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Effectiveness of Capital Controls in India: Evidence from the Offshore NDF Market

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  • Michael 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 non-deliverable forward (NDF) markets using the self-exciting threshold autoregressive (SETAR) methodology. We begin with a detailed narrative on the evolution of capital controls in India and calculate deviations from covered interest parity utilizing data from the 3-month offshore non-deliverable rupee forward market. We estimate a no-arbitrage band using SETAR where boundaries are determined by transactions costs and by the effectiveness of capital controls. We identify several distinct periods reflecting changes in capital control application and intensity for India, and estimate the model over each sub-sample in order to capture the de facto effect of changes in capital controls on return differentials over time. We find that Indian capital controls are asymmetric over inflows and outflows, have changed over time from primarily restricting outflows to effectively restricting inflows; and that arbitrage activity closes deviations from CIP when the threshold boundaries are exceeded in all sub-samples. Moreover, our results indicate a significant reduction in the barriers to arbitrage since 2008. As a robustness test of the methodology, we also apply it 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, show no sign of gradual relaxation or liberalization.

Suggested Citation

  • Michael Hutchison & Gurnain Kaur Pasricha & Nirvikar Singh, 2011. "Effectiveness of Capital Controls in India: Evidence from the Offshore NDF Market," Staff Working Papers 11-29, Bank of Canada.
  • Handle: RePEc:bca:bocawp:11-29
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. 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.
    2. 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.
    3. 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.
    4. 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.
    5. 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.
    6. Rajeswari Sengupta, 2015. "The impossible trinity: Where does India stand?," Indira Gandhi Institute of Development Research, Mumbai Working Papers 2015-05, Indira Gandhi Institute of Development Research, Mumbai, India.
    7. Gurnain Pasricha & Matteo Falagiarda & Martin Bijsterbosch & Joshua Aizenman, 2015. "Domestic and Multilateral Effects of Capital Controls in Emerging Markets," Staff Working Papers 15-37, Bank of Canada.
    8. Radhika Pandey & Gurnain Pasricha & Ila Patnaik & Ajay Shah, 2015. "Motivations for Capital Controls and Their Effectiveness," Staff Working Papers 15-5, Bank of Canada.
    9. 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.
    10. Shekhar Hari Kumar & Ila Patnaik, 2018. "Internationalisation of the Rupee," Working Papers id:12551, eSocialSciences.
    11. repec:pal:imfecr:v:65:y:2017:i:2:d:10.1057_s41308-016-0013-1 is not listed on IDEAS
    12. Kumar, Shekhar Hari & Patnaik, Ila, 2018. "Internationalisation of the Rupee," Working Papers 18/222, National Institute of Public Finance and Policy.
    13. 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.
    14. 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.
    15. 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.

    More about this item

    Keywords

    International financial markets; Econometric and statistical methods; International topics;

    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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