In the present study, an attempt has been made to explain the dynamics of exchange rate in Indian foreign exchange market. The empirical study is based on ‘Multiple Regression Analysis’ to identify the factors that drove the exchange rate of USD/INR during the period January 1999 through March 2011. Apart from the secondary data, the primary data on exchange rate of USD/INR was collected through a questionnaire from 175 professionals across the world. The results suggest that lagged value of the dependent variable (USD/INR), current account balance, relative money supply, index of industrial production and interest rate differential are the most significant variables in determining the USD/INR exchange rate. It is also observed that forward premia, capital account and RBI’s net intervention do affect exchange rates (significant at 10% level), but their impact is found to be marginal. The survey results, based on primary data, suggest that Indian foreign exchange market has become deep, liquid and efficient over a period of time. A majority of the respondents agreed that forward premia influence future exchange rates. There is a near unanimous view that RBI played a proactive role during the financial crises in the past. The results have policy implications since exchange rates affect all the sectors of the economy.

An exchange rate is the price of one currency in terms of another. Exchange rate is determined in a market called ‘foreign exchange market’. The rates quoted in foreign exchange market fluctuate every moment due to a wide variety of economic and political factors apart from traditional market forces, viz., demand and supply. Besides, the actions, positions and expectations of market players do influence the exchange rate behavior.

With the increasing integration of international financial markets, the role of exchange rate has become important from the viewpoint of policy makers and market players, and hence calls for a credible assessment of dynamics of exchange rate. Throughout the world, extensive research on exchange rate determinants and volatility during the last four decades has been documented. In India, though considerable number of research studies have been undertaken in this area, it is felt that there is a genuine need to undertake a fresh research study to identify the forces that determine the exchange rates in the wake of excessive volatility witnessed by Indian Rupee against US Dollar (INR against USD) in the recent times. For instance, INR breached the psychological barrier of 50 per USD in October 2008, reflecting the prevailing volatile market conditions during the global financial crisis; later, INR reached its all-time low of 57.92 per USD in June 2012, primarily due to higher Current Account Deficit (CAD), escalating oil import bill, huge redemptions in External Commercial Borrowings (ECBs)/Foreign Currency Convertible Bonds (FCCBs), lower capital inflows from Foreign Institutional Investors (FIIs) and sovereign debt crisis in the Eurozone.

Against this background, the objective of the present study is to determine the forces that affect the movements in exchange rate of USD/INR, since more than 96% of India’s foreign exchange turnover is denominated in USD as per the BIS Central Banks’ Triennial Survey, 2010. As per the survey, Indian foreign exchange market is the 15th largest market in the world with a daily average net turnover of USD 27.4 bn (market share increased from 0.1% in 1998 to 1% in 2010). The rest of the paper is structured as follows: the next section presents an overview of the Indian foreign exchange market and literature review, followed by the research methodology of the study. The subsequent section presents an empirical analysis of the exchange rate of USD/INR, and the final section provides the conclusion.

Applied Finance Journal, Exchange, Rate, Dynamics, Indian, Foreign, Exchange Market, Empirical, Investigation, Movement, USD, INR.