Abstract
The present debate over capital controls emphasizes their potential role as tools for macroeconomic and financial stability. The effectiveness of these tools may depend on whether a country has the legal and administrative machinery to implement capital controls. This paper contributes to the analysis of the costs and benefits of capital controls by studying the experience of India, a country that has a system of capital controls that had never been dismantled. The paper finds that when the capital controls were used as tools of macroeconomic policy, during a capital surge, the Indian experience appears to be similar to that of other countries.
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Notes
Other market-based measures such as transaction taxes and reserve requirements were considered by policymakers, but considered inappropriate or cumbersome (Reddy, 1998).
See Table 2 for details. Available de jure indices available for this period do not seem to measure these changes.
There are also concerns that the lack of development of a bond-currency-derivatives nexus has weakened monetary policy transmission in India (Mistry, 2007).
The Reserve Bank of India identified the period from 2001 to 2002 as one marked with sustained surges in capital inflows (RBI, 2004). Pradhan and others (2011) date the period of the surge as running from 1999 to 2008. Forbes and Warnock (2011), who study surges, stops, flight, and retrenchment by defining sharp increases or decreases in inflows and outflows, rather than net capital inflows, identify the period of surge from October 2006 to March 2008.
The law does not permit the Reserve Bank of India to issue bonds. From 2004 onwards, sterilization was done through the sale of “Market Stabilisation Scheme” bonds. The interest cost of these bonds was clearly placed upon the exchequer.
For instance, Reddy (2006) says “Capital flows are managed from the viewpoint of avoiding adverse impact on primary liquidity growth and inflationary pressures.”
The 2007–08 official figures need to be adjusted upward to reflect off balance sheet borrowing.
See the cover story in The Economist of February 3, 2007 titled “India on fire” that focused on India's overheating economy.
Malaysia was an exception witnessing less rapid appreciation.
See Table 1 in Elekdag and Wu (2011).
See: Table 2.1, Financial Stability Report, Reserve Bank of India (March 2010) for a description of countercyclical prudential regulation for banks.
The new policy framework was based on the recommendations of the high-level committee report on Balance of Payments in 1999.
FDI inflows rose from 0.5 percent of GDP in 2000 to 2.8 percent in 2010, above the emerging market average and second only to China.
As a signatory to IMF's Article VIII India has to allow capital flows related to trade.
We estimated an ARIMA model of the seasonally adjusted growth rate of capital goods imports along with a dummy for the period during which the rupee-related restrictions were in place, after controlling for the world price of capital goods. The coefficient on the dummy variable is significant and positive.
External borrowing by firms must be of at least three years maturity below a specified sum and of at least five years maturity beyond. Borrowing up to a specified sum by a firm “for certain specified end-users”—for example, expanding a factory, or importing capital goods—is allowed without requiring permissions. This is subject to a ceiling whereby approvals for borrowing by all firms (put together), in a year, should not exceed a given limit per year.
Government committee reports on making Mumbai an international financial center, on domestic financial sector reform, and on rationalizing capital controls have recommended dismantling many capital controls. Currently, a financial sector legislative reforms commission is reviewing and redrafting all financial law, including the capital controls law.
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Additional information
*The authors are professors at the National Institute for Public Finance and Policy in New Delhi, where they jointly lead the Macro/Finance Group. This paper draws on many useful discussions with Josh Felman. It has greatly benefited from the numerous improvements suggested in seminars at the IMF, ICRIER, NIPFP, and IGC. The authors acknowledge useful discussions with Stijn Claessens, Ayhan Kose, Prakash Loungani, Rex Ghosh, Jonathan Ostry, Sebastian Mallaby, Michael Carson, Michael Hutchison, Kalpana Kochhar, Sanjaya Panth, Olivier Blanchard, U.K. Sinha, and K.P. Krishnan. The authors are grateful to the referees and editors for extensive feedback which helped to strengthen the paper substantially.