Macroprudential Policies for the External Sector: India’s Approach and Experience

This chapter provides a perspective on India’s approach and experience in its macroprudential policies for the management of its external sector. Section 1 presents the empirical motivation and a conceptual framework for jointly deploying forex reserves and capital controls in the macroprudential policy of a “small” open economy such as India, that is vulnerable to the risk of “sudden stops” in external capital flows. Section 2 discusses how macroprudential policies have been used in India to date, focusing on their recent evolution, particularly since the Global Financial Crisis (GFC). Section 3 provides an event-study analysis of the effectiveness of one specific macroprudential policy adopted by India in the aftermath of the “Taper Tantrum”1 episode of 2013. Throughout, the focus is on external sector flows relating to fixed-income securities only, which come under the purview of the central bank in India (Reserve Bank of India [RBI]); equity investments in India are regulated by the securities exchange board and are largely perceived to be unrestricted except in the case of a few companies which have especially large foreign ownership.