The inflows of foreign capital into India have been a mixed blessing for the economy. Capital inflows have been associated with increased investment and rising Gross Domestic Product (GDP). The main focus of the paper lies in analyzing the behavior of the macroeconomic indicators in relation to the inflows of foreign capital and exchange rates in India since 1991, the year in which several major reform programs were initiated. It analyzes the trends in inflows of foreign capital into India and variations in exchange rate of the Indian rupee and their mutual interdependence over the period 1990-91 to 2007-08. It shows the correlation between exchange rate and inflows of capital in India, and also between the exchange rate and some macroeconomic indicators such as GDP and money supply. Further, it also shows the relationship of nominal effective exchange rate (both trade-based and export-based) with foreign direct investment and foreign portfolio investment in India. The correlation analysis of selected indicators shows that GDP is strongly related to the exchange rates of Indian rupee per unit of US dollar, pound sterling and SDR. This suggests that the prevailing exchange rates helped in the growth of Indian GDP. It also focuses on the effects of inflows of foreign capital on some macroeconomic variables in India. This paper also studies how the Reserve Bank of India prevents the exchange rate appreciation associated with rising capital inflows by accumulating foreign exchange reserves and foreign investments.

The world economy is undergoing increased integration of goods and financial markets. Global trade in goods and services has outpaced the growth in world output since the 1990s. Even though the world output growth has decelerated from 3.3% during the 1980s to 3.1% during the 1990s, growth in the volume of world trade in goods and services has accelerated from 4.5% to 6.4% over the period from 1980s to 1990s. Between 1980 and 2003, while the world output has doubled, the world trade has trebled (RBI, 2004).

Accompanying the increased trade flows is a fundamental change in the movement of capital flows. In fact, capital inflows significantly influence the exchange rates and the economy. In the 1990s, the capital inflows into developing economies had increased rapidly and these inflows were mainly private capital flows that were in part associated with the strengthening of microeconomic policy frameworks and structural reforms in these economies.

One of the most important features of the capital inflows into India since 1992, is the change in its composition from debt to non-debt creating sources. External commercial borrowing, which was the major source of the foreign capital inflows during the 1980s, became less important during the 1990s.

Applied Economics Journal, Economic Reforms, Foreign Portfolio Investments, Foreign Direct Investments, Gross Domestic Product, GDP, Microeconomic Policy, External Commercial Borrowing, Financial Markets, Capital Mobility, Goods Production, Financial Sectors, Emerging Economies, Economic Development, Macroeconomic Indicators, Foreign Investment Policy.