The effective exchange rate is a measure of whether or not the currency is appreciating or depreciating against a basket of foreign currencies. In this paper an attempt has been taken to enquire the relationship between exchange rate and trade balance in India, here we use we use 36 currency trade based effective exchange rate both nominal and real. A decline in the value of effective exchange rate implies a depreciation of the home currency against the basket of currencies. The data are taken from statistical hand book of published by RBI. The variables in this study are Trade Balance, Nominal Effective Exchange Rate, Real Effective Exchange Rate. Trade balance is measured by taking the ratio of import and export then converted in to logarithmic form, so trade balance implies log import – log export. This study shows that increase of trade balance of our country is one of the important reasons for depreciating our currency. Since trade balance is the ratio of import and export hence increase in trade balance implies more of import and or less of export is one of the important reasons for depreciation of our currency over the time period of the study.

effective exchange rate, trade balance, India, Vector Error Correction model