Indian experience with gross capital flows and its Implications on macroeconomic policies

Abstract

Based on experiences with volatile debt flows, views about the sustainability of debt flows, and views about a desirable composition of flows, India liberalized its capital flows in 1990s2 . The approach consisted of liberalizing the current account, opening up to foreign direct investment (FDI) for domestic and foreign firms, opening up to portfolio flows for foreigners, and restricting debt flows. The currency regime has been shifted away from a fixed-but-adjustable exchange rate to a “market determined exchange rate,” which was pegged to the U.S. dollar through extensive trading on the currency market by the central bank. Indian capital controls consist of an intricate web of a very large number of quantitative restrictions, operated by a substantial bureaucratic apparatus which have also been liberalized gradually. The removal of quantitative restrictions, and the sharp drop in tariffs, served to spur both imports and exports. Through these, gross flows on the current account rose from 25 percent of gross domestic product (GDP) in 1992–93 to 35 percent in 2003–4. Major changes took place on the capital account also. Restrictions on both equity portfolio investors and on FDI were eased in this period. The portfolio flows are generally volatile in emerging economies. However, in India’s experience, there has been no episode of a significant retreat by foreign investors. Net FDI and net portfolio flows have been fairly stable while debt flows have been relatively volatile. The study aims at studying the above aspects of gross capital flows in India and aims at developing a framework for understanding the shifts in India’s monetary and fiscal policy based on these flows. OBJECTIVES: A) To understand the underlying factors behind the high amount of gross capital flows to India B) To find the sectors attracting capital flows, understand the basic reason behind their attractiveness and profiling of some prominent sectors C) To study the volatility of the capital flows to India: Short-term or Long-term D) To study the regulations present in the country such as capital account convertibility and its implications on gross capital flows E) To understand the impact of the capital flows on: a) GDP growth of the country, b) Monetary policy of the country, c) Exchange rate expectations of R.