some new perspectives on india’s approach to capital account liberalization
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Some New Perspectives on India’s Approach to Capital Account Liberalization. Eswar Prasad Cornell University. Benefits of Financial Integration: Theory. Efficient international allocation of capital Consumption smoothing via international risk sharing - PowerPoint PPT PresentationTRANSCRIPT
Some New Perspectives on India’s
Approach to Capital Account LiberalizationEswar Prasad
Cornell University
Benefits of Financial Integration:
Theory Efficient international allocation of capital
Consumption smoothing via international risk sharing
Large welfare effects for developing economies
Growth Benefits of Financial Integration: Evidence
About 25 studies of growth effects
No effect 4Mixed: 18Positive: 3
No robust macroeconomic evidence of growth benefits
Correlation between Growth and Current A/c Balance
Non-industrial Countries, 1970-2004
DZA
ARG
BGD
BOL
BRA
CMR
CHL
CHN
COLCRI
CYP
CIV
DOM
ECU
EGY
SLV
ETH
GHA
GTM HTIHND
IND
IDN
IRN
ISR
JAM
JORKEN
KOR
MDG
MWI
MYS
MLI
MUS
MEXMAR
NGA
PAKPAN
PRY
PER
PHLRWA
SEN
SLE
ZAF
LKA
TZA
THA
TTO
TUN
TUR
UGA
URY
VENZMBZWE
-20
24
68
Pe
r ca
pita
GD
P g
row
th
-10 -5 0 5Average current account balance to gdp
Above Median
Below Median
Below Median
Above Median
0.00
1.00
2.00
3.00
Ave
rage
Per
Cap
ita
GD
P G
row
th
Investment/GDP
Current Account/GDP
Figure 6. Current Accounts, Investment and Growth in Developing Countries
Volatility and Risk Sharing
No evidence that financial integration by itself is proximate determinant of financial crises
Developing economies, including emerging markets, have not attained better risk sharing
Financial Integration and Risk Sharing(Industrial Countries)
0.2
0.3
0.4
0.5
1987 1989 1991 1993 1995 1997 1999 2001 2003
Ris
k Sh
arin
g (1
-BE
TA
)
-0.2
0
0.2
0.4
0.6
0.8
1
1.2
Fin
anci
al O
penn
ess,
Sto
ck
Risk sharing
Financial Openness, stock
Financial Integration and Risk Sharing(Emerging Markets)
0
0.1
0.2
0.3
0.4
1987 1989 1991 1993 1995 1997 1999 2001 2003
Ris
k Sh
arin
g (1
-BE
TA
)
-0.3
-0.2
-0.1
0
0.1
0.2
0.3
0.4
Fin
anci
al O
penn
ess,
Sto
ck
Risk Sharing
Financial Openness, Stock
New Evidence: A Summary
Equity market liberalization seems to work
FDI benefits becoming more apparent
Benefits more evident in micro data
The Traditional View
Financial Globalization
More efficient international allocation of capital
Capital deepening
International risk-sharing
GDP growth
Consumption volatility
A Different Perspective
Traditional Channels
Potential Collateral Benefits
Financial market developmentInstitutional development
Better governanceMacroeconomic discipline
Financial Globalization
GDP / TFP Growth
Consumption volatility
Complication: Threshold Effects
Threshold ConditionsFinancial market development
Institutional Quality, GovernanceMacroeconomic policies
Trade integration
Financial Globalization
GDP / TFP growth
Risks of Crises
GDP / TFP growth
Risks of Crises
Above Thresholds
Below Thresholds
X
?
TENSION !!
Financial integration can catalyze financial development, improve governance, impose discipline on macro policies...
But, in the absence of a basic pre-existing level of these supporting conditions, financial integration can wreak havoc
Collateral Benefits Framework Could Help Make Progress
Unified conceptual framework
Country-specific requirements, initial conditions can be taken into account
Selective approach to liberalization based on prioritization of collateral benefits
Can manage risks during transition to thresholds, but can not eliminate them
Really New Evidence:Composition of External
Liabilities Matters FDI and portfolio equity liabilities improve risk
sharing outcomes; Debt worsens risk sharing
FDI and portfolio equity liabilities boost TFP growth; Debt has negative impact
Negative effects of debt attenuated by deeper financial markets, better institutions
Level of financial integration itself is a threshold
Reality on the Ground
De facto financial openness increasing
Capital controls becoming less effective
> Expansion of trade
> Larger international financial flows
> Rising sophistication of international investors
Trying to maintain rigid capital controls doesn’t solve inflows problem + creates distortionary costs
How Open is India’s Capital Account?
De jure capital account openness
> Capital controls
De facto financial integration
> Stocks of external assets, liabilities as ratio to GDP
De Jure Capital Account Openness
Full Sample India ChinaMedian Minimum Median Maximum
Chinn Ito1985 -1.13 -1.80 -1.13 2.54 -1.13 -1.131995 -0.09 -1.80 -0.09 2.54 -1.13 -1.132006 0.14 -1.13 0.03 2.54 -1.13 -1.13
Edwards1985 50.00 12.50 37.50 75.00 25.00 37.501995 75.00 25.00 50.00 100.00 25.00 37.502000 81.25 37.50 62.50 100.00 75.00 37.50
Miniane1985 0.86 0.83 0.86 1.00 0.831995 0.43 0.71 0.86 1.00 0.832000 0.36 0.71 0.86 0.86 0.86
Emerging Markets
De Facto Financial Integration
0
10
20
30
40
50
60
70
1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006
External Liabilities (ratio to GDP)
External Assets (ratio to GDP)
External Assets + Liabilities (ratio to GDP)
De Facto Financial Integration:
Emerging Markets (2006)
0
50
100
150
200
250
300
Balance of Payments (in billions of U.S. dollars)
2004-05 2005-06 2006-07 2007-08
Gross international reserves 141.5 151.6 199.2 309.7(in percent of GDP) 20.3 18.8 21.6 27.2
Change in international reserves 28.5 10.1 47.6 110.5
A. Current account balance -2.5 -9.2 -9.6 -17.4 (in percent of GDP) -0.4 -1.1 -1.0 -1.5
Merchandise trade balance -33.7 -51.8 -64.9 -90.1 (in percent of GDP) -4.8 -6.4 -7.0 -7.9 B. Capital account balance 28.0 23.4 44.9 108.0 FDI, net 3.7 4.7 8.4 15.5 portfolio flows, net 9.3 12.5 7.1 29.3 C. Errors and omissions, net 0.6 0.8 1.3 1.5
D. Valuation change 2.4 -4.9 11.0 18.4
Nominal GDP 696.0 806.0 922.7 1140.0
Foreign Exchange Reserves: Flows and Stocks
(in billions of U.S. dollars)
-6
-1
4
9
14
19
Jan-95 Jan-97 Jan-99 Jan-01 Jan-03 Jan-05 Jan-07
0
50
100
150
200
250
300
350
Monthly Changes
Stock of Reserves
A Decomposition of the Recent Reserve Buildup (in billions of U.S.
dollars)1998-2001 2001-06 2006-08 2001-06 2006-08 -1998-2001 -2001-06
(1) (2) (3) (2) - (1) (3) - (2)
Increase in foreign reserves 4.4 21.7 79.1 17.3 57.3
Current account balance -3.8 2.4 -13.5 6.2 -15.9 Capital account balance 9.2 17.5 76.5 8.3 59.0 FDI, net 2.6 3.8 12.0 1.2 8.2 Errors and omissions, net 0.1 0.3 1.4 0.3 1.1
Valuation Changes -1.1 1.5 14.7 2.6 13.2
Non-FDI capital account balance (including errors and omissions) 6.7 14.1 65.9 7.3 51.8
Annual averages Changes
Has the Benefit-Cost Tradeoff Improved?
Composition of inflows, stocks of external liabilities has become more favorable
Share of FDI and Portfolio Liabilities
in Gross External Liabilities
0
10
20
30
40
50
60
70
1990 1992 1994 1996 1998 2000 2002 2004 2006
Ratio of FDI + Portfolio Liabilities to Gross External Liabilities:
Emerging Markets (1995)
0
10
20
30
40
50
60
70
Ratio of FDI + Portfolio Liabilities to Gross External Liabilities:
Emerging Markets (2006)
0
10
20
30
40
50
60
70
80
90
Has the Benefit-Cost Tradeoff Improved?
Composition of inflows, stocks of external liabilities has become more favorable
High levels of foreign exchange reserves
International Investment Position (in billions of U.S. dollars)
1996-97 2000-01 2006-07
Net Position -81 -76 -45
A. Assets 38 62 244
1. FDI 1 3 242. Portfolio 0 1 1 Equity 0 0 0 Debt 0 0 0
3. Other investment 10 16 20 Other assets
4. Reserve assets 27 43 199
Foreign exchange reserves 22 40 192
B. Liabilities 119 139 289
1. FDI 11 20 722. Portfolio 19 31 80 Equity 14 17 63 Debt 5 14 17
3. Other investment 89 87 136
External Debt Stocks
0
5
10
15
20
25
30
35
40Short term debt (ratio to GDP)
Long term debt (ratio to GDP)
Reserve Adequacy(ratio of reserves to relevant
variables)
Months of imports
Short- term External Debt
External Debt
Non-FDI external
liabilities M3
2005 9.5 18.0 1.1 0.7 0.22006 9.6 16.7 1.1 0.7 0.22007 12.5 16.0 1.4 0.2
Has the Benefit-Cost Tradeoff Improved?
Composition of inflows, stocks of external liabilities has become more favorable
High levels of foreign exchange reserves
Rising trade openness
Trade Openness Ratio
0.00
0.05
0.10
0.15
0.20
0.25
0.30
0.35
0.40
0.45
0.50
The Savings-Investment Balance(in percent of GDP)
0
5
10
15
20
25
30
35
-3
-2
-1
0
1
2Savings (LHS)
Investment (LHS)
Current Account (RHS)
Has the Benefit-Cost Tradeoff Improved?
Composition of inflows, stocks of external liabilities has become more favorable
High levels of foreign exchange reserves
Rising trade openness
Greater exchange rate flexibility
Nominal Exchange Rate Relative to U.S. Dollar
30
35
40
45
50
Jan-96 Jan-98 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08
6
7
8
9
10
Rupees per $ (LHS)
Renminbi per $ (RHS)
Real and Nominal Effective Exchange Rates
80
85
90
95
100
105
110
Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08
REER NEER
Has the Benefit-Cost Tradeoff Improved? Composition of inflows, stocks of external
liabilities has become more favorable
High levels of foreign exchange reserves
Rising trade openness
Greater exchange rate flexibility
Financial markets stronger (banking reforms) and broader (equity markets deep and liquid)
More international flows of capital, including by institutional investors who have longer-term horizons; new financial instruments
India’s Share of Gross Inflows to Emerging Markets and Other
Developing Countries
-8
-4
0
4
8
12
16
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
Total
FDI
Portfolio
India’s Share of Gross Outflows from Emerging Markets and Other
Developing Countries
-1
0
1
2
3
4
5
6
7
8
9
10
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
Total
FDI
Portfolio
But … May still be below threshold levels of financial,
institutional development
Managed exchange rate; absence of singular focus of monetary policy on inflation objective
Surges in inflows create macro complications
Financial markets still have way to go: bond markets not working well, banking sector problems tied in with other aspects of government policy (fiscal)
Many imperfections in international financial markets: herding behavior; incomplete markets; risks in system harder to trace
Interest Rate Differentials Relative to U.S.
0
1
2
3
4
5
6
7
8
Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08
Govt. Security 1-year
U.S. 3-month t-bill
U.S. 3-year t-bond
Outstanding Stock of Market Stabilization Bonds(in billions of INR)
200
400
600
800
1000
1200
1400
1600
1800
Apr-04 Apr-05 Apr-06 Apr-07 Apr-08
Implications
Best to actively manage process of capital account liberalization rather than fight the inevitable
Seize windows of opportunity when benefit-risk tradeoff improves; but coast is never completely clear.
Capital account liberalization not an end in itself; needs to be put in the context of a more complete policy/reform agenda
Extra Slides
Chinas Foreign Exchange Reserves: (billions of U.S. dollars)
0
10
20
30
40
50
60
70
0
200
400
600
800
1000
1200
1400
1600
1800
Monthly Changes
Stock of Reserves
Growth Accounting for More Financially Open Economies (MFO) (1966-1985 and 1986-2005)
-0.5
0.0
0.5
1.0
1.5
2.0
Pre-Globalization Globalization
Real GDP per worker TFP contributionK/Y Contribution H Contribution
Growth Accounting for Less Financially Open Economies (LFO) (1966-1985 and 1986-2005)
Real GDP per worker TFP contributionK/Y Contribution H Contribution
0.0
0.5
1.0
1.5
2.0
2.5
Pre-Globalization Globalization
Does the Composition ofExternal Liabilities Matter?
FE GMM FE GMM
CA Openness 0.03685 0.04967 0.02837 0.03830[0.03741] [0.04595] [0.04312] [0.05047]
FDI & Equity Liab. -0.00141 0.00607*** 0.00022 0.00695***[0.00190] [0.00220] [0.00246] [0.00207]
Debt Liab. -0.00229* -0.00383*** -0.00305** -0.00378***[0.00122] [0.00117] [0.00116] [0.00087]
0.00361* -0.00332[0.00196] [0.00228]
0.00033 0.00261**[0.00131] [0.00113]
0.00101 -0.00640***[0.00240] [0.00223]
0.00226* 0.00392***[0.00120] [0.00120]
Institutional Quality * Debt Liab.
Private Sector Credit * FDI & Equity Liab.
Private Sector Credit * Debt Liab.
Institutional Quality * FDI & Equity Liab.