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Financial Repression and Exchange Rate Management in Developing Countries; Theory and Empirical Evidence for India

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  • Renu Kohli
  • Kenneth Kletzer

Abstract

Most developing countries have imposed restrictions on domestic and international financial transactions at one time or another. Such restrictions have allowed governments to generate significant proportions of their revenues from financial repression while restraining inflation. The eventual fiscal importance of the revenues from seignorage and from implicit taxation of financial intermediation pose a challenge for financial reform and liberalization. This paper presents a model of the role of financial repression in fiscal policy and exchange rate management under capital controls. We show how a balance of payments crisis arises under an exchange rate peg without capital account convertibility in the model economy and how the instruments of financial repression may be used for exchange rate management. The model is compared to the experience of India, a country that exemplifies the fiscal importance of financial restrictions, in the last two decades. In particular, we discuss the dynamics leading up to devaluation in 1991 and the role of financial repression in exchange rate intervention afterwards.

Suggested Citation

  • Renu Kohli & Kenneth Kletzer, 2001. "Financial Repression and Exchange Rate Management in Developing Countries; Theory and Empirical Evidence for India," IMF Working Papers 01/103, International Monetary Fund.
  • Handle: RePEc:imf:imfwpa:01/103
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    References listed on IDEAS

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    Cited by:

    1. Renu Kohli, 2001. "Capital Flows and Their Macroeconomic Effects in India," IMF Working Papers 01/192, International Monetary Fund.
    2. Pinto, Brian & Zahir, Farah, 2004. "India : why fiscal adjustment now," Policy Research Working Paper Series 3230, The World Bank.
    3. Aizenman, Joshua, 2008. "On the hidden links between financial and trade opening," Journal of International Money and Finance, Elsevier, vol. 27(3), pages 372-386, April.
    4. Joshua Aizenman & Ilan Noy, 2009. "Endogenous Financial and Trade Openness," Review of Development Economics, Wiley Blackwell, vol. 13(2), pages 175-189, May.
    5. Pasricha, Gurnain Kaur, 2008. "Imperfect Competition in Financial Markets and Capital Controls: A Model and a Test," MPRA Paper 12125, University Library of Munich, Germany.
    6. James B. Ang, 2009. "Financial Liberalization And The Aid Growth Relationship In India," Development Research Unit Working Paper Series 10-09, Monash University, Department of Economics.
    7. Joshua Aizenman, 2004. "Financial Opening and Development: Evidence and Policy Controversies," American Economic Review, American Economic Association, vol. 94(2), pages 65-70, May.
    8. Siddiki, Jalal Uddin & Morrissey, Oliver, 2006. "Capital inflows and the demand for money in South Asian countries," Economics Discussion Papers 2006-4, School of Economics, Kingston University London.
    9. Kenneth M. Kletzer, 2004. "Liberalizing Capital Flows in India: Financial Repression, Macroeconomic Policy, and Gradual Reforms," India Policy Forum, Global Economy and Development Program, The Brookings Institution, vol. 1(1), pages 227-275.
    10. Noriaki Kinoshita & Cameron McLoughlin, 2012. "Monetization in Low- and Middle-Income Countries," IMF Working Papers 12/160, International Monetary Fund.
    11. Joshua Aizenman & Ilan Noy, 2004. "Endogenous Financial and Trade Openness: Political Economy Considerations," Economics Study Area Working Papers 72, East-West Center, Economics Study Area, revised Sep 2004.
    12. Renu Kohli, 2004. "Capital Flows and Domestic Financial Sector in India," International Finance 0405012, EconWPA.
    13. Joshua Aizenman & Ilan Noy, 2003. "Endogenous Financial Openness: Efficiency and Political Economy Considerations," NBER Working Papers 10144, National Bureau of Economic Research, Inc.
    14. Singh, Nirvikar & Srinivasan, T. N., 2004. "Fiscal Policy in India: Lessons and Priorities," Santa Cruz Department of Economics, Working Paper Series qt8nx3v467, Department of Economics, UC Santa Cruz.
    15. James B. Ang, 2010. "Does Foreign Aid Promote Growth? Exploring the Role of Financial Liberalization," Review of Development Economics, Wiley Blackwell, vol. 14(2), pages 197-212, May.
    16. Kohli, Renu, 2004. "The Transition from Official Aid: to Private Capital Flows Implications for a Developing Country," WIDER Working Paper Series 046, World Institute for Development Economic Research (UNU-WIDER).
    17. Joshua Aizenman & Ilan Noy, 2004. "Endogenous Financial and Trade Openness: Efficiency and Political Economy Considerations," Working Papers 200404, University of Hawaii at Manoa, Department of Economics.

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