Asymmetric shocks and the Role of Exchange Rate in Emerging Markets : Evidence from India

This paper examines the stabilization role of the flexible exchange rate in theface of asymmetric shocks for one of the prominent emerging markets and openeconomies, India, using a sign-identified structural Bayesian vector autoregressionmodel over the post reform period 1996-2019. My results show that asymmetricmonetary policy and exchange rate shocks account for a larger fraction of thevariation in the Indian rupee in the short run, compared to relative demand andsupply shocks. Jointly, monetary policy and exchange rate shocks account foralmost half of the variation in the Indian rupee. The foreign exchange marketappears to be a major source of disturbance to the Indian rupee. Although theIndian rupee floating exchange rate is able to absorb shocks in the long run, itplays a more dominant role as a source of shock in the short run. This study holdsimportant policy implications for currency stability in India, as well as similaremerging markets and open economies. Policymakers need to monitor exchangerate risks, and be prepared to mitigate exchange rate volatility stemming fromforeign exchange market for macroeconomic stability