The exchange rate of a country has a major impact on its level of trade. In the era of currency convertibility, volatility of exchange rate seems to largely affect the level of trade or trade balance. However, the presence of hedging instruments could neutralize this effect.This study is an attempt to find the relationship between the trade balance of India and the exchange rate volatility. It has taken quarterly data from January 1993 to March 2004. REER (Real Effective Exchange Rate) is used for the purpose of determining exchange rate volatility. The study uses two measures of volatility to find out its impact on trade balance. It concludes that during the said period, volatility in the currency has failed to have an impact on the trade balance of India. Also, there exists no lagged impact of exchange rate on the trade balance of India, which proves that the J-curve effect is not observed here.

The trade balance of a nation can be improved either through an internal approach or an external approach. The internal approach involves changing the supply side policies like labor productivity or wages, by lowering inflation or by relaxing rigid market conditions. The external approach, on the other hand, involves devaluing or depreciating the country’s currency. In this paper, the authors have empirically tested the second approach to improve the trade balance.

The relationship between exports and exchange rate is a well-researched area. Depreciation of a country’s currency with respect to its trading partner helps in making the exports more competitive and hence, the likeliness of exports increasing with respect to that trading partner, improves. India had gone convertible on current account in the year 1993-94, and has followed the policy of managed float since then. The Indian currency has also devaluated/depreciated by 3.86% annually since that time. In the same period, exports registered a growth of 11%. However, the Indian economy has undergone varied changes over the same period and the service sector has come to dominate the GDP of the country as compared to the manufacturing or agriculture sectors.

Along with this, the profile of exports has also undergone similar changes. Indian exports can be chiefly divided into categories of primary products (mainly agricultural products and Ores), manufactured goods, petroleum products and others. Since 1993-94, the share of manufactured goods in the total exports has more or less been constant.