Dynamics of Crude Oil and Real Exchange Rate in India

Abstract

This scholarly work is an effort to capture the effects of oil prices on the actual exchange rate between dollar and rupee. This is done with‎reference to the U.S. dollar as oil prices are marked in USD (U.S. Dollar) in the international market, and India is among the top five‎importers of oil. Using monthly data from January 2001 to May 2020. The study used the real GDP, money supply, short-term interest rate‎difference between two countries, and inflation apart from the crude oil prices per barrel as the factors that help define the exchange rate.‎The analysis, through cointegration and vector error correction method (VECM), suggests long and short-run causality amid prices of oil‎and the rate of exchange fluctuations. Oil prices are found to be negatively related to the exchange rate in the long term but positively related‎in the short term. The result of the Wald test also indicates the short-run causation from the short-term interest rate and the prices of crude‎oil towards the exchange rate. The present study shows that oil prices are evidence of the existence of short-term and long-term driving‎associations with short-term interest rates and exchange rates.