Impact of exchange rate fluctuations on

India's exports and imports

General Introduction

The exchange rate, which is the price of a currency in terms of another currency, is the
most important factor in determining the economic scenario for trade sectors.
Appreciation or depreciation of currency affects the economic performance of a country.
Any government at any point in time seeks the stability of the exchange rate because it
helps in planning before the varying costs and prices of goods and services. An
exchange rate depreciation can make a country's exports cheaper and imports more
expensive. When a country is importing goods, this represents an outflow of funds from
that country. Local companies are the importers and they make payments to overseas
entities or the exporters.

The relationship between a nation's imports and exports and its exchange rate is
complex because there is a constant feedback loop between international trade and the
way a country's currency is valued. The exchange rate has an effect on the trade
surplus or deficit, which in turn affects the exchange rate, and so on. In general,
however, a weaker domestic currency stimulates exports and makes imports more
expensive. Conversely, a strong domestic currency hampers exports and makes
imports cheaper.

For example, consider an electronic component priced at $10 in the U.S. that will be
exported to India. Assume the exchange rate is 50 rupees to the U.S. dollar. Neglecting
shipping and other transaction costs such as importing duties for now, the $10
electronic component would cost the Indian importer 500 rupees.
If the dollar were to strengthen against the Indian rupee to a level of 55 rupees (to one
U.S. dollar), and assuming that the U.S. exporter does not increase the price of the
component, its price would increase to 550 rupees ($10 x 55) for the Indian importer.
This may force the Indian importer to look for cheaper components from other locations.
The 10% appreciation in the dollar versus the rupee has thus diminished the U.S.
exporter's competitiveness in the Indian market.

At the same time, assuming again an exchange rate of 50 rupees to one U.S. dollar,
consider a garment exporter in India whose primary market is in the U.S. A shirt that the
exporter sells for $10 in the U.S. market would result in them receiving 500 rupees
when the export proceeds are received (neglecting shipping and other costs).

If the rupee weakens to 55 rupees to one U.S. dollar, the exporter can now sell the shirt
for $9.09 to receive the same amount of rupees (500). The 10% depreciation in the
rupee versus the dollar has therefore improved the Indian exporter's competitiveness in
the U.S. market.

The result of the 10% appreciation of the dollar versus the rupee has rendered U.S.
exports of electronic components uncompetitive, but it has made imported Indian shirts
cheaper for U.S. consumers. The flip side is that a 10% depreciation of the rupee has
improved the competitiveness of Indian garment exports, but has made imports of
electronic components more expensive for Indian buyers.

When this scenario is multiplied by millions of transactions, currency moves can have a
drastic impact on a country's imports and exports.

Impact on India's imports and exports

In the last quarter-century, the global economy has witnessed a rapid expansion in
international trade and the growing prominence of dynamic emerging economies on the
global trade landscape. However, despite steady growth in global trade, there have
been recurring concerns about the impact of exchange-rate movements on trade -
rekindled more recently by the 1997 Asian financial crisis and the 2008 global financial
crisis. India provides an interesting case study of how exchange-rate fluctuations impact
exports. This column investigates the exchange-rate effects on exports using data on a
sample of Indian non-financial sector firms from 2000 to 2010.
In 1991, India embraced a reform agenda and implemented a series of globalization
and liberalization measures targeting the foreign exchange market and tradable sectors.
Undeniably, India's economy has become increasingly integrated with the rest of the
world and now has a considerable presence as an exporter in the global economy. The
annual growth rate of India's exports of goods and services increased from 16% in
1999-2000 to around 33% in 2010-2011. The contribution of exports to the Gross
Domestic Product (GDP) went up from 6% in 1990 to 12% in 2000 and to 23% in 2010.
Simultaneously, India's overall share of total world trade (including trade in both goods
and services) increased from 0.5% in 1990 to about 1.4% in 2010. As a result, India
moved up seven places between 1999 and 2009, securing a ranking as the world's 14th
largest trading center. During 2000-2010, growth in exports of commercial services (an
average of 23% per year) outstripped the export of goods (18% per year). India also
adopted a more market-oriented exchange rate regime in the first half of the 1990s.
Since deregulation, the rupee's exchange rate has mostly been in a managed floating
regime1, under which the Reserve Bank of India (RBI) intervenes from time to time to
stabilize the nominal exchange rate2. It is striking that the high export growth occurred
despite an appreciation of about 1.4% in India's real effective exchange rate (REER)3
over the period from 2000 to 2010 (with the exception of the post-crisis period of 2009
when there was a sharp depreciation). The fact that Indian exports grew rapidly after
2000 despite REER appreciation does not necessarily imply that REER appreciation
had no adverse impact on exports. The growth rate of exports might have been higher
without REER appreciation.
For example, Once you get an importer to buy your goods, you enter into a business contract with
your overseas buyer. Your buyer may insist you quote the price of your goods in U.S. Dollars, Euro
Dollars, or in any other foreign currency. In some cases, you may be asked to quote in foreign
currency of an overseas buyer's country. You can convert your selling price into the currency which
the buyer is required to be quoted.

Here the question is, how does the exchange rate affect such business contracts?

Ok, you have contracted your selling price in foreign currency as per the requirement of the buyer.
The term of payment could be advance payment, Documents against acceptance, Documents
against payment after a period of time of export, a Letter of credit at sight, and a Letter of credit with
a credit period of some months after exports. The point is, you receive the amount of your sale of
goods after duration from contracting time except under advance payment. (Advance payment
transactions are a great deal in any business for a seller). At the time of maturity of payment, the
exchange rate of foreign currency could either fall down or rise up. Either you may lose or gain.
Right?
On maturity of payment as per the agreed contractual period between you and your foreign buyer,
the amount will be sent to you by your overseas buyer through his bank to your bank. If you want to
withdraw the said amount, the said foreign currency has to be converted into your local currency. So,
fluctuation in exchange rates at the time of realization of export bills affects the profit of any sales in
exports
Exchange rates in India are prone to high fluctuations, which are pegged against a
strong currency, usually the U.S. dollar. This study examines the impact of fluctuations
of Indian currency on foreign trading in India. Monthly data for the period of April 1997 –
December 2012 will be used to estimates the dollar rate fluctuation in accordance with
foreign trading with the help of a regression model. The model testing procedure will
include an augmented dickey fuller test and the Ordinary least square method.

TOOLS OF DATA ANALYSIS

1.The Stationarity Test (Unit Root Test)

It is suggested that when dealing with time series data, a number of econometric issues can
influence the estimation of parameters using OLS. Regressing a time series variable on another
time series variable using the Ordinary Least Squares (OLS) estimation can obtain a very high
R2, although there is no meaningful relationship between the variables. Therefore, prior to
testing Cointegration and regression econometric methodology needs to examine the
stationarity.Most macro economic data are non stationary, i.e. they tend to exhibit a deterministic
and/or stochastic trend. Therefore, it is recommended that a stationarity (unit root) test be carried
out to test for the order of integration. A series is said to be stationary if the mean and variance
are time-invariant. Data said to be stationary simply implies that the mean [(E(Yt)] and the
variance [Var(Yt)] of Y remain constant over time for all t, and the covariance [covar(Yt, Ys)]
and hence the correlation between any two values of Y taken from different time periods
depends on the difference apart in time between the two values for all t≠s. Since standard
regression analysis requires that data series be stationary , we use the Augmented Dickey Fuller
(ADF) test which is mostly used to test for unit root.If the ADF test-statistic (t-statistic) is less (in
the absolute value) than the Mackinnon critical t-values,the null hypothesis of a unit root can not
be rejected for the time series and hence,one can conclude that the series is non-stationary at
their levels .
Ordinary Least Square Technique
After the data is stationary we used ordinary least square regression model.
The Regression model of the study is of form :
BOT = α + βER +ε
α and β>0 where,
BOT: Balance of Trade
E.R.: Effective exchange Rate

HYPOTHESES

H01:Balance of trade has unit root.

H02:Exchange rate has a unit root.

Ordinary Least Square Technique:

Analysis of the regression results indicates that the slope parameter is significantly
different from zero (p=.002) at the 0.01% level. It indicates that there is a significant
relationship between the balance of trade and exchange rate fluctuations in India. But
intercept is not significantly different from zero. Table 4 presents the results of our
regression analysis. From table 4 the
regression equation is as follows:
dBOT(-) = -307.790 +(-2127.589) dER ………(1)
The β is negative, showing that currency depreciation (increase in the exchange rate)
worsens the trade balance for India .Frankel and Wei (1993), Wei (1999), Dell'Ariccia
(1999), Rose (2000),and Tenreyro(2003) also worked on this topic employing the
gravity model and found some significant evidence of a negative relationship between
exchange rate variability and trade The regression equation indicates that if rupee value
raise by 1 with respect to dollar the trade of balance decreases by Rs 2127. R2, the
coefficient of determination, gives the greatest indication of the strength of the
relationship. Here, R=0.254, means that 25.4% of the variation in response variable can
be explained a linear relationship with the predictor.
EMPIRICAL RESULTS
Table 1 presents the descriptive results of various study. And Figure 1 and 2 presents
the trends of international trade and exchange rate over the period of 29 years (1991 to
2019). The trends show positive movements in both the variables taken. When we see
the fluctuations in international trade and exchange rate (Figure 3) exchange rate is
fluctuation more and even has negative change while international trade also fluctuates
a lot. Table 2 present the coefficient of correlation between the variables taken and as
per results the high correlation between the variables can be concluded. Table 3
presents the results of the ADF unit root and Phillips Perron Unit root test. As per the
results it can be said that both the time series of exchange rate and international trade
are stationary. So it fulfills the assumption to run OLS regression. Table 4 shows the
results of regression model summary. The results show that the exchange rate is
significant in predicting the values of international trade in India. The value of adjusted
R-square is .712 which implies that the exchange rate is capable of explaining 71.2%
change in international trade of India. Table 5 shows the values of coefficient of
exchange rate in explaining international trade and it is significant. Figure 4 presents the
distribution of time series data of international trade. The normality of data distribution is
one of the assumptions to run ordinary least square regression. From the figure the
normal distribution of international trade data can be confirmed Figure 5 presents the
deviation of residual values from actual and as per figure, it can be said that the model
developed is suitable as it shows a good fit to the data taken.

Conclusion

This paper's principal outcomes that can be concluded from the above test and data
analysis is that tha uncertainty of the exchange rates influences the Indian sense of
foreign trade and the misalignment of the exchange rates greatly affects foreign
trade flows. Currency undervaluation promotes exports and limits imports, and vice
versa in the case of overvaluation.
.