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Indian Capital Control Liberalization: Evidence from NDF Markets

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  • Hutchison, Michael
  • Kendall, Jake
  • Pasricha, Gurnain
  • Singh, Nirvikar

Abstract

This paper analyzes the extent to which the effectiveness of capital controls in India have changed over time. We begin by calculating deviations from covered interest parity utilizing data from the 3-month offshore non-deliverable rupiah forward (NDF) market. Then, using the self-exciting threshold autoregression methodology, we estimate a no-arbitrage band whose boundaries are determined by transactions costs and by the effectiveness of capital controls. Inside 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 identify three distinct periods, and estimate the model 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; (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 University Library of Munich, Germany in its series MPRA Paper with number 21771.

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Date of creation: Mar 2010
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Handle: RePEc:pra:mprapa:21771

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Keywords: capital controls; India; arbitrage; non-deliverable forward markets; covered interest parity; self-exciting autoregressive threshold model;

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References

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  1. 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, Econometric Society, vol. 69(2), pages 473-98, March.
  2. Levy Yeyati, Eduardo & Schmukler, Sergio L. & Van Horen, Neeltje, 2006. "International financial integration through the law of one price," Policy Research Working Paper Series 3897, The World Bank.
  3. Frankel, Jeffrey A., 1989. "Quantifying International Capital Mobility in the 1980s," Department of Economics, Working Paper Series, Department of Economics, Institute for Business and Economic Research, UC Berkeley qt4fw7c7bh, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
  4. 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.
  5. Taylor, Mark P, 1989. "Covered Interest Arbitrage and Market Turbulence," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 99(396), pages 376-91, June.
  6. 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, Blackwell Publishing, vol. 34(1), pages 51-75, February.
  7. Yin-Wong Cheung & Dickson C. Tam & Matthew S. Yiu, 2008. "Does the Chinese interest rate follow the US interest rate?," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 13(1), pages 53-67.
  8. Pasricha, Gurnain, 2008. "Financial Integration in Emerging Market Economies," Santa Cruz Department of Economics, Working Paper Series qt7z35t1cn, Department of Economics, UC Santa Cruz.
  9. BAI, Jushan & PERRON, Pierre, 1998. "Computation and Analysis of Multiple Structural-Change Models," Cahiers de recherche, Universite de Montreal, Departement de sciences economiques 9807, Universite de Montreal, Departement de sciences economiques.
  10. repec:nbr:nberwo:11387 is not listed on IDEAS
  11. 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.
  12. Frenkel, Jacob A & Levich, Richard M, 1975. "Covered Interest Arbitrage: Unexploited Profits?," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 83(2), pages 325-38, April.
  13. 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.
  14. 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.
  15. Hansen, Bruce E, 1996. "Inference When a Nuisance Parameter Is Not Identified under the Null Hypothesis," Econometrica, Econometric Society, Econometric Society, vol. 64(2), pages 413-30, March.
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Citations

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Cited by:
  1. 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.
  2. Jinzhao Chen, 2012. "Crisis, Capital Controls and Covered Interest Parity: Evidence from China in Transformation," PSE Working Papers halshs-00660654, HAL.
  3. repec:hal:wpaper:halshs-00660654 is not listed on IDEAS
  4. Mahvash S. Qureshi & Jonathan D. Ostry & Atish R. Ghosh & Marcos Chamon, 2011. "Managing Capital Inflows: The Role of Capital Controls and Prudential Policies," NBER Working Papers 17363, National Bureau of Economic Research, Inc.
  5. 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.
  6. repec:pra:mprapa:39771 is not listed on IDEAS
  7. Aizenman, Joshua & Sengupta, Rajeswari, 2012. "The Financial Trilemma in China and a Comparative Analysis with India," Santa Cruz Department of Economics, Working Paper Series qt2xn3238g, Department of Economics, UC Santa Cruz.
  8. 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.

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