Is the movement of the INR/USD Exchange Rate and the Indian Stock Market Linked? Fresh Evidence

Dollar exchange rate and Indian stock market are leading economic indicators. The present study investigates the relationship between the two economic indicators during the period April 2005 to December 2019. Analysis of Johansen cointegration test reveals that positive long-run cointegrating relationship exists between the variables. The vector error correction mechanism shows that INR/USD exchange rate influences the Indian stock prices negatively in the short-run. The study also observes the presence of bidirectional causality between the variables in the short-run. The variance decomposition analysis further reveals that the Indian stock market is driven to considerable extent by innovations in INR/USD exchange rate. The close relationship that the study found between INR/USD exchange rate and Indian stock market will be an important factor in the decision making of both individual and institutional investors. Furthermore, the study recommends the Indian government to adopt a cautious approach in implementing the foreign currency exchange rate policies