India’s real exchange rate and trade balance: Fresh empirical evidence

Abstract

This paper studies the relationship between India’s real exchange rate and its trade balance with her major trading partners using quarterly trade data for 15 countries over the period 1975 Q1-2011Q1. Apart from oft used bilateral trade model we use Pooled Mean Group estimator of Pesaran and Smith (1995) to get direct estimates of long term income and real exchange rate elasticities. We find that real exchange rate depreciation is positively associated with the trade balance in the long run. At the same time real exchange rate volatility is negatively correlated with India’s trade balance in the long run.