The Impact of Exchange Rate Volatility on Trading in India

Trade has positive impacts on economic growth of the economy so the focus of governments always has been to boost exports and explore markets for the locally produced goods to obtain higher levels of economic growth. Despite the global meltdown, India should steady growth in the economy. Projection of Indian economy by IMF, World Bank, and united nation provide positive output and trade growth. Trade facilitation is a priority of the government to cut down transition cost and time and thereby rendering Indian exports more competitive. There are fourteen Export promotion councils sponsored by Department of Commerce. They perform advisory and executive functions guided by foreign trade policy 2015-20.

There is substantial theoretical and empirical economic literature on the impact of liberalized trade on macroeconomic conditions of the economy. Adam Smith and David Ricardo, the Classical economists, strongly favored free trade amongst the economies. The term domestic trade denotes trade within common currency area. Reduced exchange rates will largely depend on corresponding degrees of trade. In order to gain some ideas about the magnitude of variables which depend upon exchange rate were estimated econometrically. IMF (1984) produced a study of the General Agreement on Tariffs and Trade (GATT) on the impact of exchange rate volatility on world trade. In last two decades, there are notable cases of large exchange rate volatility. This has been of particular concern to developing countries and emerging market economies. As a growing fraction of international transactions undertaken by multinational firms, exchange rate volatility may have a declining impact on world trade. Other changes in the world economy may have reduced impact of exchange rate volatility. Rose (2000), looks at the common currency arrangements on trade.

During the 1980s and 1990s, exchange rate fluctuations have increased currency and balance of payments crises.1984 study reinforced the conclusion that there is no unambiguous relationship between exchange rate volatility and trade flows. The general presumption that trade adversely affects exchange rate fluctuations depends on a number of specific assumptions and does not necessarily hold in all cases, especially in general equilibrium models where other variables change along with exchange rates. Turkcan and Keskinel (2009) examined the impact of exchange rate volatility on fragmentation in the US auto parts industry.

Mundell’s (1961) optimal currency area hypothesis suggests an opposite direction of causality, where trade flows stabilize real exchange rate fluctuations, thus reducing real exchange rate volatility. Most of the existing studies focused on the effects of exchange rate regimes or volatility on trade by effectively assuming that the exchange rate process is driven by exogenous shocks and is unaffected by other endogenous variables.

A large number of studies have examined Trade and exchange rate volatility under two broad frameworks. An academic study on the Exchange rate volatility on trading is very important and pertinent in the context of its structural existence. In the present study, following reviews are available in the area of exchange rate volatility with Macroeconomic variables. The research studies conducted in exchange rate volatility are related mostly to different macroeconomic variables.

Michael D McKenzie and R.M.I.T Melbourne (1999) examined The Impact of Exchange Rate Volatility on International Trade Flows, which remains unresolved at both theoretical and empirical level. This paper surveys the vast literature in the area in an attempt to identify major issues which have contributed to the development of the debate and examine whether any general direction for consensus may be found.

M Kabir Hassan (2001) examined Is SAARC a viable economic block? Evidence from gravity model Intra-South Asian Association for Regional Cooperation (SAARC) trade appears to be very small compared to other existing regional blocks. This might be because of normal outcome or because of unexplored trade opportunity. It then increased trade within this region might be welfare improving. This study attempts to make a formal analysis of these issues and estimates a gravity model of international trade to examine whether intra-SAARC is lower or higher than what is predicted by an economic model. This gives an idea about the structure of comparative advantage in the SAARC countries that helps to explain why intra-SAARC trade is low and how trade among them can be increased. It also helps us to understand the possibility of trade creation and trade diversion effect resulting from South Asian Preferential Trading Arrangements among SAARC countries. Whereas the gravity model has been extensively used to measure bilateral trade among countries, they have, to the best of my knowledge, never been used to measure intra-SAARC trade. Our gravity model results suggest that SAARC member countries are yet to achieve trade-creating benefits. Appropriate policies need to be formulated for more regional integration. Liberalization of trade in SAARC countries offers significant gains for all the economies in the region. Efforts should be made to liberalize border trade and strengthen bilateral trade relations through the removal of tariff and nontariff barriers in the general framework of South Asian Preferential Trading Arrangements.

Aristotelous (2001) examined Exchange-rate volatility, exchange-rate regime, and trade volume: evidence from the UK–US export function. The period of study was conducted from 1889-1999.The tools used in the study are Gravity models. It resulted that neither exchange-rate volatility nor the different exchange-rate regimes that spanned the last century had an effect on export volume.

Baak, Mahmood, and Vixathep (2002) investigated the impact of exchange rate volatility on exports in four East Asians countries (Hong Kong, South Korea, Singapore, and Thailand). Their results indicated that exchange rate volatility has negative impacts on exports in both the short run and long run periods.

Mohsen Bahmani-Oskooee and Scott W. Hegerty (2007) examined Exchange rate volatility and trade flows This paper examined the vast empirical literature, up to 2005, to assess the main trends in modeling and estimating this tradeflows at the aggregate, bilateral, and sectoral levels. The increase in exchange-rate volatility since 1973 has had indeterminate effects on international export and import flows. Although it can be assumed that an increase in risk may lead to a reduction in economic activity, the theoretical literature provides justifications for positive or insignificant effects as well. Similar results have been found in empirical tests. While modeling techniques have evolved over time to incorporate new developments in econometric analysis, no single measure of exchange-rate volatility has dominated the literature. Originality/value – An argument put forward by the opponents of the floating exchange rates is that such rates introduce uncertainty into the foreign exchange market, which could deter trade flows. However, a theoretical argument is put forward by some to show that uncertainty could also boost trade flows if traders increase their trade volume to offset any decrease in future revenue due to exchange rate volatility.

Tenreyro (2007) examined the trade impact of nominal exchange rate volatility. The period of study was from 1970-1997.It resulted in the probability that a client anchors its currency to one of the main anchors increases when the client is closer to the anchor, and when they share a common colonial past. The propensity to anchor the currency increases with the size of the anchor, among the five considered, where size is measured by GDP per capita and geographical area. The population of the anchor does not seem relevant, although it is likely that this insignificance is due to the high correlation between population and geographical area. Finally, the larger the difference in size (as gauged by per capita GDP and population) between anchor and client, the larger the propensity to anchor the currency. In other words, relative size seems to matter (although the difference in areas is virtually irrelevant).

Wilson and Otsuki (2007) examined Regional integration in South Asia: What role for trade facilitation?. The period of study was from 1980-2000.It resulted there are significant potential gains to trade for South Asia associated with collective efforts to raise capacity in trade facilitation. The steps to reduce barriers to trade logistics in the region promise expanded trade opportunities with the rest of the world

Rahman (2008) examined The foreign trade of Bangladesh: its composition, performance, trend, and policy. The period of the study was from 1991-2003.It resulted in the trade balance with the SAARC countries, especially with India, further currency devaluation, measures to stop border smuggling, removal of tariff and non-tariff barriers on Bangladesh’s exports, arrangement for more Indian investment in Bangladesh and political harmony in the region are vital. A customs union within the SAARC region is likely to offset many of the existing trade-related problems.

Sultan (2008) examined Trade, industry and economic growth in Bangladesh. The period of study was from 1971-2003.The tools used in the study are Descriptive statistics, Correlation matrix, unit test root results, Regression tests, Johansen Bivariate and Multivariate Cointegration tests, Granger causality tests. It resulted there is no significant relationship between the Growth rate of export and the growth rate of the gross domestic product of Bangladesh. There is no causal relationship between export growth and industrial growth. Growth rate of export is Granger caused by the growth rate of industry added but not vice versa.

Ali and Talukder (2009) examined Preferential Trade among the SAARC Countries: Prospects and Challenges of Regional Integration in South Asia. It analyzed regional and international trade structures of South Asian countries through conventional trade measures such as commodity composition and direction of trade, and bilateral trade shares. It resulted in preferential trade liberalization brought trade diversion than trade creation leading to more gains for large countries and more losses for small countries. Trade policies of individual countries shaped political considerations than economic factors.

Bajwa and Siddiqi (2011) examined Trade Openness and Its Effects on Economic Growth in Selected South Asian Countries: A Panel Data Study. The period of the study was from1972-1985 and 1986-2007.The tools used in the study are co-integration tests. It resulted that there exists long-run negative relationship. In time period 1986-2007 the elasticity magnitude had a positive sign that indicated positive causation between GDP and openness. It was concluded that after the implementation of SAARC overall situation of selected countries were better. Also long-run coefficient of error term suggests that short-term equilibrium adjustments are driven by adjustment back to long-run equilibrium