Fiscal policy and real exchange rate variations in India

Biswajit Maitra () and Dhritiman Ganguli ()
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Biswajit Maitra: University of Gour Banga
Dhritiman Ganguli: University of Gour Banga

Eurasian Economic Review, 2024, vol. 14, issue 3, No 3, 619-640

Abstract: Abstract The fiscal policy's impact on the real exchange rates is highly controversial in theory and practice but noteworthy for macroeconomic policy. This issue is more pertinent in developing countries with an active fiscal policy or wider fiscal space but is explored less. To our knowledge, the fiscal policy impact on the real exchange rate in India is not documented. Against this backdrop, this study explores this in India involving disaggregated data of government consumption and investment spending and a few related variables like trade openness, private consumption spending, and money supply for the period 1996:1–2023:1. The results corroborate long-run associations of real exchange rate and some combinations of the selected other variables. The real exchange rate dynamics estimated through the cointegrated vector autoregressive model followed by an impulse response analysis have shown that government investment spending causes a real appreciation. In contrast, government and private consumption spending exert pressure to depreciate the real exchange rate. Trade openness is another potent predictor of the real exchange rate. On the other hand, no significant impact of the money supply on the real exchange rate is noticed. The results accentuate effective fiscal allocation may be a policy tool for stabilizing the Indian rupee. The unique findings on the Indian economy may also help understand the fiscal effect of real exchange rates in other developing countries.

Keywords: Real exchange rate; Government consumption spending; Government investment spending; Private consumption spending; Trade openness; Fiscal policy; Money supply; O11; E62; F41; F31; C32 (search for similar items in EconPapers)
JEL-codes: C32 E62 F31 F41 O11 (search for similar items in EconPapers)
Date: 2024
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DOI: 10.1007/s40822-024-00276-w

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