Hutchison, Michael and Kendall, Jake and Pasricha, Gurnain Kaur and Singh, Nirvikar (2009): Indian Capital Control Liberalization: Evidence from NDF Markets.
Download (315kB) | Preview
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.
|Item Type:||MPRA Paper|
|Original Title:||Indian Capital Control Liberalization: Evidence from NDF Markets|
|Keywords:||capital controls; non-deliverable forward markets; India; economic reform; liberalization|
|Subjects:||G - Financial Economics > G1 - General Financial Markets > G15 - International Financial Markets
F - International Economics > F3 - International Finance > F31 - Foreign Exchange
F - International Economics > F3 - International Finance > F36 - Financial Aspects of Economic Integration
|Depositing User:||Nirvikar Singh|
|Date Deposited:||26. Feb 2009 05:01|
|Last Modified:||28. Aug 2015 01:28|
 Bai, J. and P. Perron (2003). ‘Computation and Analysis of Multiple Structural Change Models’, Journal of Applied Econometrics 18: 1-22.
 Chinn, Menzie and Ito, Hiro (2007) ‘A New Measure of Financial Openness’, mimeo, (May 2007), forthcoming in Journal of Comparative Policy Analysis.
 Cheung, Y.W., Tam, D., Yiu, M.S. (2006) ‘Does the Chinese Interest Rate Follow the US Interest Rate?’, Hong Kong Institute of Monetary Research Working Paper No 19/2006.
 Frankel, J.A. (1991). ‘Quantifying International Capital Mobility in the 1980s’, NBER Working Paper No. 2856.
 Frankel, J.A. and R.M. Levich (1975). ‘Covered Interest Arbitrage: Unexploited Profits?’, Journal of Political Economy 83, 325-338.
 Hansen, Bruce (1999). ‘Testing for linearity’, Journal of Economic Surveys, pp. 551-576.
 Jadhav, Narendra (2003). ‘Capital Account Liberalisation: The Indian Experience’, available at http://www.imf.org/external/np/apd/seminars/2003/newdelhi/jadhav.pdf.
 Levy Yeyati, Eduardo, Sergio L. Schmukler and Neeltje Van Horen (2006). ‘International Fi- nancial Integration through the Law of One Price’, World Bank Policy Research Working Paper No. 3897
 Lipscomb, Laura (2005). ‘An Overview of Non-Deliverable Foreign Exchange Forward Markets’, Federal Reserve Bank of New York, May.
 Liu, L., Otani, O. (2005) ‘Capital Controls and Interest Rate Parity: Evidences from China, 1999-2004’, Working Paper, March 2005
 Ma, G., McCauley, R. (2007) ‘Do China’s Capital Controls Still Bind? Implications for Monetary Autonomy and Capital Liberalization’, Bank of International Settlements, Working Paper No. 233, August 2007.
 Ma, G., Ho, C., McCauley, R. (2004) ‘The Markets for Non-Deliverable Forwards in Asian Currencies’, BIS Quarterly Review, June 2004, pp.81-94.
 Misra, Sangita and Behera, Harendra (2006) ‘Non-Deliverable Forward Exchange Market: An Overview’, Reserve Bank of India Occasional Papers, 27(3), Winter 2006.
 Pasricha, Gurnain (2008) ‘Financial Integration in Emerging Market Economies’, Department of Economics Working Paper No. 641, University of California, Santa Cruz.
 Potter, Simon (1999). ‘Nonlinear Time-series Modeling: An Introduction’, FRB of New York Staff Report No. 87.
 Shah, Ajay, and Patnaik, Ila. (2005) ‘India’s Experience with Capital Flows: The Elusive Quest for a Sustainable Current Account Deficit’, Working Paper 11387, National Bureau of Economic Research, Cambridge, MA.
 Taylor, M.P. (1989). ‘Covered Interest Arbitrage and Market Turbulence’, Economic Journal 99, 376-391.
 Tong, H. (1978). ‘On a Threshold Model’ in Pattern Recognition and Signal Processing. C.H. Chen (editor), Amsterdam, Sijhoff and Noordhof.
 Tsay, R.S. (1989). ‘Testing and Modeling Threshold Autoregressive Processes’, Journal of the American Statistical Association 84: 231-240.