India has opened up significantly to capital flows from 1991 onwards. The overt aspects of opening up include FDI, portfolio equity flows, and some kinds of debt flows. In addition, there has been a dramatic increase in the size of the current account. Through misinvoicing, many firms can obtain capital flows through current account transactions.
In parallel, Indian macroeconomics has been transformed by the evolution of policy in the last 20 years. A rigid, closed, controlled, supply-constrained economy has increasingly been transformed into an open market economy, with financial markets playing a vital role in processing information, sending information signals to the private sector, and shaping resource allocation. The FRBM Act appears to have delivered on bringing the phase of fiscal indiscipline, which began in the mid 1980s, to an end.
In 1992, GDP was $240 billion and gross flows across the boundary were $97 billion. Both values now exceed a trillion dollars a year; in 2006-07, gross flows were 110% of GDP. Capital flows now loom large in their impact on both domestic finance and domestic macroeconomics.
New insights into capital flows and their linkages with both finance and macroeconomics, in the new setting, are now required. Are traditional policy reflexes adequate? Or should India retreat back into a system of capital controls as was prevalent one decade ago? Or should India move forward towards a mainstream policy framework, by international standards? These grand questions need to be addressed based on a combination of the theory of open economy macroeconomics and international finance, coupled with international experiences, coupled with an examination of empirical evidence in India. At a practical level, the quest for answers to such grand questions consists of addressing a stream of small and tangible questions, where a persuasive answer can be obtained for a narrow and focused question that has an immediate salience.
In order to obtain new knowledge on these issues, the National Institute for Public Finance and Policy and the Department of Economic Affairs, Ministry of Finance, have come together to create this NIPFP-DEA Research Program on Capital Flows and their Consequences.
To track our activities, watch the program's blog.