Kunal Gaurav

The relationship between exchange rates and key economic factors is crucial and may vary across countries depending on the economic context. This paper analyzes cointegration relationships among exchange rate, balance of payments, interest rate, inflation, and trade openness using the Johansen Cointegration Test in the context of the Indian economy. The study uses annual time-series data from 2008 to 2024. Stationarity of the variables is first tested using the Augmented Dickey-Fuller test. The Johansen Cointegration Test is then applied to identify long-run equilibrium relationships, while a Vector Error Correction Model captures short-term dynamics and adjustments towards equilibrium. The exchange rate makes modest adjustments across cointegrating relationships, sometimes restoring equilibrium, other times diverging from it. The balance of payments shows large coefficients, primarily amplifying deviations. The interest rate has minimal adjustment, showing little response to disequilibrium. Inflation and trade openness have small, negative coefficients, indicating weak correction toward equilibrium. Overall, the balance of payments amplifies deviations, while other variables show varying degrees of error-correcting behavior. The model explains 67.4% of the variation in exchange rate changes (R-squared = 0.674), with an adjusted R-squared of 0.5, accounting for predictors. The F-statistic (3.87, p = 0.0115) shows the model is statistically significant. Short-run changes in the exchange rate are influenced by past exchange rates, balance of payments, inflation, and trade openness, while interest rates play a minimal role.