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Effectiveness of Capital Controls in India: Evidence from the Offshore NDF Market

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  • Michael M Hutchison
  • Gurnain Kaur Pasricha
  • Nirvikar Singh

Abstract

This paper examines the effectiveness of international capital controls in India over time by analyzing daily return differentials in the nondeliverable forward (NDF) markets using the self-exciting threshold autoregressive (SETAR) methodology. The paper presents a narrative on the evolution of capital controls in India and calculates a new index of capital account liberalization using cumulative monthly changes in restrictions on inflows and outflows. It employs the de jure indices of changes in restrictions on capital inflows and outflows to identify particular policy episodes, and tests the de facto effects of restrictions by calculating deviations from covered interest parity (CIP) utilizing data from the three-month offshore nondeliverable rupee forward market. The paper estimates no-arbitrage bands for each episode using SETAR where boundaries are determined by transactions costs and by the effectiveness of capital controls. It finds that Indian capital controls are asymmetric over inflows and outflows, have changed at one stage from primarily restricting outflows to effectively restricting inflows; and that arbitrage activity closes deviations from CIP when the threshold boundaries are exceeded in all subperiods. Moreover, the results indicate a significant reduction in the barriers to arbitrage since 2009, suggesting that gradual liberalization of India's capital account has played an important role in integrating onshore and offshore markets. The paper also applies the methodology to the Chinese RMB NDF market and find that capital controls are strictly limiting capital inflows with the exception of two periods of regional and international financial turbulence. The intensity of Chinese controls varies over time, indicating discretion in the application of capital control policy but, unlike India, shows no sign of gradual relaxation or liberalization.

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Bibliographic Info

Article provided by Palgrave Macmillan in its journal IMF Economic Review.

Volume (Year): 60 (2012)
Issue (Month): 3 (September)
Pages: 395-438

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Handle: RePEc:pal:imfecr:v:60:y:2012:i:3:p:395-438

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  1. Guonan Ma & Corrinne Ho & Robert N McCauley, 2004. "The markets for non-deliverable forwards in Asian currencies," BIS Quarterly Review, Bank for International Settlements, June.
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  4. Guonan Ma & RobertN McCauley, 2008. "Efficacy Of China'S Capital Controls: Evidence From Price And Flow Data," Pacific Economic Review, Wiley Blackwell, vol. 13(1), pages 104-123, 02.
  5. Reuven Glick & Michael Hutchison, 2008. "Navigating the Trilemma: Capital Flows and Monetary Policy in China," Working Papers 252008, Hong Kong Institute for Monetary Research.
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  7. Eswar Prasad & Shang-Jin Wei, 2005. "The Chinese Approach to Capital Inflows: Patterns and Possible Explanations," NBER Working Papers 11306, National Bureau of Economic Research, Inc.
  8. Pasricha, Gurnain, 2007. "Financial Integration in Emerging Market Economies," MPRA Paper 5278, University Library of Munich, Germany.
  9. Yin-wong Cheung & Dickson Tam & Matthew S. Yiu, 2006. "Does the Chinese Interest Rate Follow the US Interest Rate?," Working Papers 192006, Hong Kong Institute for Monetary Research.
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  11. Frenkel, Jacob A & Levich, Richard M, 1975. "Covered Interest Arbitrage: Unexploited Profits?," Journal of Political Economy, University of Chicago Press, vol. 83(2), pages 325-38, April.
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  13. Alan M. Taylor, 2000. "Potential Pitfalls for the Purchasing-Power-Parity Puzzle? Sampling and Specification Biases in Mean-Reversion Tests of the Law of One Price," NBER Working Papers 7577, National Bureau of Economic Research, Inc.
  14. Taylor, Mark P, 1989. "Covered Interest Arbitrage and Market Turbulence," Economic Journal, Royal Economic Society, vol. 99(396), pages 376-91, June.
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Cited by:
  1. Ostry, Jonathan D. & Ghosh, Atish R. & Chamon, Marcos & Qureshi, Mahvash S., 2012. "Tools for managing financial-stability risks from capital inflows," Journal of International Economics, Elsevier, vol. 88(2), pages 407-421.
  2. Reuven Glick & Michael Hutchison, 2013. "China’s financial linkages with Asia and the global financial crisis," Working Paper Series 2013-12, Federal Reserve Bank of San Francisco.
  3. Guonan Ma & Robert N McCauley, 2013. "Is China or India more financially open?," BIS Working Papers 410, Bank for International Settlements.
  4. Hutchison, Michael M. & Sengupta, Rajeswari & Singh, Nirvikar, 2013. "Dove or Hawk? Characterizing monetary policy regime switches in India," Emerging Markets Review, Elsevier, vol. 16(C), pages 183-202.
  5. Joshua Aizenman & Gurnain Pasricha, 2013. "Why Do Emerging Markets Liberalize Capital Outflow Controls? Fiscal versus Net Capital Flow Concerns," Working Papers 13-21, Bank of Canada.
  6. von Hagen, Jürgen & Zhang, Haiping, 2014. "Financial development, international capital flows, and aggregate output," Journal of Development Economics, Elsevier, vol. 106(C), pages 66-77.
  7. Ila Patnaik & Ajay Shah, 2012. "Did the Indian Capital Controls Work as a Tool of Macroeconomic Policy?," IMF Economic Review, Palgrave Macmillan, vol. 60(3), pages 439-464, September.

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