SUBMITTED BY GROUP 12 :

AKHIL NARANG F2022007

DINESH SHARMA F2022018
EXCHANGE PRANJAL THAREJA F2022034
VIDHI GODANI F2022061
ZIYADALI AMLANI F2022062
RATE: FACTORS
AFFECTING
EXCHANGE RATE
OF INDIA
Contents
INTRODUCTION ...................................................................................................................................... 2
CALCULATION OF EXCHANGE RATE : ................................................................................................. 2
TYPES OF EXCHANGE RATES .............................................................................................................. 3
EXCHANGE RATE VOLATILITY ............................................................................................................. 3
LITERATURE REVIEW .............................................................................................................................. 5
FACTORS AFFECTING EXCHANGE RATES: .............................................................................................. 6
RESEARCH OBJECTIVE............................................................................................................................. 7
METHODOLOGY AND DATA ................................................................................................................... 7
FINDINGS ................................................................................................................................................ 8
ANALYSIS: ............................................................................................................................................. 11
LEARNINGS FROM THE PROJECT.......................................................................................................... 13
CONCLUSION ........................................................................................................................................ 14
REFERENCES .......................................................................................................................................... 15

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 INTRODUCTION

The price of translating one currency into another is known as the exchange rate. It is the cost
of one currency expressed in terms of another. The foreign exchange rate or currency
exchange rate are other names for it.

The Indian Rupee has undergone a quick and significant decline versus the US Dollar due to
an episode of extreme volatility in India. The Indian Rupee achieved an all-time low against
the Dollar in October 2022 when it crossed the 83 per Dollar threshold. Exchange rate
volatility makes it harder to make decisions about international trade and investments
because it raises exchange rate risk. If international trade participants are aware of the
dangers associated with currency rates, they can choose to stop dealing in foreign markets
and instead shift to domestic industries where returns are more predictable. International
merchants can also try to use forward foreign currency markets to protect themselves from
potential losses.

Calculation of Exchange Rate :

The following methods are used to calculate exchange rates:

• Nominal Exchange Rate(E) - The number of units of the domestic currency that
may be purchased with one unit of a foreign currency is known as the nominal
exchange rate (E). In the event of a fixed exchange rate regime, a decline in E is known

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 as a nominal appreciation of currency (revaluation), whereas an increase in E is known
as a nominal depreciation of currency (Devaluation in case of a Fixed Exchange Rate
Regime)

• Real exchange rate(R) - It is the difference between domestic and international

prices, where domestic prices are expressed in domestic currency units using the
nominal exchange rate that is in effect at the time.

Types of Exchange Rates

• Fluctuation Exchange Rate - Market dynamics like supply and demand determine
the rate. Each currency represents the value that purchasers are ready to give it.

• Fixed Exchange Rate - A rate that is established and upheld by a nation's

government or a financial organisation like the Central Bank. The rate is typically
established with the US dollar and is not allowed to change.

• Managed Floating Exchange Rate - is a hybrid system since it combines the Fixed
Rate and Floating Rate systems. In this system, market forces set the exchange rate,
while the central bank governs it in the event that the domestic currency appreciates
or depreciates.

Exchange Rate Volatility

Exchange rate volatility is the propensity for foreign currency values to shift, which has an
impact on how profitable foreign exchange trades are. The volatility captures both the
magnitude and the frequency of variation in these rates. Interest rates, inflation, and the
economic standing of each nation are just a few of the many factors that affect the exchange
rate.

There are three types of risks associated with exchange rate volatility; they include the
following:

• Transaction Exposure: It is the risk that the value of the currency will fluctuate after a
firm has already undertaken a financial obligation. The effect of this type of risk is one-sided,

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which means companies that complete their transactions in foreign currency face 5
vulnerability. A high level of exposure to those losses can lead to significant losses though
certain ways to hedge those risks exist. For better understanding, we can refer to this
example; a US-based firm is willing to buy a product in Germany. The American firm needs to
pay using the German currency, which is the euro. At the time of negotiation, say the value
of euro/dollar exchange is in the 1:1.5 ratio. This means 1 Euro is equal to 1.5 USD Dollars.
Now, the transaction may take place slowly, while at the time of the final transaction, there
is a significant possibility that the exchange rate may change. Based on the ongoing market
conditions, the rates could be more or less favourable for US-based companies. This is the risk
of change in transaction exposure. This type of exposure is mostly for short-term to medium-
term.

• Translation Exposure: Here, the effect is on the company’s consolidated financial

statements. It is mainly for mid-term to long-term. This risk states that a company’s assets,
equities, liabilities, or income can change due to a shift in exchange rates. This is prominent
when a firm dominates its assets, liabilities, and others in foreign currencies. Highly
professional accountants aim to use the most effective cost accounting to hedge this risk.
Translation risk can lead to what appears to be financial loss or gain that does not result from
the change in assets but a change in the value of the currency. We can understand this with
an example, suppose a German firm is worth Euro 1 million, and the current dollar-to-euro
ratio is 1:1, then the worth will be reported as $1 million. If the ratio becomes 1:2, the German
firm will report assets worth $500,000. This will appear as a loss of $500,000 on the financial
statements even when the firm will have the exact worth of the property. There is a variety
of mechanisms to hedge risks associated with translation exposure.

• Economic or Operating Exposure: This exposure is long-term in nature. This occurs

because unexpected changes in the foreign exchange rate directly or indirectly affect the
company’s future cash flow, investments, and earnings. Exposure increases as foreign
exchange volatility increase and falls as it decreases; they share a directly proportional
relationship. This exposure can better be understood by an example; say, a US company that
manufactures electronics and sells only locally will still be affected by exchange rate 6
changes. The company will have to contend with imports from other countries like India and
China, which may get cheaper and become more competitive when the dollar strengthens.

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 Literature Review

1. Growth and undervaluation of the exchange rate were found to be related. A fluctuating
exchange rate's effect on the economy can be either positive or negative. (Rodrik, 2008)
Exchange rates provide a solution to economic issues such as fluctuating exchange rates and
unstable financial conditions. It indicates the number of units of one country's currency that
can be purchased with one standard unit of currency.
It decides how quickly currencies change. The decisions of policymakers may be influenced
by exchange rate volatility. Additionally, it affects the amount of exports and imports, how
different goods are manufactured, and the balance of payments. It offers domestic investors
a chance to invest in foreign currency to make more money. Export and import prices, reserve
currency, and growth rates are all impacted by exchange rate volatility.

2. The exchange rate may fluctuate in one of two situations.

• First off, exchange rates can respond to shocks to economic variables like
macroeconomic policies and relative prices while still being completely consistent
with them, and they can do so before adjusting to the new equilibrium level. Since it
magnifies the effects of market disruptions and unemployment domestically,
exchange rate volatility may be expensive.
• Second, if factors unrelated to economic variables have an impact on exchange rates,
they may be too volatile. Rate changes in this scenario would be unpredictable,
especially in the near future. Exchange rate volatility is brought on by changes in
macroeconomic variables and the business environment.

3. Following India's adoption of a flexible exchange rate, emerging market economies now
place more emphasis on exchange rates. This study has focused on the effects of exchange
rate volatility on various macroeconomic variables. In order to determine whether there is
any correlation between exchange rate volatility and macroeconomic factors like GDP, FDI
inflows, inflation, central government debt, lending interest rate, and net trade in goods, this
study has been carried out.
Although there is a direct theoretical connection between exchange rate volatility and
macroeconomic variables, there is no agreement because of the inconsistent results of earlier
studies.

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 Factors affecting exchange rates:
1. Inflation: Inflation, an increase in a county’s general price level, is one of the most
common causes of exchange rate fluctuations. Both cost-pull and demand-pull inflations lead
to a rise in the prices of goods and services domestically available. A rising currency’s value is
generally an effect of low inflation as the purchasing power of the consumers rises with a
decline in the price level. Conversely, high inflation reduces purchasing power and typically
leads to a depreciation in the currency. Inflation may also be driven by an increase in the
government debt, an increase in the prices of housing markets, changes in government and
taxation policies and a range of other factors.

2. Gross domestic product (GDP) - The gross domestic product (GDP) is the total
monetary worth of all finished goods and services produced within a nation's boundaries
during a given time frame. It serves as a thorough assessment of the state of the economy in
a particular nation because it is a broad indicator of total domestic production.

3. FDI net inflows – The value of inward direct investments made by investors not residing
in the reporting economy is known as Foreign Direct Investment net inflows. It includes the
reinvested earnings, the intra – company loans, repayment of loans and net of repatriation.

4. Central Government Debt - The financial obligations of the public sector are referred
to as a nation's gross government debt, also known as public debt or sovereign debt. The
general government sector's gross debt, which is represented by liabilities and debt
instruments, is the standard unit of measurement for government debt.

5.Lending Interest Rate - The amount a lender charges a borrower is called an interest
rate, and it is expressed as a percentage of principal, or the loan amount. Typically, a loan's
interest rate is expressed as an annual percentage rate, or APR (APR).

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 RESEARCH OBJECTIVE

The objective of this study is to examine the relationship between exchange rate and a few
macroeconomic variables. And to examine the effect of FDI, GDP, inflation and recession on
exchange rate.

METHODOLOGY AND DATA

This study makes use of secondary data drawn from world bank database from the period
1970 to 2020. The data analysis is done using Minitab.Multiple regression is used to test how
significantly the factors are impacting the exchange rate.

The first step is to check multicollinearity between the factors by calculating the Variance
Inflationary Factor of all the factors. If the value of VIF is less than 5, there is no
multicollinearity between the factors. In case of a value higher than 5 ,the factor with the
highest VIF value will be removed, and the regression will be repeated. This step will be
repeated till the time value of VIF becomes less than 5 for the remaining factors.

The second step is to perform multiple regression on the exchange rate and factors affecting
it on the data to get the required information on whether the model is significant or not and
which factor impacts money demand.

Null Hypothesis: β1, β2, β3, β4 = 0, i.e.,FDI, GDP, inflation and recession does not have an
impact on the exchange rate.

Alternate Hypothesis: β1, β2, β3, β4 ≠ 0, i.e., FDI, GDP, inflation and recession have an
impact on the exchange rate.

Exchange rate = β0 + β1 * FDI + β2 * GDP + β3 * Inflation + β4 * Recession

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 FINDINGS
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.902545
R Square 0.814587
Adjusted R Square 0.798464
Standard Error 9.579599
Observations 51

ANOVA
df SS MS F Significa
nce F
Regression 4 18545.9 4636.49 50.5236 2.9E-16
7 2 7
Residual 46 4221.36 91.7687
1 1
Total 50 22767.3
3

Coefficient Standard t P- Low Upp Low Upp

s Error Stat valu er er er er
e 95% 95% 95.0 95.0
% %
Intercept 16.931384 3.03147 5.58 1.21 10.8 23.0 10.8 23.0
36 6578 519 E-06 293 334 293 334
4 4 3 4 3
Foreign direct investment, 8.2888675 2.84497 2.91 0.00 2.56 14.0 2.56 14.0
net inflows (% of GDP) 52 5711 351 550 222 155 222 155
1 1 8 1 8 1
GDP (current US$) 1.51E-11 2.81804 5.35 2.66 9.42 2.08 9.42 2.08
E-12 398 E-06 E-12 E-11 E-12 E-11
5
Inflation, consumer prices - 0.28687 - 0.26 - 0.25 - 0.25
(annual %) 0.3252318 8278 1.13 279 0.90 222 0.90 222
59 369 7 269 4 269 4

Recession - 4.59546 - 0.54 - 6.47 - 6.47

2.7731709 6546 0.60 916 12.0 702 12.0 702
58 346 8 234 3 234 3

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 ANALYSIS:
We check the significance of the model, i.e., if the model can be used for analysis purposes,
by comparing the value of F significance with a 5% significance level. Here, after running the
regression on the independent variable FDI, GDP, inflation and recession and dependent
variable exchange rate, we got the value of F significance less than the 5% significance level.
This means that this model can be used for further calculations, and we reject the null
hypothesis. This means we are accepting the alternate hypothesis inferring that there is an
impact of FDI, GDP, inflation, and recession on exchange rate.

The equation that we get from this model:

Exchange rate = 16.9313843630225 + 8.28886755221858 * FDI + 1.50877530596216E-

11*GDP + -0.325231859157811 * Inflation + -2.77317095771699 * Recession
R2 = 81.54%, It means that 81.54% of variation can be explained through FDI, GDP, inflation,
and recession.

P-value of FDI is very less than the significance level (5%) so we can reject the null
hypothesis. Hence, FDI has significant impact on exchange rate.

P-value of recession is more than significance level (5%) so we can accept the null
hypothesis. Hence recession has no significant impact on exchange rate.

P-value of inflation is more than significance level (5%) so we can accept the null
hypothesis. Hence inflation has no significant impact on exchange rate.

P-value of GDP is very less than the significance level (5%) so we can reject the null
hypothesis. Hence GDP has significant impact on exchange rate.

β0 - This value came to be 16.9313843630225, which is a constant value, meaning that the
exchange rate changes by 16.9313843630225 units even when there is no change in the
factors effecting it.
β1 - This value represents the slope of the equation, which is 1.50877530596216E-11. The
positive value of β1 implies a positive relationship between exchange rate and the GDP. In
other words, when GDP changes by 1 unit, the exchange rate changes by
1.50877530596216E-11 units, or one standard deviation change in the GDP produces
1.50877530596216E-11 units standard deviation change in exchange rate.

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β2 - This value represents the slope of the equation, which is 8.28886755221858. The
positive value of β1 implies a positive relationship between exchange rate and the FDI. In
other words, when FDI changes by 1 unit, the exchange rate changes by 8.28886755221858
units, or one standard deviation change in the FDI produces 0.885 units standard deviation
change in exchange rate.

β3 - This value represents the slope of the equation, which is -0.32523185915781. The
positive value of β1 implies a negative relationship between exchange rate and the inflation.
In other words, when inflation changes by 1 unit, the exchange rate changes by 32.52 units,
or one standard deviation change in the FDI produces 32.52 units standard deviation change
in exchange rate.

β4 - This value represents the slope of the equation, which is -2.7731709577169. The
positive value of β1 implies a negative relationship between exchange rate and the
recession. In other words, when inflation changes by 1 unit, the exchange rate changes by
27.73 units, or one standard deviation change in the recession produces27.73units standard
deviation change in exchange rate.

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 LEARNINGS FROM THE PROJECT
• Since inflation can be viewed as a decline in a currency's purchasing power, inflation
tends to devalue a currency. As a result, nations with high inflation typically see a
weakening of their national currencies in relation to other currencies.

• The real return of a portfolio is based on the exchange rate of the currency in which
most of its assets are held.

• Higher production rates, which are a sign of higher demand for that nation's goods, are
reflected in high GDPs. Higher demand for a nation's products and services frequently
results in increased demand for that nation's currency.

• A rise in prices as measured by the CPI is a sign that the country's currency is losing
buying power.

• A country offering higher interest rates is usually more appealing to investors than a
country offering relatively lower rates.

• Investors typically find a country with higher interest rates more desirable than one with
comparatively lower rates. Thus, the country with higher interest rates would generally
see its currency value appreciate.

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 CONCLUSION
• Although most people may not feel the consequences of exchange rate changes in their
daily lives, indirect effects are more pervasive than many people believe.

• Exchange rates can also have an impact on the employment market and real estate
market in addition to having an impact on inflation, interest rates, and investment
performance.

• There are some correlations between GDP and exchange rates, but they vary depending
on the time frame you study. It could be a soft relationship sometimes, or it might be
one that is strong. Due to the differences in monetary policies and how they affect
foreign exchange rates, as well as the potential impact of additional factors, this is not
the same for every country.

• According to macroeconomic theory, the variation in two nations' inflation rates largely
explains the movement in those countries' exchange rates. Thus, a nation (let's say
India) with higher inflation than another (let's say the US) will experience a decline in the
value of its rupee relative to the latter nation's dollar. Our model suggested that
Inflation does not have a significant impact on Exchange rates.

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 References
https://fred.stlouisfed.org/series/INDCPIALLQINMEI
https://fred.stlouisfed.org/series/NGDPNSAXDCINQ
https://rb.gy/huhogj
https://fred.stlouisfed.org/series/INDCPIALLQINMEI
https://fred.stlouisfed.org/series/NGDPNSAXDCINQ
https://rb.gy/huhogj
https://data.worldbank.org/indicator/FP.CPI.TOTL.ZG?locations=IN
https://m.rbi.org.in/Scripts/PublicationsView.aspx?id=20346
Data for India

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