Capital Inflows and Exchange Rate Variations under Economic Reforms in India

The inflows of foreign capital into India have been a mixed blessing for the economy. Capital inflows have been associated with increased investment and rising Gross Domestic Product (GDP). The main focus of the paper lies in analyzing the behavior of the macroeconomic indicators in relation to the inflows of foreign capital and exchange rates in India since 1991, the year in which several major reform programs were initiated. It analyzes the trends in inflows of foreign capital into India and variations in exchange rate of the Indian rupee and their mutual interdependence over the period 1990-91 to 2007-08. It shows the correlation between exchange rate and inflows of capital in India, and also between the exchange rate and some macroeconomic indicators such as GDP and money supply. Further, it also shows the relationship of nominal effective exchange rate (both trade-based and export-based) with foreign direct investment and foreign portfolio investment in India. The correlation analysis of selected indicators shows that GDP is strongly related to the exchange rates of Indian rupee per unit of US dollar, pound sterling and SDR. This suggests that the prevailing exchange rates helped in the growth of Indian GDP. It also focuses on the effects of inflows of foreign capital on some macroeconomic variables in India. This paper also studies how the Reserve Bank of India prevents the exchange rate appreciation associated with rising capital inflows by accumulating foreign exchange reserves and foreign investments