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Capital account liberalisation in a large emerging economy: An Analysis of onshore-offshore arbitrage

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  • Nidhi Aggarwal

    (Indian Institute of Management, Udaipur)

  • Sanchit Arora

    (Ernst and Young)

  • Rajeswari Sengupta

    (Indira Gandhi Institute of Development Research)

Abstract

In this paper, we decipher the openness of India's capital account by calculating the covered interest parity (CIP) deviations between the onshore-offshore rupee market. India is a country with an elaborate and comprehensive system of capital controls covering all kinds of international financial transactions. This has led to a thriving offshore rupee market of non-deliverable currency forward (NDF) contracts. We analyse more than 20 years (1999- 2020) of daily return differentials in the NDF market vis-a-vis the onshore spot market, estimate structural breaks in CIP deviations and connect these sub-periods to the patterns of changes in de-jure capital control actions announced by the Indian authorities. We also estimate no-arbitrage bands around the CIP using a Self-Exciting Threshold Autoregressive (SETAR) model. We find that on average over the duration of our sample period the capital controls broadly restrict capital outflows more than they restrict capital inflows. We also find that over time India has become more financially integrated with the rest of the world, though the process of capital account opening has not been a continuous and smooth one. This is reflected in large variations in CIP deviations across the period, and in recent times, smaller deviations and narrowing no-arbitrage bands that capture the transactions costs and the degree to which the capital controls are binding.

Suggested Citation

  • Nidhi Aggarwal & Sanchit Arora & Rajeswari Sengupta, 2021. "Capital account liberalisation in a large emerging economy: An Analysis of onshore-offshore arbitrage," Indira Gandhi Institute of Development Research, Mumbai Working Papers 2021-013, Indira Gandhi Institute of Development Research, Mumbai, India.
    • Handle: RePEc:ind:igiwpp:2021-013
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    Cited by:

    1. Eugenio Cerutti & Haonan Zhou, 2024. "Uncovering CIP Deviations in Emerging Markets: Distinctions, Determinants, and Disconnect," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 72(1), pages 196-252, March.
    2. Ajay Shah, 2023. "The journey of Indian finance," Working Papers 25, xKDR.

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    More about this item

    Keywords

    Capital account openness; Financial integration; Covered interest parity; Capital controls; Foreign exchange market;
    All these keywords.

    JEL classification:

    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • F30 - International Economics - - International Finance - - - General
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements

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