Oil price, exchange rate and the Indian macro economy

Abstract

The general discussions on the Indian macro economy have centered on two things in the recent past: how will the economy be impacted by falling value (depreciation) of rupee and the effects of falling world oil prices. However the exact impact of a depreciation of rupee or fall in oil prices on different macroeconomic variables of the Indian economy is still open to debates. The paper investigates the dynamic relationship between movements in oil prices and exchange rates with macroeconomic variables like price, output, interest rate and money by using structural vector auto regression (SVAR) approach. Additionally, a comparative analysis is done to show how each of these structural shocks historically has affected price, output and exchange rate. The results are in favor of a strong link among these variables. Three results have important policy implications: first, the world price of oil has a great potential to impact India’s output. Second, targeting depreciation of Indian rupee to expand output may not be an effective policy tool for the RBI. Third, variation in rupee’s value can have medium to long term impact on world price of oil that the world should care about.