Managing Capital Flows

Managing Capital Flows

The Search for a Framework

ADBI series on Asian Economic Integration and Cooperation

Edited by Masahiro Kawai and Mario B. Lamberte

Managing Capital Flows provides analyses designed to help policymakers develop a framework for managing capital flows that is consistent with prudent macroeconomic and financial sector stability.

Chapter 9: Managing Capital Flows: The Case of India

Ajay Shah and Ila Patnaik

Subjects: asian studies, asian economics, development studies, development economics, economics and finance, asian economics, development economics


Ajay Shah and Ila Patnaik INTRODUCTION 9.1 In the early 1990s, India faced a balance of payments (BOP) crisis. This crisis was followed by an IMF structural adjustment program, economic reforms, and liberalization of the trade and capital accounts. Policymakers were, however, very cautious about opening up the economy to debt flows. The experience of the BOP crisis as well as the lessons learned from other developing countries suggested that debt flows, especially short-term debt flows, could lead to BOP difficulties if the country faced macroeconomic imbalances and had an inflexible exchange rate. The emphasis was, therefore, on foreign investment – both foreign direct investment (FDI) and portfolio investment. Even these were opened up slowly and a system of capital controls remained in place (see Shah and Patnaik 2007a for a detailed treatment of the easing of capital controls in the 1990s). This chapter on managing capital flows in India is organized into six sections. Following the introduction, Section 9.2 is a discussion of types of capital flows and controls in India. Section 9.3 compares India’s capital controls and degree of openness to capital flows with those of major economies, using international measures. The next section is devoted to portfolio flows, owing to their increasing importance in the capital account. Section 9.5 examines the macroeconomic impacts of capital flows, and finally Section 9.6 offers policy recommendations. 9.2 9.2.1 CAPITAL CONTROLS AND TYPES OF CAPITAL FLOWS Inbound FDI India opened up slowly to FDI in the 1990s. The limits on the share...

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