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The IUP Journal of Applied Economics
Macroeconomic Determinants of Indiaís Foreign Exchange Reserves: An Empirical Analysis
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The study of foreign exchange (forex) reserves has assumed importance due to increasing globalization of emerging market and developing economies. The journey of India from abysmally low reserves in 1991 to todayís comfortable position has made the study of forex reserves very relevant in Indian context. This study, covering the period from 1996-97:Q1 to 2014-15:Q4, attempts to identify various macroeconomic determinants of Indiaís forex reserves. While the ratio of Indiaís forex reserves to its GDP is considered as the dependent variable, the ratio of M3 to GDP of India, trade openness of India, and volatility of US dollar-INR bilateral nominal exchange rate are considered as the explanatory variables. The study performs stationarity tests, Johansenís cointegration test, Johansenís Vector Error Correction Model (VECM) in VAR, impulse response function and variance decomposition analysis. With all the variables in log terms being I(1), Johansenís cointegration test confirms one long-run relationship among the variables. Forex reserves are found to be varying positively with money supply and trade openness, and negatively with exchange rate volatility. Deviations in forex reserves adjust towards the equilibrium level in the long run, but at a low speed. Therefore, RBI may be engaged in active reserve management.

 
 
 

The study of foreign exchange (forex) reserves has assumed importance because of increasing globalization of emerging market and developing economies. Forex reserves have also become important in the context of debt crisis leading to banking crisis, which in turn leads to financial crisis in several countries. The debt crisis in the early 1990s, the 1997 East Asian Crisis, and the Global Financial Crisis in 2007-08 have posed several challenges to policy makers in management of forex reserves. The subject of forex reserves can be broadly divided into two parts, viz., the theory of reserves and the management of reserves. The theory of reserves talks about the rationale behind maintaining reserves, viz., statutory basis, institutional arrangements, composition of reserves, objectives for holding reserves, exchange rate regimes, etc. Statutory basis, institutional arrangements, and exchange rate regimes are country-specific. Forex reserves do not have any unique conceptual definition. However, in terms of IMF’s Balance of Payments and International Investment Position Manual (BPM6), forex reserves include the unencumbered international assets which are owned by a central bank, which can take care of the external payment obligations and the central bank’s interventions in the domestic forex market.

 
 
 

Applied Economics Journal, Macroeconomic, Determinants, Indiaís, Foreign Exchange Reserves, Vector Error Correction Model (VECM), Bank for International Settlements (BIS), An Empirical Analysis.