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Indian capital control liberalization: Evidence from NDF markets

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  • Hutchison, Michael

    (Department of Economics, University of California, USA)

  • Kendall, Jake

    (Department of Economics, University of California, USA)

  • Pasricha, Gurnain

    (Department of Economics, University of California, USA)

  • Singh, Nirvikar

    (Department of Economics, University of California, USA)

Abstract

The Indian government has taken a number of incremental measures to liberalise legal and administrative impediments to international capital movements in recent years. This paper analyses the extent to which the effectiveness of capital controls in India, measured by the domestic less net foreign interest rate differential (deviations from covered interest rate parity) have changed over time. We utilise the 3-month offshore non-deliverable forward (NDF) market to measure the effective foreign interest rate (implied NDF yield). Using the self exciting threshold autoregression (SETAR) methodology, we estimate a no-arbitrage bandwidth whose boundaries are determined by transactions costs and capital controls. Inside of the bands, small deviations from CIP follow a random walk process. Outside the bands, profitable arbitrage opportunities exist and we estimate an adjustment process back towards the boundaries. We allow for asymmetric boundaries and asymmetric speeds of adjustment (above and below the band thresholds), which may vary depending on how arbitrage activity is constrained by capital controls. We test for structural breaks, identify three distinct periods, and estimate these parameters over each sub-sample in order to capture the de facto effect of changes in capital controls over time. We find that de facto capital control barriers: (1) are asymmetric over inflows and outflows, (2) have changed over time from primarily restricting outflows to effectively restricting inflows (measured by bandwidths and positions); (3) arbitrage activity closes deviations from CIP when the threshold boundaries are exceeded in all sub-samples. In recent years, capital controls have been more symmetric over capital inflows and outflows and the deviations from CIP outside the boundaries are closed more quickly.

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Bibliographic Info

Paper provided by National Institute of Public Finance and Policy in its series Working Papers with number 09/60.

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Length: 25
Date of creation: Apr 2009
Date of revision:
Handle: RePEc:npf:wpaper:09/60

Note: Working Paper 60, 2009
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Web page: http://www.nipfp.org.in

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  1. Pasricha, Gurnain, 2008. "Financial Integration in Emerging Market Economies," Santa Cruz Department of Economics, Working Paper Series qt7z35t1cn, Department of Economics, UC Santa Cruz.
  2. Guonan Ma & Robert N. McCauley, 2007. "Do China's capital controls still bind? Implications for monetary autonomy and capital liberalisation," BIS Working Papers 233, Bank for International Settlements.
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  4. Taylor, Alan M, 2001. "Potential Pitfalls for the Purchasing-Power-Parity Puzzle? Sampling and Specification Biases in Mean-Reversion Tests of the Law of One Price," Econometrica, Econometric Society, vol. 69(2), pages 473-98, March.
  5. Jeffrey A. Frankel, 1991. "Quantifying International Capital Mobility in the 1980s," NBER Chapters, in: National Saving and Economic Performance, pages 227-270 National Bureau of Economic Research, Inc.
  6. Eduardo Levy Yeyati & Sergio Luis Schmukler & Neeltje Van Horen, 2006. "International Financial Integration through the Law of One Price," Business School Working Papers 2006-01, Universidad Torcuato Di Tella.
  7. 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.
  8. 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.
  9. Hansen, Bruce E, 1996. "Inference When a Nuisance Parameter Is Not Identified under the Null Hypothesis," Econometrica, Econometric Society, vol. 64(2), pages 413-30, March.
  10. Taylor, Mark P, 1989. "Covered Interest Arbitrage and Market Turbulence," Economic Journal, Royal Economic Society, vol. 99(396), pages 376-91, June.
  11. BAI, Jushan & PERRON, Pierre, 1998. "Computation and Analysis of Multiple Structural-Change Models," Cahiers de recherche 9807, Universite de Montreal, Departement de sciences economiques.
  12. Peel, David A & Taylor, Mark P, 2002. "Covered Interest Rate Arbitrage in the Interwar Period and the Keynes-Einzig Conjecture," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 34(1), pages 51-75, February.
  13. Bruce E. Hansen, 1997. "Threshold effects in non-dynamic panels: Estimation, testing and inference," Boston College Working Papers in Economics 365, Boston College Department of Economics.
  14. 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.
  15. Ajay Shah & Ila Patnaik, 2007. "India’s Experience with Capital Flows: The Elusive Quest for a Sustainable Current Account Deficit," NBER Chapters, in: Capital Controls and Capital Flows in Emerging Economies: Policies, Practices and Consequences, pages 609-644 National Bureau of Economic Research, Inc.
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Cited by:
  1. Aizenman, Joshua & Sengupta, Rajeswari, 2011. "The financial trilemma in China and a comparative analysis with India," MPRA Paper 34485, University Library of Munich, Germany.
  2. Mahvash S. Qureshi & Jonathan D. Ostry & Atish R. Ghosh & Marcos Chamon, 2011. "Managing Capital Inflows: The Role of Capital Controls and Prudential Policies," NBER Chapters, in: Global Financial Crisis National Bureau of Economic Research, Inc.
  3. Karl Friedrich Habermeier & Annamaria Kokenyne & Chikako Baba, 2011. "The Effectiveness of Capital Controls and Prudential Policies in Managing Large Inflows," IMF Staff Discussion Notes 11/14, International Monetary Fund.
  4. Hutchison, Michael & Sengupta, Rajeswari & Singh, Nirvikar, 2010. "India’s trilemma: financial liberalization, exchange rates and monetary policy," MPRA Paper 25327, University Library of Munich, Germany.
  5. repec:pra:mprapa:39771 is not listed on IDEAS
  6. Jonathan David Ostry & Atish R. Ghosh & Karl Friedrich Habermeier & Marcos Chamon & Mahvash Saeed Qureshi & Dennis B. S. Reinhardt, 2010. "Capital Inflows," IMF Staff Position Notes 2010/04, International Monetary Fund.
  7. Jinzhao Chen, 2012. "Crisis, Capital Controls and Covered Interest Parity: Evidence from China in Transformation," PSE Working Papers halshs-00660654, HAL.
  8. repec:hal:wpaper:halshs-00660654 is not listed on IDEAS

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