Determination and Stabilization Issues of India's Exchange Rate – A Game Theoretic Approach

• Published in: Journal of Economic Policy and Research 2020-04, Vol.15 (2), p.14-34
• Main Authors: Shekhar, Ch Sai Raj, Raju, G Raghavender
• Format: Article
• Language: English
• Subjects: Balance of payments; Banking; Currency; Econometrics; Economic development; Economic growth; Economic reform; Fixed exchange rates; Floating exchange rates; Foreign exchange markets; Foreign exchange rates; Foreign investment; Game theory; Games; GDP; Gross Domestic Product; International finance; International trade; Investments; Liberalization; Macroeconomics; Markets; Monetary policy; Money; Securities markets; Speculation; Tax revenues; Variables; Volatility
• ISSN: 0975-8577

Exchange Rate is a key macroeconomic and a financial variable, which reflects the position of the economy to the rest of the world and is subject to high volatility. It affects the decisions of various economic agents, who operate in international market, in the fields of trade, banking, investments, etc. The foreign exchange market is a worldwide-decentralized financial market for currency trading. In 1990s, the Indian forex market experienced a new phase of developments beginning with the Balance of Payments crisis in 1991, after which the Indian currency experienced heightened volatility due to the growing integration with the rest of the world. Hence, it becomes a necessary task to understand the sources of the uncertainties in the exchange rate. The study revolves around the identification of various macroeconomic, financial and fiscal factors with a significant influence on the exchange rate. An attempt has also been made to capture the impact of the market factors like speculation, on the exchange rate and to check for the effectiveness of the monetary and the fiscal policies in containing the speculation, using the Game Theoretic approach. The period of study has been from 1990 to 2015 with an annual frequency. The econometric models namely the ARCH-GARCH methods of estimation, Structural Vector Auto-Regressive (SVAR) and the Impulse Response Function (IRF), have been used for analysis. The conclusions obtained from the study show a significant impact of the macroeconomic variables like the GDP differential, real monetary shock, etc. and also of the fiscal variables like the debt to GDP and the tax revenues, on the exchange rate. The study has also led to the conclusion that, it is necessary for the monetary and the fiscal authorities to operate in a coordinated fashion to achieve a positive sum game with regards to controlling the speculative activities in the forex market and stabilize the exchange rate.