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Indian Capital Control Liberalization: Evidence from NDF Markets

Author

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  • Hutchison, Michael
  • Kendall, Jake
  • Pasricha, Gurnain Kaur
  • Singh, Nirvikar

Abstract

The Indian government has taken a number of incremental measures to liberalize legal and administrative impediments to international capital movements in recent years. This paper analyzes the extent to which the effectiveness of capital controls in India, measured by the domestic less net foreign interest rate differential (deviations from covered interest rate parity) have changed over time. We utilize the 3-month offshore non-deliverable forward (NDF) market to measure the effective foreign interest rate (implied NDF yield). Using the self exciting threshold autoregression (SETAR) methodology, we estimate a no-arbitrage band width whose boundaries are determined by transactions costs and capital controls. Inside of the bands, small deviations from CIP follow a random walk process. Outside the bands, profitable arbitrage opportunities exist and we estimate an adjustment process back towards the boundaries. We allow for asymmetric boundaries and asymmetric speeds of adjustment (above and below the band thresholds), which may vary depending on how arbitrage activity is constrained by capital controls. We test for structural breaks, identify three distinct periods, and estimate these parameters over each sub-sample in order to capture the de facto effect of changes in capital controls over time. We find that de facto capital control barriers: (1) are asymmetric over inflows and outflows, (2) have changed over time from primarily restricting outflows to effectively restricting inflows (measured by band widths and positions); (3) arbitrage activity closes deviations from CIP when the threshold boundaries are exceeded in all sub-samples. In recent years, capital controls have been more symmetric over capital inflows and outflows and the deviations from CIP outside the boundaries are closed more quickly.

Suggested Citation

  • Hutchison, Michael & Kendall, Jake & Pasricha, Gurnain Kaur & Singh, Nirvikar, 2009. "Indian Capital Control Liberalization: Evidence from NDF Markets," MPRA Paper 13630, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:13630
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    References listed on IDEAS

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    1. Hansen, Bruce E., 1999. "Threshold effects in non-dynamic panels: Estimation, testing, and inference," Journal of Econometrics, Elsevier, vol. 93(2), pages 345-368, December.
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    Citations

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    Cited by:

    1. Jonathan David Ostry & Atish R. Ghosh & Karl F Habermeier & Marcos d Chamon & Mahvash S Qureshi & Dennis B. S. Reinhardt, 2010. "Capital Inflows; The Role of Controls," IMF Staff Position Notes 2010/04, International Monetary Fund.
    2. Kuo-Shing Chen & Chien-Chiang Lee & Chun-Ming Chen, 2017. "Arbitrage, Covered Interest Parity and Cointegration Analysis on the New Taiwan Dollar/US Dollar FOREX Market Revisited," International Journal of Economics and Financial Issues, Econjournals, vol. 7(1), pages 420-428.
    3. Mahvash S. Qureshi & Jonathan D. Ostry & Atish R. Ghosh & Marcos Chamon, 2011. "Managing Capital Inflows: The Role of Capital Controls and Prudential Policies," NBER Chapters,in: Global Financial Crisis National Bureau of Economic Research, Inc.
    4. Prachi Mishra & Peter J Montiel & Rajeswari Sengupta, 2016. "Monetary Transmission in Developing Countries; Evidence from India," IMF Working Papers 16/167, International Monetary Fund.
    5. Jinzhao Chen, 2012. "Crisis, Capital Controls and Covered Interest Parity: Evidence from China in Transformation," Working Papers halshs-00660654, HAL.
    6. Jinzhao Chen, 2012. "Crisis, Capital Controls and Covered Interest Parity: Evidence from China in Transformation," PSE Working Papers halshs-00660654, HAL.
    7. repec:pra:mprapa:39771 is not listed on IDEAS
    8. Michael Hutchison & Rajeswari Sengupta & Nirvikar Singh, 2012. "India’s Trilemma: Financial Liberalisation, Exchange Rates and Monetary Policy," The World Economy, Wiley Blackwell, vol. 35(1), pages 3-18, January.
    9. Aizenman, Joshua & Sengupta, Rajeswari, 2011. "The financial trilemma in China and a comparative analysis with India," MPRA Paper 39798, University Library of Munich, Germany, revised 03 Jul 2012.
    10. Kuga Iakov & Elena Kuzmina, 2016. "Covered interest parity: evidence from Russian money market," EERC Working Paper Series 16/01e, EERC Research Network, Russia and CIS.
    11. Karl F Habermeier & Annamaria Kokenyne & Chikako Baba, 2011. "The Effectiveness of Capital Controls and Prudential Policies in Managing Large Inflows," IMF Staff Discussion Notes 11/14, International Monetary Fund.
    12. repec:rnp:ecopol:ep1711 is not listed on IDEAS

    More about this item

    Keywords

    capital controls; non-deliverable forward markets; India; economic reform; liberalization;

    JEL classification:

    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration

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