Examining Responsiveness of India’s Trade Flows to Exchange Rate Movements

Determinants of trade flows have always attracted researchers. In this paper, we model monthly trade flows in India over January 2000 - December 2007 in a bid to gauge their responsiveness to exchange rate movements. Capital account and overall BOP surplus have led the Indian Rupee (INR) to appreciate and forex reserves to accumulate. In so far as the RBI intervenes to stem this forex accretion by the net purchase of USD, it puts further pressure on the INR to appreciate. It therefore becomes important to study the response of the current account to these changes in the exchange rate. We employ standard empirical estimations of India's export supply and import demand functions using data from the Reserve Bank of India. We also assess the short-term dynamics of these trade flows through error correction models. Finally, we estimate vector auto regression models to gauge the extent of contemporaneous interaction between trade flows and the explanatory variables in the system