti Management Review (Dec 2017)
A Study on Relationship Between FDI Flows and Real Exchange Rates in India
Abstract
This paper analyzes the relationship between the net capital flow components and other fundamentals and the real exchange rate (RER) in India consequent for the liberalization of the capital account in 1990s for the period 1996- 1997 to 2012-13 using the Autoregressive Distributed Lag approach to co integration. The estimation includes net capital flow components: foreign direct investment (FDI) flows, foreign portfolio flows, debt creating flows and other capital flows, government consumption expenditure, change in foreign exchange reserves, and current account balance as explanatory variables for investigating the relationship with the RER. The empirical results indicate that FDI flows are not significantly associated with the real appreciation but portfolio flows and debt creating flows are associated with real appreciation in a statistically significant manner. Government consumption expenditure is not found to be significantly associated with real appreciation. Current Account Balance has a positive and statistically significant association with RER indicating that the outflows on account of current account deficits have been associated with depreciation of RER or prevention of the appreciation on account of capital flows. The change in foreign exchange reserves has a negative and statistically significant association with RER indicating that the accumulation of reserves by the Reserve Bank of India in the face of increasing net capital flows has prevented the appreciation of RER and mitigated their adverse consequences on the competitiveness of the Indian economy.
