RBI study links rupee value to capital flows

The movement of the Indian rupee is largely influenced by capital flows rather than traditional determinants like trade flows, says a report released by he Development Research Group (DRG) constituted by the Reserve Bank's Department of Economic Analysis and Policy.

The study, entitled, Exchange Rate Policy and Modelling in India, covers two main topics, various aspects of economic policy with respect to the exchange rate, and modelling and forecasting the exchange rate.

"Though the capital flows are generally seen to be beneficial to an economy, a large surge in flows over a short span of time in excess of the domestic absorptive capacity can be a source of stress to the economy giving rise to upward pressures on the exchange rate, overheating of the economy, and possible asset price bubbles," it said.

It was co-authored by Pami Dua, a professor of economics at the Delhi School of Economics, and Rajiv Ranjan, director in the department of economic analysis and policy of RBI.

The study analyses India's exchange rate policy and discusses the structure of the foreign exchange market in India in terms of participants, instruments and trading platform, as also turnover in the Indian foreign exchange market and forward premia.

It also attempts to develop a model for the rupee-dollar exchange rate taking into account variables from monetary and microstructure models as well as other variables, including intervention by the central bank.