| Abstract: |
This paper examines the effectiveness of international capital controls in
India over time by analyzing daily return differentials in the non-deliverable
forward (NDF) markets using the self-exciting threshold autoregressive (SETAR)
methodology. We begin with a detailed narrative on the evolution of capital
controls in India and calculate deviations from covered interest parity
utilizing data from the 3-month offshore non-deliverable rupee forward market.
We estimate a no-arbitrage band using SETAR where boundaries are determined by
transactions costs and by the effectiveness of capital controls. We identify
several distinct periods reflecting changes in capital control application and
intensity for India, and estimate the model over each sub-sample in order to
capture the de facto effect of changes in capital controls on return
differentials over time. We find that Indian capital controls are asymmetric
over inflows and outflows, have changed over time from primarily restricting
outflows to effectively restricting inflows; and that arbitrage activity
closes deviations from CIP when the threshold boundaries are exceeded in all
sub-samples. Moreover, our results indicate a significant reduction in the
barriers to arbitrage since 2008. As a robustness test of the methodology, we
also apply it to the Chinese RMB NDF market and find that capital controls are
strictly limiting capital inflows with the exception of two periods of
regional and international financial turbulence. The intensity of Chinese
controls varies over time, indicating discretion in the application of capital
control policy but, unlike India, show no sign of gradual relaxation or
liberalization. |