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INTRODUCTION
The recent wave of financial globalization and its aftermath has been marked by
a surge in international capital flows among the industrial and developing
countries, where the notions of tense capital flows have been associated with
high growth rates in some developing countries. Some countries have
experienced periodic collapse in growth rates and financial crisis over the same
period. It is true that many developing economies with a high degree of
financial integration have also experience higher growth rate. Low Developing
Countries (LDCs) are eager to welcome any kind of foreign capital inflows to
overcome the debt crisis situation. They are facing the challenges from the
foreign capital and the invisible resource. From the supply side also there are
some strong inducing factors, which led the international investors towards the
financial market of the developing countries. The correlation between the
movements in developed and developing countries financial market, the
deceleration in industrial economy markets and high growth prospects of the
less developed market are some of the important reasons, which made them an
attractive option for portfolio diversification.
It is fact that international capital flows on financial market can be very volatile.
However, different countries experienced different degree of volatility of
financial market and this may be systematically related to the quality of macroeconomic policies and domestic financial governance. In this context high
volatility of capital flows has affected the macro economic variables such as
exchange rate, interest rate, money stock (M3) and inflation negatively. Even in
countries where a conducive atmosphere is created for the free flow of capital
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LITERATURE REVIEW
Lensik et al (1999) examine the impact of uncertain capital flows on the growth
of 60 developing countries during the 1990s. They distinguished between total
capital flows, official capital flows and private capital flows. For the three types
of capital flows, they derived a yearly uncertainty measure. They have used the
yearly uncertainty measures in Ordinary Least Square (OLS) as we as
Generalized Method of Moments (GMM) estimates, to explain the impact of
uncertain capital flows on growth. They conclude that both types of estimates
suggest that uncertain capital flows have a negative effect on financial market
and growth in developing countries.
Rangrajan (2000) investigates the capital flows and its impact on the capital
formation and economic growth taking into the variable as net private capital
flows, net direct investment, net official flows, net portfolio investment and
other net investments in 22 countries during 1992 to 2000. If capital inflows
were volatile or temporary, the country would have to go through an adjustment
process in both the real and financial market. Inflows, which take the form of
direct foreign investment, are generally considered more permanent in
character. Capital flows can be promoted purely by external factors which may
tend to be less sustainable than those induced by domestic factors. Both capital
inflows and outflows when they are large and sudden have important
implication for economies. When capital inflows are large, they can lead to an
appreciation of real exchange rate. He concludes that the capital account
liberalization is not a discrete event.
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Khanna (2002) examines the macro economic impact on Indian capital market
as well as the corporate sector and what are the macro economic effects on
inflows of capital to Indian and micro economic effects on the capital market
during 1989 to 2002. He took the macro variable as FDI, FPI, NRI deposits,
external assistance and GDP/GDS/GNP. He tells that entry of international
capital flows helps to provide greater depth to the domestic capital market and
reduce the systematic risk of the economy. He argues that advanced for
liberalizing capital market for liberalizing capital market and opening them to
foreign investor are to increase the availability of capital with domestic
industries and commercial firms. On the other hand, the Indian stock market is
today largely dominated by a small group of FIIs, are able to move the market
by large intervened. He concludes that in case of India, the microanalysis of
stock market also fails to provide any evidence that the entry of FII has reduced
the cost of Indian corporate sector.
Kohli (2003) examines how capital flows affect a range of economic variables
such as exchange rates, interest rates of foreign exchange reserves, domestic
monetary condition and financial system in India during the period 1986 to
2001. She has examines how capital inflows induce real exchange rate
appreciation, stock market and real estate boom, real accumulation and
monetary expansion as well as effects on production and consumption. She
investigates the impact on capital flows upon the domestic financial sector in
India. Inflows of foreign capital have a significant impact on domestic money
supply and stock market growth, liquidity and volatility. At the conclusion, the
domestic financial sector that is the banking sector and capital market in the
event of a heavy inflow of foreign capital in India. Correlation between
domestic and foreign financial market highlights Indias vulnerability to
external financial shocks. For India on the relationship between portfolio flows
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fueling higher growth. He suggests that in the short run, globalization triggers
bankruptcy of the financial system and protracted recession. The exploration of
capital flows to emerging markets in the early and mid 1990s and the recent
reversal following the crisiss around the globe have ignited once again a heated
debate on how to manage international capital flows. He indicates capital
outflows worry policy makers, but so do capital inflows as they may trigger
bubbles in asset market and foster an appreciation of the domestic currency and
a loss of competitiveness.
OBJECTIVES
1. To study the trends and composition of Capital Flow
2. To study the Economic Reforms, Capital Flows and Economic Growth in
India
3. To analyze the types and Magnitude of Capital Flows
4. Changes Of Financial Markets In India After Liberalization, 1991
RESEARCH METHDOLOGY
This data has been collected from different sources like reference books, reports
and websites.
SCOPE OF THE STUDY:
This project represents the Economic Reforms, Capital Flows and Economic
Growth in India, trends and composition of Capital Flow, types and Magnitude
of Capital Flows and Changes Of Financial Markets In India After
Liberalization, 1991
.
LIMITATIONS:
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This study contains only the Economic Reforms, Capital Flows and Economic
Growth in India, trends and composition of Capital Flow, types and Magnitude
of Capital Flows Changes Of Financial Markets In India After Liberalization,
1991.
CHAPTER SCHEME
This project comprises of Chapters mainly as shown below:
Chapter 1: Trends and composition of Capital Flow
Chapter 2: Economic Reforms, Capital Flows and Economic Growth in India
2.1 : Capital Flows and Economic Growth in India
2.2 : Importance of Foreign Capital Flow
2.3 : Economic Reforms in India and Capital Flows
Chapter 3: Types and Magnitude of Capital Flows.
1.1
1.2
1.3
1.4
1.5
1.6
CHAPTER 1
TRENDS AND COMPOSITION OF CAPITAL FLOWS
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The trends in net capital inflows (sum of FDI, portfolio, loans and resident
Indian deposits) into India between 1985-98. The plot shows a recovery of net
capital inflows that had begun to decline in the late eighties and bottomed out in
the 1991 crisis. Following liberalisation of restrictions on inward investment in
1991-92, there was a sharp increase in capital inflows between 1992-95 and
1996-97.3 This is similar to the experiences of other emerging economies in
Asia and Latin America, all of who typically experienced a rise in inward
foreign capital following market- oriented reforms. The magnitude of capital
flows into India is much smaller though; the peak level for India is 3.5 per cent
of GDP in 1993-94, which is small when compared to other emerging markets.
For instance, the peak levels are above 20 per cent for Malaysia, 13 per cent for
Thailand, 10 per cent for the Philippines and almost 10 per cent for Singapore
between 1990-93.
Second, the swing in the capital account observed in the case of other emerging
economies is not visible for India so far. In 1995 estimate a change in the capital
account from 2.4 per cent (GDP) on an average between 1984-89 to 1.6 per
cent (1990-93) for ten Latin American countries and from 1.6 (1984-88) to 3.2
(1989-93) per cent (GDP) for eight Asian ones. Comparative figures for India
are 2.3 (1985-89) and 2.4 (1993-985) per cent of GDP, indicating only a
marginal increase. This is probably explained by Indias relatively late start in
liberalizing its trade and investment regimes, by which time the competition for
international capital had already stiffened.
Though the magnitude of capital inflows into India is at variance vis--vis Latin
America and other parts of Asia, there is a common pattern in the composition.
World capital flows in the nineties have displayed a steep decline in official
capital flows and a rise in private investment, particularly portfolio capital. This
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CHAPTER 2
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External commercial borrowing has been relaxed but as regulated with respect
of maturities and interest rate spreads. Effective restrictions continued on the
acquisition of foreign financial assets by residents and on currency
convertibility for capital account transaction. Recently these restrictions have
been slightly eased to allow domestic resident to investment in foreign equities.
The experience of capital account liberalization elsewhere suggests that opening
domestic financial markets to international capital flows exacerbates imprudent
practice under weak regulation or regulatory forbearance. The large
accumulation of reserves by RBI provides insurance against rapid capital
outflows but at the loss of foreign interest earnings.
The rapid liberalization of financially repressed economy often leads to large
capital and rapid expansion of domestic financial market followed by a capital
account crisis and economic contraction. The elimination of capital controls
exposes domestic capital markets and macro economic policies to discipline of
international capital market, starting a race between financial reforms and crash.
Indian policy is following a determined gradual path towards economic
liberalization and international integration. Following the liberalization of
transaction on the current account, restrictions on capital inflows have been
relaxed steadily with an emphasis on encouraging long-term investment and
saving.
The pattern of liberalization capital inflows in India has been the gradual raising
of quantitative restriction on inflows and the size of flows that automatically
approved. The gradual relaxation on restriction on capital outflows would
logically follow, while restriction that discourages short-term inflow, which are
the parts of current policy. Capital control means that the Government borrows
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CHAPTER 3
TYPES AND MAGNITUDE OF CAPITAL FLOWS.
The Indian Approach to Capital Controls
In the early 1990s India faced a balance of payments crisis. This crisis was
followed by an IMF structural adjustment program, economic reforms and
liberalization of the trade and capital accounts. Policy makers were, however,
very cautious about opening up the economy to debt flows. The experience of
the Balance of Payments (BOP) crises 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.
Inbound FDI
India opened up slowly to FDI in the 1990s. The limits on the share of foreign
ownership was slowly increased in every sector. By 2000, while most sectors
were open up to 100 per-cent, sectors where FDI was restricted include retail
trading (except single brand product retailing), atomic energy, and betting. Table
1 shows the areas where FDI caps exist. While inbound FDI investors have the
ability to repatriate capital, so far, in the Indian experience, this reverse flow of
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Portfolio Flows
In the early 1990s, India opened up to portfolio inflows through \foreign
institutional investors" (FIIs). This policy framework was largely in place by
2000. Equity investment by foreign institutional investors involves the
following constraints: The aggregate foreign holding in a company is subject to
a limit that can be set by the shareholders of the company. This limit is, in turn,
subject to sectorial limits which apply in certain sectors. No one foreign
portfolio investor can own more than 10% of a company. Foreign ownership in
certain sectors (telecom, insurance, banking) is capped at various levels. Barring
these constraints, portfolio investors have convertibility in the sense that they
are free to bring capital in and out of the country without requiring permissions.
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financial
listing.
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Sovereign Debt
One element of the policy framework of the early 1990s was encouragement for
equity flows but barriers against debt inflows. Technically, the government of
India has no sovereign debt program. Aid flows are miniscule. There is a cap on
the stock of ownership of government bonds by FIIs which is set at a miniscule
number of $1.5 billion. Hence, as a practical matter, FII investment into rupee
-denominated government bonds is zero. However, from time to time, banks
have borrowed abroad depending on the government's assessment of the stock
of foreign exchange reserves and their adequacy. One form this has taken is
borrowing in the form of bank deposits of Non-Resident Indians (NRIs).
The interest rates on these deposits are set by the RBI and fluctuate according to
whether the government wishes to encourage or discourage inflows. Three quarters of Indian bank deposits are with government-owned banks, which are
explicitly guaranteed by the government. Even with private banks, there is an
implicit liability of the State, for no significant private bank has ever been
followed to fail. The borrowing of an Indian bank is, then, visibly backed by the
government. The authorities claim that a massive reduction in offshore debt,
particularly offshore sovereign debt, took place in the 1990s.
By the official classification, the external debt of GOI stagnated at between $45
billion and $50 billion over 1998-2007. However, a more accurate rendition of
the situation requires addressing a phenomenon that we term \quasi-sovereign"
debt. Quasi-sovereign borrowing, based on a reclassification of the detailed
statistics for debt stock. While sovereign debt measured in dollars has stagnated,
implying a rapid decline in sovereign debt expressed as percent to GDP (from
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Debt of Firms
Firms are allowed to borrow abroad through \External commercial Borrowing."
These include loans or bond issues abroad that are foreign currency
denominated. Small transactions are processed by the government with
automatic approval," and bigger transactions require permission. Under the
present policy framework:
External borrowing by firms must be of at least 3 years' maturity for
borrowing below $20 million, and at least 5 years' maturity beyond.
Borrowing up to $500 million by a firm for certain specified end-uses is
allowed without requiring permissions.
The evolution of ECB, expressed as percent of GDP. The borrowing of a
given year inevitably induces repayment in the following years; the net inflows
on account of ECB reflects the combination of fresh issuance of the year and
repayments owing to older transactions.
Apart from ECB, foreign institutional investors can buy rupeedenominated corporate debt on the domestic market. However, there is a
miniscule cap on ownership of corporate bonds by all FIIs put together at $2.5
billion. Hence, as a practical matter, FII investment into corporate debt is nonexistent.
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Capital Outflows
Outward capital flows primarily take two forms. The first and massive
mechanism is the purchase of US treasury bills and other foreign assets by RBI
when it builds reserves. The other form of capital outflows that has become
important in recent years is outbound FDI by Indian companies. Outbound FDI
flows from India have risen sharply since 2004.
India's overseas investment policy was liberalized in 1992. The rationale for
opening up Indian investment overseas was to provide Indian industry access to
new markets and technologies with a view to increasing their competitiveness.
The policy was further liberalized in 1995. Since 2004 Indian companies have
been allowed to invest in entities abroad up to 200% of their net worth in a year.
In response, thousands of Indian firms have embarked on turning themselves
into multinational corporations.
Overseas investment approvals have been steadily increasing since 1996.
Approvals for investment abroad were at 1395 ($2,855 million) in 2005-06 as
compared to 290 approvals ($557 million) in 1996-97. But the sharpest growth
took place in 2006-07. In 2006-07, between April and October, 870 approvals
were granted to Indian companies for overseas investments worth $6,034.87
million as compared with 822 approvals worth $1,191 million in the
corresponding period of last year, a sharp jump of more than 5 times.
Inbound and outbound (net) FDI flows, both expressed as percent to GDP.
Outbound flows have risen sharply, to a level of over 1% of GDP a year. In
2006 the flow of outbound FDI as a percentage of gross fixed capital formation
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CHAPTER 4
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BIBLIOGRAPHY
1. A published volume from the National Bureau of Economic Research Publication Date: May 2007 Title: Indias Experience with Capital
Flows: The Exclusive Quest for a Sustainable Current Account Deficit
2. Economic Reforms, Capital Flows And Macro Economic Impact On
India by Narayan Sethi
https://www.google.co.in/url?
sa=t&rct=j&q=&esrc=s&source=web&cd=10&cad=rja&uact=8&ved=0
CFgQFjAJ&url=http%3A%2F%2Fwww.igidr.ac.in%2Fmoney
%2Fmfc_10%2FNarayan
%2520Sethi_submission_51.pdf&ei=ezDoVJyzPMG1uQTLpYCYBA&u
sg=AFQjCNEfMMRqfHvc-c783UAEDx4FGaW9bg&sig2=0w-9_91r9a4goZ9YNYvtA
3. Managing capital flows: The case of India by Ajay Shah, Ila Patnaik
May 2008
NIPFP-DEA Research Program on Capital Flows and their Consequences
National Institute of Public Finance and Policy
New Delhi
http://www.nipfp.org.in/nipfp-dea-program/index.html
4. Capital Flows And Their
Macroeconomic Effects In India
Renu Kohli
March, 2001
http://icrier.org/pdf/renu64.pdf
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