An Empirical Analysis of Exchange Rate Pass-Through in India: Relevance for Inflation Management

The recent episode of accelerating prices in India has created a widespread debate in the policy circles and in the media reasoning out possible causal factors and prescribing a variety of remedies. One such issue is pertaining to engineering exchange rate appreciation for yielding a nice dent on domestic inflation. The extent to which the exchange rate movements are reflected in domestic prices has long been a question of interest in international economics. However, in the last decade, considerable moderation and stability in inflation was witnessed, despite exchange rate variations in both directions. Empirical literature in cross-country perspective, covering both industrial and emerging economies corroborated the decline in exchange rate pass-through to prices, in general. These studies also found evidence of considerable differences in exchange rate pass-through across countries. For gaining a fair judgment on the prescription of exchange rate appreciation to tame present inflation in India, the present paper contributes to the debate by empirically assessing the degree of exchange rate pass-through in India, particularly in the post-reform period (since decoupling from the fixed exchange rate system). For the empirical analysis, a Vector Auto Regression (VAR) framework incorporating dynamic interlinkages amongst the relevant variables was employed. The empirical evidences could not find much support for using exchange rate as a useful antidote to arrest domestic inflation in India.