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For policymakers trying to assess the impact of exchange rate movements on the real economy, these results provide various important insights. Firstly, the short-run impact of a real depreciation on firm’s output growth is likely to be negative since it is the import cost channel that dominates in the short run. Further, the impact is asymmetric, with real depreciation having a stronger impact as compared to real appreciation.
At the same time, maintaining a competitive real exchange rate is imperative for boosting Intermediate and long-term economic growth and maintaining the external balance. Thus, using scarce foreign exchange reserves to prevent currency depreciation in the face of sustained downward pressure on the currency due to growing fiscal deficit and/ or massive capital outflows would be problematic, apart from being unsustainable. On the whole, for countries relying on volatile foreign capital inflows to finance their consumption and investment needs, a careful reserve management policy along with a sound fiscal policy are necessary to balance the multiple objectives of stable growth and external sector balance in the long run.
Inflation rates in India have risen about 8.50% amid concerns surrounding the devaluation of the rupee and the erosion of the purchasing power of savings. In spite of Governmental interventions, the rupee is in a free-fall, having slipped by over 20%, making it one of the most awful performing currencies globally. RBI made thirteen rate increases attempts to docile the inflation in last one year but hardly achieved any significant result. Inflation rate maintained upwards trend. This is now reflected through the currency depreciation. Inflation directly enhances prices and thereby affects the purchasing power of currency. Currency value and inflation have a direct co- relation and impact each other. The currency re-evaluation is also essential with the change in domestic prices affected by inflationary forces. Currency is considered to be overvalued if the suitable adjustment is not made with the price index fluctuations.
India currency devaluation has also resulted in surge of import by over 200% of gold and silver. Statistics show that imports of gold and silver to India were $8.96 billion a growth of 222%. The Reserve Bank of India purchased 200 tons of gold from the International Monetary Fund in 2009. From the start of 2011, some 30 banks in India have been granted permission to import gold and silver. Further gold purchases are expected in coming months, as the Reserve Bank has issued licenses to seven more banks to import gold and silver. Indian banks are therefore contributing to the massive increase in demand for gold and silver. Chinese banks are also catering to the increased demand of Chinese people for gold bullion for investment and savings purposes.
In fact, most of the world’s central banks are now diversifying from major currencies such as the dollar and euro into gold. In addition to India and China, these countries include Russia, Sri Lanka, Bangladesh, Mauritius, Mexico, Iran and Saudi Arabia. Financial experts believe the increased demand for gold and silver from India and wider Asia is sustainable and that it will keep the precious metal market thriving. For policymakers trying to assess the impact of exchange rate movements on the real economy, these results provide various important insights. Firstly, the short-run impact of a real depreciation on firm’s output growth is likely to be negative since it is the import cost channel that dominates in the short run. Further, the impact is asymmetric, with real depreciation having a stronger impact as compared to real appreciation.
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