Determination of Exchange Rate under Flexible Exchange Rate Regime in India: An Analysis Using ARDL Model

Since March 1993, the Indian economy has accepted the flexible exchange rate regime in
which the rates are determined by the market. In this flexible exchange rate regime, the
degree of volatility has been observed to be comparatively high, and it affects the economy
in many different ways. The present paper is an attempt to examine and explain these
variations in exchange rate through the theory of purchasing power parity. The primary
purpose of this study is to develop an empirical framework to estimate the determinants of
exchange rate by employing a time series data of exchange rate and gross domestic product
measured at purchasing power parity, and for this, the data used have been for the period
1994 to 2013. In the present paper, the statistical tools such as Pair wise Granger Causality
Tests, Breakpoint Unit Root Test, Cointegration Test and finally ARDL model have been
applied to develop a viable relationship between regressor and regressand. The result of this
endeavor has revealed that there is a definite causal relationship between exchange rate and
gross domestic product expressed at purchasing power parity, but the larger variation in the
exchange rate is explained by the lag value exchange rate.