Foreign exchange market in India has gone through many structural reforms since last decade. The study tests the market efficiency in forex market using data for the period, March 1993 to May 2004. The weak form of efficiency cannot be rejected. The mean reversion theory can be well accepted. The Augmented Dickey-Fuller (ADF) test testing for stationarity also supports the weak form of efficiency of the market. The `day effect' was not found in the study though all the "days' mean" returns were significantly non-zero. It was found that AR(2) and AR(3) models tracks the market volatility better in comparison to other models.

The process of economic liberalization and thrust on reforms in the financial sector and the foreign exchange market in particular that was initiated in India in early nineties has resulted into increasing integration of the Indian FX market with that of the global markets. With a large number of foreign funds and foreign institutional investors now actively participating in the Indian financial markets (foreign exchange reserves standing at about USD118 bn), the style of functioning of the market itself has undergone a lot of change and result of microstructure changes are visible. Today the Indian FX market, which was insulated from outside impacts, has been getting integrated with the world markets. It is, in general, the belief that markets in the developing and less developed countries are not efficient in terms of EMH. However, to substantiate this belief very few studies have been undertaken in comparison to the number of studies on the markets in developed nations. This study has the objective of test the Efficient Market Hypothesis for the Indian FX market (using closing INR-USD exchange rate) in its weak form. The daily closing data from March 1993 to May 2004 have been analyzed for the purpose of this study.

About a generation ago the Efficient Market Hypothesis was widely accepted by the financial economists. It was the general belief that securities markets were extremely efficient in the sense that they were able to absorb information very quickly which was reflected immediately. This meant that investors cannot benefit either from the technical analysis. Previous studies have suggested an increase in correlation among the world’s FX markets as many developing countries have introduced capital account convertibility. India is a country where the domestic currency is not fully convertible though capital account convertibility is gaining momentum in recent years. This implies that now the international diversification of portfolios won’t be able to assist the portfolio managers in reducing the risk of the portfolio.

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