Empirical analysis of long run equilibrium between exchange rate and foreign exchange reserve – an Indian perspective

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The present study makes an effort to find the long run equilibrium between Exchange Rate and Foreign Exchange Reserve. Fifteen years data of these variables has been extracted from the official website of Reserve Bank of India and has been analyzed by devising statistical software E – Views.

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Nội dung Text: Empirical analysis of long run equilibrium between exchange rate and foreign exchange reserve – an Indian perspective

International Journal of Management (IJM) Volume 7, Issue 6, September–October 2016, pp.89–94, Article ID: IJM_07_06_010 Available online at http://www.iaeme.com/ijm/issues.asp?JType=IJM&VType=7&IType=6 Journal Impact Factor (2016): 8.1920 (Calculated by GISI) www.jifactor.com ISSN Print: 0976-6502 and ISSN Online: 0976-6510 © IAEME Publication EMPIRICAL ANALYSIS OF LONG RUN EQUILIBRIUM BETWEEN EXCHANGE RATE AND FOREIGN EXCHANGE RESERVE – AN INDIAN PERSPECTIVE Dr. Pritpal Singh Bhullar Assistant Professor - Department of Humanities & Management Studies, Giani Zail Singh Campus College of Engineering & Technology, India. Manika Dhameja CA (Final), ICAI New Delhi, India ABSTRACT The present study makes an effort to find the long run equilibrium between Exchange Rate and Foreign Exchange Reserve. Fifteen years data of these variables has been extracted from the official website of Reserve Bank of India and has been analyzed by devising statistical software E – Views. Regression analysis has been applied through SPSS to evaluate the relationship between foreign exchange reserve and exchange rate. The statistical output of present research supports the previous research documents and shows the existence of long run equilibrium between these foreign exchange reserve and exchange rate. It also supports the influence of foreign exchange reserve on the exchange rate of country. Key words: Foreign exchange Reserve, Exchange Rate, Regression. Cointegration Test and Unit Root Test. Cite this Article: Dr. Pritpal Singh Bhullar and Manika Dhameja, Empirical Analysis of Long Run Equilibrium between Exchange Rate and Foreign Exchange Reserve – An Indian Perspective. International Journal of Management, 7(6), 2016, pp. 89–94. http://www.iaeme.com/IJM/issues.asp?JType=IJM&VType=7&IType=6 1. INTRODUCTION Capital flow acts as the blood in veins of the economy. High capital flow boosts the chances of growth of economy. The positive global macroeconomic signs are true symbolic representation of rise of capital flow in any economy. With globalization, the interdependence of economies has been increased. The global events have significant impact on the capital flow of the economies. The financial recession of 2008 dent the capital inflow in all the major economies across the globe. With globalization, the financial flow has been inclined developed countries to developing countries and under developed countries. The manifold rise has been reported in capital flows in many developing economies. Kohli (2203) supports the fact that increase in capital flow to any economy boost its liquidity, stock market growth and growth prospects of corporate. Carderelli et al (2010) analyzed that capital flow has significant effect upon the economic sectors like real estate, financial sector and manufacturing sectors. Dua and Sen (2013) documents the http://www.iaeme.com/IJM/index.asp 89 editor@iaeme.com
Dr. Pritpal Singh Bhullar and Manika Dhameja dependency between capital flow and several macro economic variables like current account deficit, liquidity, inflation and money supply. Since last one decade, India has been emerged as a global destination for investment. Major global investors have been attracted to India for their bulk investment as Indian market has sent positive sentiments to the global investors. The countries maintain their foreign exchange reserves to meet their international short term and long term payment obligations. These obligations consists of sovereign debt, import financing, commercial debt, for intervention in the foreign currency markets during periods of volatility, besides helping to boost the confidence of the market in the ability of a country to meet its external obligations and to absorb any unforseen external shocks, contingencies or unexpected capital movements. Foreign exchange reserve comprises of Foreign Currency Assets, Gold and SDR (Special Drawing Rights) and Reserve Tranch Position in which each member is allocated a special quota by IMF. These include sovereign bonds, treasury bills and short-term deposits in top-rated global banks besides cash accounts. with the change in the patterns of global trade and other developments including several currency crises. Foreign exchange reserves acts as catalyst in maintaining stability of macro-economy. The accumulation of foreign exchange reserve build the strong platform for enhancing the control of economy of any country, rise in efficiency in currency intervention and also avoids the probability of occurring financial crisis and national and international level. The rapid fluctuations in foreign exchange reserve indicates the weak foreign trade activities and economic policies. Reza, Ostry and Sheehy (2011) quote that foreign exchange reserve acts as external assets that assists in maintaining Balance of Payments (BOP) and controlling exchange rate with other countries. The exchange rate intervention also have significant effect upon the foreign exchange reserve of any country. Kasman and Ayman (2008) examines short term and long term unidirectional flow of causality from foreign exchange rate to real exchange rate as well as from nominal exchange rate to foreign exchange reserve. 2. REVIEW OF LITERATURE Emmanuel (2013) study the effect of foreign exchange reserve on exchange rate in Nigeria and finds that foreign exchange reserve has significant effect upon the exchange rate of Nigeria. Hoshikawa (2012) analyzed the existence of long term rerelationship between foreign exchange reserve and exchange rate. Romero (2011) perform a comparative analysis of factors affecting foreign exchange reserve on India and China and find that an inverse relationship between exchange rate and foreign reserve. They find that with rise in exchange rate the foreign exchange reserve falls down. Prasad and Raju (2010) find an inverse relationship between foreign exchange international reserve and exchange rate. They explore that an inverse relation between foreign exchange reserve and exchange rate when the currency of home country depreciates. Kasman and Ayan (2008) study the relationship between foreign exchange reserve and exchange rate in Turkey and finds that long run relationship exist between them. Elhiraika and Ndikumana (2007) examine that countries maintain foreign exchange reserve to lower the inflation and foreign exchange rate in home country. Bachhante et al. (2006) confirms the harmful effect of volatile exchange rate and foreign exchange reserve on the economic growth of any economy. Dua and Sen (2006) analyse empirically from financial year 1993 to financial year 2004 and finds that Cointegration exist between capital flow level, volatility in capital flow and real exchange rate. Aizenman and Lee (2005) confirms that countries reserve foreign exchange reserve to maintain low exchange rate and enhance economic growth 3. OBJECTIVES OF STUDY The present study is aimed at fulfil the following objectives from Indian prospective: • To analyze the existence of long run equilibrium between foreign exchange reserve and exchange rate • To analyze the existence of causal relationship between foreign exchange reserve and exchange ratio 4. RESEARCH METHODOLOGY To achieve the objectives stated in the present research paper, statistical techniques have been devised. Causal relationship between foreign exchange reserve and exchange reserve has been measured by Unit http://www.iaeme.com/IJM/index.asp 90 editor@iaeme.com
Empirical Analysis of Long Run Equilibrium between Exchange Rate and Foreign Exchange Reserve – An Indian Perspective Root Test, Johansson Co -integration Test and Vector Auto Regression (VAR) test. E-views Statistical software has been used to devised these tests for the statistical interference. Foreign exchange reserve data and exchange rate have been used as the variables. The data of Indian foreign exchange reserve and exchange rate from FY 2005 to FY 2016 has been collected from the official website of Reserve Bank of India. The influence of foreign exchange reserve and exchange rate has been examined by the regression analysis by applying SPSS software. 5. HYPOTHESIS • Hypothesis I – A long run relationship does not exist between foreign exchange reserve and foreign exchange rate • Hypothesis II – Foreign Exchange Reserve has no significant affect on Exchange rate. 6. DATA ANALYSIS 6.1. Unit Root Test at Levels (Augmented Dickey - Fuller Test) Unit Root Test has been performed to analyze whether the data is stationary of not. Table 1 Unit Root Test at Level Level No Trend With Trend Variables t– t- p p statisti Critical Values statisti Critical Values value value c c 1% 5% 10% 1% 5% 10% 0.199 - 0.767 LNEXRATE -2.221 -3.438 -2.865 -2.568 -1.66 -3.415 -3.130 1 3.969 3 LNFRXCRAT - 3.000 -3.438 -2.865 -2.568 1.000 -0.201 -3.415 -3.130 0.993 E 3.969 6.2. Unit Root Test at First Difference (Augmented Dickey - Fuller Test) Table 2 Unit Root Test at First Difference First Difference No Trend With Trend Variables p t- p t- Critical Values valu statisti Critical Values valu statistic e c e 1% 5% 10% 1% 5% 10% - LNEXRATE -3.438 -2.865 -2.568 0.000 -23.861 -3.969 -3.415 -3.130 0.000 23.7980 LNFRXRAT -10.893 -3.438 -2.865 -2.568 0.000 -11.500 -3.969 -3.415 -3.130 0.000 E http://www.iaeme.com/IJM/index.asp 91 editor@iaeme.com
Dr. Pritpal Singh Bhullar and Manika Dhameja The above statistics shows that series is not stationary in both the cases but it become stationary after taking first difference. The p value for both the variables becomes lower than 0.05 that shows the stationarity of series. 6.3. Johansen Juselius (J-J) Cointegration Test Johansen and Juselius Cointegration test (1990) has been performed to analyze the long run relationship between variables Table 3 J-J Cointegration Test Trace Max-Eigen Critical Values (5% ) Hypothesized No. p - Values of CEs Trace Max - Statistics Statistics Trace Max-Eigen Eigen r=0 13.30554 11.79033 15.49471 14.26460 0.1041 0.1188 r≤1 1.515210 1.515210 3.841466 3.841466 0.2183 0.2183 The above Trace test statistics and Max – Eigen statistics shows that no Cointegration exists between the variables as the p values in both the cases is higher than 0.05. Higher the p – values more than its significant vale (5%) leads to rejection of null hypothesis at this level. The non - existence of Cointegration supports the existence of long run equilibrium in both the variables. 6.4. Pairwise Granger - Casuality Test The Granger Causality test indicates a causality run from foreign exchange reserve to exchange rate Table 4 Granger Causality Test Null Hypothesis: A variable does not Granger cause the other F- p- p value & S. No Null Hypothesis Decision statistics value Significant level LNEXRATE does not Granger Reject Null 3.80371 0.0227 0.022 < 0.05 Cause LNFOREXCRESERVE Hypothesis. 1 LNFOREXCRESERVE does not Can’t Reject 0.63018 0.5328 0.532 > 0.05 Granger Cause LNEXRATE Null Hypothesis The above statistical table depicts a causal relationship between Exchange rate and foreign exchange reserve. The p values (0.02 < 0.05) show that Foreign Exchange Reserve cause changes in change in Exchange Rate. http://www.iaeme.com/IJM/index.asp 92 editor@iaeme.com
Empirical Analysis of Long Run Equilibrium between Exchange Rate and Foreign Exchange Reserve – An Indian Perspective 7. RESIDUAL GRAPH The residual graphs show that no autocorrelation exists between residuals LNEXRATE Residuals .06 .04 .02 .00 -.02 -.04 -.06 100 200 300 400 500 600 700 LNFOREXCRESERVE Residuals .06 .04 .02 .00 -.02 -.04 -.06 100 200 300 400 500 600 700 8. REGRESSION ANALYSIS Model Summaryb Model Change Statistics Adjusted Std. Error R R R of the Square Sig. F Durbin- R Square Square Estimate Change F Change df1 df2 Change Watson 1 .563a .453 .448 .12881 .448 111.253 1 784 .000 .005 dimension0 a. Predictors: (Constant), LNFOREXCRESERVE b. Dependent Variable: LNEXRATE Coefficientsa Model Unstandardized Standardized Coefficients Coefficients B Std. Error Beta t Sig. 1 (Constant) 2.953 .089 33.010 .000 LNFOREXCRESERV .078 .007 .353 10.548 .000 E a. Dependent Variable: LNEXRATE http://www.iaeme.com/IJM/index.asp 93 editor@iaeme.com
Dr. Pritpal Singh Bhullar and Manika Dhameja The above graphs shows that there foreign exchange reserve affects the exchange rate of country. The statistics depit in the above model that foreign exchange reserve affects 35.3% to the exchange rate of Indian Economy. Regression Equation = + = 0.353 ∗ + 2.953 9. CONCLUSION We observe that there is a stable long run relationship between Exchange Rate and Foreign Exchange Reserve. The result of our study produces similar result with previous studies Hoshikawa (2012). The present study also explores the effect of foreign exchange reserve on the exchange rate of country. This finding also similar with Prasad and Raju (2010) and Aizenman and Lee (2005). The findings of the present study helps in providing the firm roots to the previous studies and provide guidelines to the future researchers to consider the influence of other variables. REFERENCE [1] Bhatia, A., & Kishor, N. (2013). Impact of FII Investments on Stock Market Volatility and Foreign Exchange Reserves: The Indian Experience. Transnational Corporations Review, 5(3), 26-45 [2] Emmanuel Umeora Chinweobo (2013) , “Accumulation of External Reserves and Effects on Exchange Rates and Inflation in Nigeria” International Business and Management, Vol. 6, No. 2, 2013, pp. 105- 114 [3] Dua, P., & Sen, P. (2006). Capital Flow Volatility and Exchange Rates: The Case of India”, Centre for Development Economics, Working Paper No. 144, Department of Economics, Delhi School of Economics, Delhi University, New Delhi. Retrieved from http://www.cdedse.org/pdf/work144.pdf [4] Elhiraika A. and Ndikumana (2007), Reserves Accumulation in African Countries: Sources, Motivations and Effects, University of Massachusetts Amherst Working Paper, 2007-12, pp 1-27 [5] Soniya Mohil, “Liaison between Exchange Rate and Trade Balance: an Empirical Study on India”. International Journal of Management (IJM), 4(6), 2013, pp. 159–164. [6] Kasman & Ayhan. (2008). Foreign Exchange reserves and Exchange rate in Turkey: Structural breaks, unit roots and Cointegration. Journal of Economic Modeling, 25: 83-92. [7] Prasad & Raju. (2010). Foreign Exchange Reserves management in India: Accumulation and Utilization, Global Journal of Finance and Management,2: 295-306. [8] Olayungbo D.O. and Akinbobola T.O. (2011), Foreign Exchange Reserves and Exchange Rates in Nigeria. Structural Breaks, Unit Roots and Cointegration tests, Journal of Social and Economic Development. pp 1-6 [9] Dr. M. Sheik Mohamed and Dr. M.A.Shakila Banu, “”Study on Weak-Form Efficiency of Foreign Exchange Markets of Developing Economies: Some India Evidence”. International Journal of Management (IJM), 6(1), 2015, pp. 331–342. [10] Reza M, Ostry J.D and Sheehy R. (2011), Assessing Reserves Adequacy. IMF, prepared by Money and Capital Markets, Research strategy, Policy and Review Department. Pp 1-49 [11] Romero A.M (2011), Comparative Study: Factors that Affect Foreign Currency Reserves in China and India, the Park Economists, vol x 111. Pp 79-88 http://www.iaeme.com/IJM/index.asp 94 editor@iaeme.com