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External shocks

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  • Goyal, Ashima

Abstract

After the global financial crisis, India was exposed to many external shocks from commodity prices and foreign capital flows. Although capital flow fluctuations were largely due to global risk-on risk-off factors, a widening current account deficit (CAD) contributed to India’s vulnerability to external shocks. The major source of shocks was external, but policy mistakes increased India’s vulnerability. These included inadequate attention to sectoral bottlenecks that reduced export growth and domestic financial savings, while substitution away from expensive oil imports was discouraged. Dependence on foreign capital, to finance the CAD, rose while degrees of freedom from continuing capital controls were underutilized to reduce exchange rate volatility and to smooth interest rates. Steep depreciations combined with volatility did not help exporters. Evaluation of measures to stabilize the exchange rate establishes that temporarily taking oil marketing companies demand out of the market was the most effective, since small demand-supply mismatches lead to large currency movements in thin markets. Prudential measures such as increasing position limits, margin requirements are to be preferred to a ban on a market or a transaction-type. If market restrictions become necessary, they should be carefully targeted. Accumulation and use of reserves, use of market information and of signalling can all help implement managed floating. Such an exchange rate regime can contribute to effective inflation targeting without the policy rate rising to reduce depreciation as in the classic interest rate defense.

Suggested Citation

  • Goyal, Ashima, 2014. "External shocks," MPRA Paper 72498, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:72498
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    References listed on IDEAS

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    1. Vasco Curdia & Michael Woodford, 2010. "Conventional and unconventional monetary policy," Review, Federal Reserve Bank of St. Louis, vol. 92(May), pages 229-264.
    2. Sushanta Mallick & Helena Marques, 2008. "Passthrough of Exchange Rate and Tariffs into Import Prices of India: Currency Depreciation versus Import Liberalization," Review of International Economics, Wiley Blackwell, vol. 16(4), pages 765-782, September.
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    Cited by:

    1. Ashima Goyal, 2015. "Foreign exchange markets, intervention and exchange rate regimes," Indira Gandhi Institute of Development Research, Mumbai Working Papers 2015-011, Indira Gandhi Institute of Development Research, Mumbai, India.
    2. Ashima Goyal & Vaishnavi Sharma, 2019. "Estimating the Relationship Between the Current Account, the Capital Account and Investment for India," Foreign Trade Review, , vol. 54(1), pages 29-45, February.
    3. Ashima Goyal & Abhishek Kumar, 2018. "The effect of oil shocks and cyclicality in hiding Indian twin deficits," Journal of Economic Studies, Emerald Group Publishing Limited, vol. 45(1), pages 27-45, January.
    4. Yanamandra, Venkataramana, 2015. "Exchange rate changes and inflation in India: What is the extent of exchange rate pass-through to imports?," Economic Analysis and Policy, Elsevier, vol. 47(C), pages 57-68.
    5. Ashima Goyal, 2015. "Financial stability: Underlining context," Indira Gandhi Institute of Development Research, Mumbai Working Papers 2015-014, Indira Gandhi Institute of Development Research, Mumbai, India.

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    More about this item

    Keywords

    External shocks; current account deficit; exchange rate regime; volatility; market interventions;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • F42 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Policy Coordination and Transmission

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