Capital Flows and Capital Controls in India: Confronting the Challenges

Abstract

This chapter examines India’s experience with capital account liberalization, and management of capital flows. Aware of the risks posed by capital flows, Indian policy makers have taken a cautious approach to capital account liberalization—with inflows liberalized before outflows, and within inflows, equity flows, especially direct investment, preferred over debt flows. This approach has protected the domestic economy from financial contagion and crisis, while the liberalization of FDI flows has been beneficial for economic growth. Yet, as India has gone down the path of liberalization, the volatility of capital flows has increased. India has responded to this volatility by deploying multiple policy tools—including foreign exchange intervention, prudential measures, and adjustment of capital controls. Going forward, Indian policy makers need to carefully calibrate the pace of further liberalization, especially of short-term debt flows.