Effect of Monetary Policy On Foreign Trade in India
Effect of Monetary Policy On Foreign Trade in India
Effect of Monetary Policy On Foreign Trade in India
in India
INTRODUCTION
For decades of years now, the geometric acceleration of a long term sustainable
economic growth and development especially, through increase in export as one of
the major macroeconomic objectives has been the desired aim of every economy in
the world. The realization of this goal, undoubtedly, is not automatic. However, it
requires policy guidance which involves manipulation of policy instruments. Such
macroeconomic policies that could be used to actualize the above aim encompass
mutually monetary and fiscal policies. These policies are inextricable, apart from
instruments and implementing authorities. However, MONETARY POLICY
appears more effective in correcting short term macroeconomic maladjustments
due to its frequency in applying and altering policy tools, relative ease of its
decision process and sheer nature of the sector which propagates its effect to the
real economy. Hence, economists see monetary policy as an essential instrument
that every nation can install for the accurate maintenance of domestic price and
exchange rate stability, as a significant condition for the attainment of a sustainable
economic growth and development. Monetary policy as a macroeconomic tool is
widely used by central banks, RBI or other regulatory committees to control
quantity and rate of money supply in an economy, essentially affecting interest
rates. A country’s macro economy environment is affected by its monetary policy.
Financial system is the mechanism where a nation's financial authority, usually a
reserve bank, monitors the flow of money to the nation by imposing its power over
policy rate in order to retain stable growth and gain better wealth creation.
The FOREIGN TRADE is considered as lifeblood of an economy and is referred
to be a major contributor and determinant of its economic growth. The transfer and
exchange of goods as well as resources between the nations minimizes the chances
of having unintended surpluses and shortages. The countries can specialize in the
production of articles for which they have comparative advantage and then trade
with other nations. It is not possible for any nation to produce each and every
article by itself and then absorb by itself .The foreign trade also ensures the
efficient utilization of resources leading to the overall welfare being of individuals
in the society. There are many factors that may affect the trade activates between
two nations and the exchange rate is also considered as a major such contributing
factoring.
This paper studies the impact of monetary policy shocks on the exports
and foreign investment inflows. The call money interest rate (INT) would be acting
as a proxy for the monetary policy. In addition to these variables, GDP growth rate
(GDP) and inflation rate (CPI) have been included to study their impact on the
exports (EXP) and foreign investment inflows (FDI). Inclusion of GDP growth rate
is based on the premise that a higher GDP growth should encourage foreign
investment inflows indicating bright future prospects for the economy. This in turn
should be impacting the exports positively.
India’s gross domestic product (GDP), at current prices, stood at Rs. 51.23 lakh
crore (US$ 694.93 billion) in the first quarter of FY22, as per the provisional GDP
estimates for the first quarter of 2021-22. India’s trade and external sector had a
significant impact on the GDP growth as well as expansion in per capita income.
According to the Ministry of Commerce and Industry, India’s overall exports
between April 2021 and August 2021 were estimated at US$ 256.17 billion (a
44.04% YoY increase). Whereas overall imports between April 2021 and August
2021 were estimated at US$ 273.45 billion (a 64.18% YoY increase).
How Imports and Exports affect you?
When a country is importing goods, this represents an outflow of funds from that
country. Local companies are the importers and they make payments to overseas
entities, or the exporters. A high level of imports indicates robust domestic
demand and a growing economy. If these imports are mainly productive assets,
such as machinery and equipment, this is even more favorable for a country since
productive assets will improve the economy's productivity over the long run.
A healthy economy is one where both exports and imports are experiencing
growth. This typically indicates economic strength and a sustainable trade surplus
or deficit. If exports are growing, but imports have declined significantly, it may
indicate that foreign economies are in better shape than the domestic economy.
Conversely, if exports fall sharply but imports surge, this may indicate that the
domestic economy is faring better than overseas markets.
For example, the U.S. trade deficit tends to worsen when the economy is growing
strongly. This is the level at which U.S. imports exceed U.S. exports. However,
the U.S.’s chronic trade deficit has not impeded it from continuing to have one of
the most productive economies in the world.
However, in general, a rising level of imports and a growing trade deficit can have
a negative effect on one key economic variable, which is a country's exchange
rate, the level at which their domestic currency is valued versus foreign
currencies.
Exchange rate
Until 1991, India followed fixed exchange rate system and only occasionally
devalued the rupee with the permission of IMF. The policies of floating exchange
rate and increasing openness and globalization of the Indian economy, adopted
since 1991, have made the exchange rate of rupee quite volatile.
Exchange rate the price of a currency in terms of another currency is arguably the
single most important variable in determining the economic environment for trade
sectors. Appreciation or depreciation of currency affects the economic
performance of a country. Any government at any point in time seek the stability
of the exchange rate because it provides economic agents to plan ahead of varying
costs and prices of goods and services. An exchange rate depreciation can make a
country’s exports cheaper and imports more expensive. Exchange rates in India are
prone to high fluctuations, which are pegged against a strong currency, usually the
U.S. dollar .This study examines the impact of fluctuations of Indian currency on
foreign trading in India.
The changes in capital inflows and capital outflows and changes in demand for and
supply of foreign exchange, particularly US dollar, arising from the imports and
exports cause great fluctuations in the foreign exchange rate of rupee. In order to
prevent large depreciation and appreciation of foreign exchange rate Reserve Bank
has to take suitable monetary measures to ensure foreign exchange rate
stability.Owing to the fixed exchange rate system prior to 1991 the concern about
foreign exchange rate had not played a significant role in the formulation of
monetary policy.
Today, the exchange rate of rupee is determined by demand for and supply of
foreign exchange (say, US dollar). When there is mismatch between demand for
and supply of foreign exchange, external value of rupee changes.