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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.

Suggested Citation

  • Michael M Hutchison & Gurnain Kaur Pasricha & Nirvikar Singh, 2012. "Effectiveness of Capital Controls in India: Evidence from the Offshore NDF Market," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 60(3), pages 395-438, September.
  • Handle: RePEc:pal:imfecr:v:60:y:2012:i:3:p:395-438
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Radhika Pandey & Gurnain Pasricha & Ila Patnaik & Ajay Shah, 2015. "Motivations for Capital Controls and Their Effectiveness," Staff Working Papers 15-5, Bank of Canada.
    2. Shekhar Hari Kumar & Ila Patnaik, 2018. "Internationalisation of the Rupee," Working Papers id:12551, eSocialSciences.
    3. Rajeswari Sengupta, 2015. "The Impossible Trinity: Where does India stand?," Working Papers id:6659, eSocialSciences.
    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. Vladyslav Sushko & Claudio Borio & Robert Neil McCauley & Patrick McGuire, 2016. "The failure of covered interest parity: FX hedging demand and costly balance sheets," BIS Working Papers 590, Bank for International Settlements.
    6. Martin T. Bohl, Badye Essid, Pierre Siklos, 2018. "Short-Selling Bans and the Global Financial Crisis: Are they Inter-Connected?," LCERPA Working Papers 0112, Laurier Centre for Economic Research and Policy Analysis, revised 30 Jan 2018.
    7. Glick, Reuven & Hutchison, Michael, 2013. "China's financial linkages with Asia and the global financial crisis," Journal of International Money and Finance, Elsevier, vol. 39(C), pages 186-206.
    8. Aizenman, Joshua & Pasricha, Gurnain Kaur, 2013. "Why do emerging markets liberalize capital outflow controls? Fiscal versus net capital flow concerns," Journal of International Money and Finance, Elsevier, vol. 39(C), pages 28-64.
    9. Gurnain Pasricha & Matteo Falagiarda & Martin Bijsterbosch & Joshua Aizenman, 2015. "Domestic and Multilateral Effects of Capital Controls in Emerging Markets," NBER Working Papers 20822, National Bureau of Economic Research, Inc.
    10. Kumar, Shekhar Hari & Patnaik, Ila, 2018. "Internationalisation of the Rupee," Working Papers 18/222, National Institute of Public Finance and Policy.
    11. repec:pal:imfecr:v:65:y:2017:i:2:d:10.1057_s41308-016-0013-1 is not listed on IDEAS
    12. Ma, Guonan & McCauley, Robert N., 2013. "Is China or India more financially open?," Journal of International Money and Finance, Elsevier, vol. 39(C), pages 6-27.
    13. Ila Patnaik & Ajay Shah, 2012. "Did the Indian Capital Controls Work as a Tool of Macroeconomic Policy?," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 60(3), pages 439-464, September.
    14. 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.
    15. 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.

    More about this item

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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