Factors Influencing Rupee-Dollar Exchange Rate in the Post-Reform Period: An ARDL Approach

Abstract

In the era of growing global economic integration, international transactions such as trade, investment, and financial activities have become inevitable for every country, and central to these activities is the exchange rate. Nowadays, the Indian economy is more open, and hence, the stability of the rupee-dollar exchange rate (₹/$ ER) has become a crucial issue for the economy. Despite the historic 1993 reform in the Indian exchange rate management system, the rupee remained highly volatile, especially against the dollar, raising questions about the factors driving its fluctuations. The present study aims to identify these factors. The study employs the ARDL model, using annual data from reliable sources such as the Reserve Bank of India (RBI) and the World Bank for the post-reform period (1993-2023). The analysis reveals a long-run cointegrating relationship among the variables in the reference period. The estimated long-run ARDL model suggests that, among the selected macroeconomic factors, inflation and the interest rate are significant determinants of the ₹/$ ER in the post-reform period, and that, among the selected external factors, foreign portfolio investment (FPI), the current account balance, and oil prices are significant determinants of the ₹/$ ER in the post-reform period. However, the short-run dynamics highlight the role of interest rates and FPI alone, while the error-correction term confirms a moderate adjustment toward equilibrium. Identification of the significant factors affecting the ₹/$ ER would help in implementing policies to control these factors, at least to some extent, which may help to keep the ₹/$ ER more or less stable.  The findings underscore the interconnectedness of monetary policy, trade dynamics, and global financial flows in shaping exchange rate behaviour.