FINANCIAL GLOBALIZATION IN INDIA – OPPORTUNITY AND VOLATILITY

Renu Kohli
(Oxford Handbook of the Indian Economy, 2014)

INTRODUCTION

1. Financial globalization (hereafter FG) may be broadly described to mean the extent
to which countries are linked through cross border financial holdings.
2. It is not a new phenomenon, earlier being observed in the 19 th century wave of
globalization (and even earlier)
3. A novel feature of the current round of globalization is the change in the operational
environment- technological progress and financial liberalization (FL) has changed the
landscape and according to Kohli has made it infinitely riskier.
4. The outcome of FG is mixed. Financial crisis and volatility have been increasing while
the gains remain nebulous.
5. The financial crisis of 2008, in particular, made many question unfettered FG.

FINANCIAL GLOBALIZATION AND ECONOMIC THEORY

1. In theory, countries gain from FG in several ways –Foreign capital positively impacts
growth through:
a. Easing financial constraints
b. Lowering costs of funds, and consequently, increasing investments and
output growth
a. Technology spill over
b. Competition
c. Learning effects to raise the efficiency and productivity of capital
6. It also enables
a. international risk sharing
b. consumption smoothening.
7. Indirectly it also
a. Promotes development of domestic financial sector
b. Disciplines the macroeconomic policies of receiving countries

FINANCIAL GLOBALIZATION AND EMPIRICAL EVIDENCE

1. As noted earlier, empirical evidence on the benefits of foreign capital is somewhat
mixed.
8. According to some authors (Prasad, Rogoff and Wei, IMF occasional papers, 2003),
financial globalization benefits once countries cross a certain threshold.
9. However, in this context too many observed results are counter-intuitive e.g. –
 a. Non-industrial countries that rely on lesser foreign capital have clocked
higher growth rates on average in the long run (Prasad et al. 2007).
b. Countries financing more of their investments domestically have, on average,
grown much faster (Aizenman et al. 2007)
c. Capital seems to flow more to countries that invest and grow less
d. Countries with faster productivity growth appear to attract less foreign
capital (allocation puzzle) (Gourinchas and Jeanne 2007)
e. International risk sharing gains are increasing over time but in the initial
stages (emerging markets), it is found to be non-existent or insignificantly low
or restricted to industrial countries (Lewis 1996, Kose et. al, 2007).
10. Also, although FG seems to be associated with lower inflation, there is little evidence
to support that it disciplines macroeconomic policies.
11. However, institutional quality and governance are observed to improve as countries
undertake reforms in response to FL and financial market development is observed
after basic institutional structures develop.

Empirical Proof on Types of Foreign Capital

1. FDI, or stable long term flows are more positively associated with growth through
micro-linkages.
2. Equity market liberalization is found positively linked to higher investments and
growth.
3. Debt flows, especially short term, are decisively found to yield no obvious benefits to
the recipient and are systematically linked to an increased likelihood of financial
crisis.

FG, VOLATILITY AND FINANCIAL CRISIS

1. How does FG relate to volatility?
a. Most studies indicate a striking rise in GDP and consumption correlations
with increased global integration.
b. In other words, the more integrated a country, the more synchronized is its
business cycle with the global one.
2. The association with macroeconomic volatility also depends on a country’s financial
development and the quality of its institutions.
a. Higher output volatility is linked to higher financial risk, i.e. the ability of a
country to pay or not pay its debts.
3. FG also coincides remarkably with a higher frequency in the occurrence of financial
crisis, especially in developing and emerging economies,
a. for example Latin American debt crisis in the 1980s and the Japanese
recession and banking sector problems since late 1980s, East Asian crisis in
1997, global financial crisis of 2008-09, etc.
4. The nature of global capital flows has become highly pro-cyclical, herding behaviour
and speculative attacks.
a. FG amplified the costs of policy and regulatory failures in preventing the crisis
and its management thereafter.
5. To conclude then, interestingly many economists, including Bhagwati, who generally
support free trade, criticize the unfettered movement of global capital.

POLICY IMPLICATION AND THE WAY FORWARD FOR INDIA

6. What does this imply for liberalizing, emerging and developing countries?
a. The international opinion is now more favourably inclined towards the
management of capital flows, including endorsement of capital controls as an
additional tool.
b. The way forward for FG is designing global, national and regional policy
frameworks to cope with high levels of international financial integration.
7. All these issues have a bearing for India, which has been a gradual but a steady
liberalizer of its financial markets for over 2 decades now as it belongs to a group of
countries whose financial opening coincided with the trend towards increasing
financial globalization.
8. This chapter is an attempt to explore these issues.

FINANCIAL GLOBALIZATION OF INDIA; AN OVERVIEW

1. Before 1991, India had a closed capital account. In other words, barring trade, all
external transactions between private residents and non-residents were prohibited.
2. Capital movements were mostly official transactions leaving the government as the
only effective borrower abroad.
3. The BOP crisis in 1991 prompted the restructuring of economic policies including–
a. Opening up of the economy to private foreign capital in 1992-93.
b. Re-orienting the country’s external financing pattern from expensive debt
towards cheaper equity.
c. The crisis reinforced the urgency to reduce foreign currency debt.
4. This typically meant encouraging equity over debt, more specifically - foreign direct
investment (FDI) and foreign portfolio equity capital.
a. These factors effectively shifted the weight of liberalization towards foreign
portfolio equity capital, as even FDI at the time depended critically on other
economic reforms including the sustainability and certainty of economic
policies to inspire the confidence of long term commitment of foreign
investors.
b. This was helped by the fact that unlike most developing countries, India had a
reasonably well developed equity market when liberalization began in the
1990s.
5. To sum up then,India’s approach towards capital account liberalization has been as
follows –
a. Preference to equity over debt. This tends to minimize the interest rate and
liquidity risks for firms.
b. In case of debt - long term borrowings have been favoured over short term
ones to enhance the productive capacity of the economy and lessen liquidity
and rollover risks from a sudden reversal.
c. Inflowsof foreign capital have been liberalized before outflows (however, in
times of surpluses, outflows have been liberalized fairly fast)
d. (Liberalization of) Non-resident capital flows have taken precedence over
residents. This results from a fear of domestic capital flight and the non-
readiness to make the currency convertible.
e. Among the residents, preference hierarchy is as follows,
i. Corporates
ii. Non-bank financial intermediaries (NBFCs)
iii. Banks
iv. Individuals

CAPITAL ACCOUNT LIBERALIZATION POLICY

1. India’s strategy w.r.t. to capital account liberalization (first articulated in Tarapore
Committee reports - I (1997) and II(2005)) is to aim at striking a balance between
fulfilling the country’s foreign capital needs while striving for BOP sustainability.
2. The two reports clearly linked the dismantling of key capital account restrictions with
the achievements of macroeconomic objectives like -
a. reducing inflation,
b. fiscal consolidation, and
c. monetary-fiscal separation (i.e. removing the strong dependence of the fisc
on the domestic banking system for financing the fiscal deficit through
‘financial repression’).
3. Since liberalization, foreign participation in the debt market has increased
incrementally to support public debt issuance needs, while implementing a fiscal
responsibility framework.
4. Despite these ‘radical’ changes, and after successive reviews of the liberalization
process in India, capital account is still not fully open and debt flows are tightly
managed.
5. Rakesh Mohan has given a clear account of the logic behind this approach, the
government considers that capital inflows in excess of domestic absorptive capacity
can lead to overheating of the economy and create asset price bubbles.
6. In light of the above Indian regulation discriminates against debt flows in two ways:
a. Foreign investor’s participation in the domestic government bond market is
capped
 b. Indian corporates can borrow abroad above a minimum maturity and below a
maximum interest cost. These limits vary per economic sector, depending on
perceived needs.
7. India’s pace of capita account opening - slow and gradual – has often been
commented upon by observers. In passing it may be noted that this is not specific to
capital account liberalization alone; much of India’s reform process is characterized
by gradualism.
a. But compared to OECD countries, India’s pace is not particularly slow. OECD
counties began to dismantle the capital controls in 1960s when they adopted
the OECD code on capital moments to complete dismantling in the 1980s. On
average these countries took anything from 20-25 years to fully liberalize
their capital accounts.
b. However, there is no gainsaying that financial openness remains limited in
India today, particularly when compared with many other emerging market
economies.
8. Of course, measuring FG is inherently difficult and there can be many measure de
jure and de facto and can often show results contradictory to each other.
a. For example, an oft-quoted index, the Chinn-Ito index of financial openness
puts India as the least open with an index value of -1.13 (that is a minus 1.13)
in 2007 compared to 0.99 for Brazil, 1.18 for Indonesia, -0.19 for Malaysia
and 0.14 for Philippines.
9. Some economists however question this measure as it has hardly changed for India
since 1970s. By many other measures India remained at the low end of the
distribution but moved up significantly after 1995.

THE EXPERIENCE: OPPORTUNITY AND VOLATILITY

1. How has India benefitted from its rising level of FG?

2. There are few studies that have looked at the issue in its entirety, although several
examine one or the other aspect.
3. For example, efficiency gain from stock market integration, greater vulnerability in
times of distress from market integration, role of capital controls, macroeconomic
effects of financial opening, etc.
4. The current section attempts to provide an overview of the issue. It assumes that the
measure of FG is gross capital flows, as it measures the underlying exposure of an
economy to cross border financial flows and its integration and can accurately
capture the stress that emerging economy can face in surges and draught of
liquidity.

Capital Flows - Data

1. As a share of GDP, gross capital flows more than doubled between 2005 and 2007 to
US$ 770 Billion, a 10-fold increase over 2000 levels.
 5. The net capital account more than doubled from 4% of GDP in 2004-05 to 9.3% of
GDP in 2007-08 reflecting the fast pace of integration with global financial markets.
6. This boom, however, turned to bust when foreign capital reversed following the
2008 crisis; net capital (in)flows collapsed to 0.6% of GDP.
7. Post crisis the net capital account is averaging 3.5% of GDP.
8. Perhaps, more than the quantity it is the quality that we should pay attention to.
Figure 8.2 (p. 193) dissects the quality of capital entering India.
9. The various categories of Foreign Capital are: -
a. Loans
b. Portfolio Capital 1. Loans and Portfolio
c. Banking Capital Capital are more
d. FDI volatile and
2. Stable and Long term dominate more than
e. Other Capital
flows like FDI have
lagged behind with

INDIA AND FINANCIAL GLOBALIZATION

1. How has FG benefitted India, if at all?
10. There is little doubt that high growth rates and low, stable inflation and interest
rates accompanied this financial globalization (Table 8.1)

Table 8.1

Financial GDP (in%) Investment Inflation Interest Fiscal Current

Openness Rate (Wholesale Rate Deficit Account
Price) (Repo) (% of GDP)
(% of GDP)
2000-02 17.9 4.7 24 4.7 7.7 9.7 0.4
2003-07 38.6 8.9 34 5.5 6.4 6.3 -0.3
2008-09 47.8 7.4 37 6.0 6.5 9.0 -2.6
2010-11 51.8 7.5 32 9.3 6.6 7.8 -3.4
Observations from the Table
a. FG almost trebled to 50% of GDP.
b. Average GDP rate almost doubled from 4.5% to 8.9%.
11. But this does not necessarily imply an association between the two phenomena as
the period is characterised by significant structural changes in many spheres of
India’s economic policy.
12. Nonetheless, growth inducing channels of FGthat work through an expanded pool of
resources and lower cost of capital to -
a. raise the share of Investment in GDP (24% to 38% in India) andan increase in
output can be observed in the Indian case.
b. Alongside, corporate financial pattern changed to absorb higher share of
external funding - that is now almost 33% of their overall financing.
 13. Effective borrowing costs have fallen significantly since 2000 relative to bank lending
ratesEasing of financial constraints undoubtedly facilitated growth. The level of
external commercial borrowing (ECB) - selectively permitted with caps on quality,
interest rate maturity and so on
a. rose from a monthly average of US$880 million in 2004 to US$ 2.5 billion by
2007, and
b. continued to remain between US$2-2.5 billion even in the post crisis period.
14. FDI has risen 7 fold and is in line with the patterns observed in countries like China.
15. Simultaneously, outward direct investments by Indian firms have risen 5-fold in this
period.

FG and Macroeconomic Discipline

1. Question:Has FG fostered Macroeconomic discipline?
2. From the table (8.1) above we find that
a. Inflation rates tumbled down into a range of 4% until mid-2000s but have
resurged to high levels thereafter.
b. Domestic inflation was closely linked to the global phase of low inflation, but
i. As the commodity cycle turned up, domestic inflation surged.
ii. This was additionally fuelled by domestic supply constraint in relation
to overall demand.
iii. Fiscal deficit, another explanatory factor of inflation, had also
rebounded since the crisis.
c. The current account gap, which widens in India with higher growth rate, had
expanded unsustainably in the last decade.
i. This gap has led to rising dependency on short term financing from
abroad (situation with falling petrol prices in 2015-16 had led to the
reduction in the gap once again).
ii. Prima facie therefore, there is little evidence of disciplining effect of
FG in India.

Financial Globalization and Volatility

1. Question: Has FG led to higher volatility?
3. The short answer is – yes.
4. The increasing co-movements of output, price and interest rates (figure 8.4)
indisputably reflect the synchronization of Indian business cycle with the global one.
5. A Study about India (Ang 2011) finds
a. consumption volatility has risen after financial liberalization which is
consistent with the experience of other countries.
b. The GDP volatility – measured by the coefficient of variation – more than
doubled from 0.12 to 0.31 while
 c. The private consumption was 3 times as volatile (0.11 & 0.31 respectively)
between 1997-2002 & 2003-2011.
d. Inflation volatility was range-bound (0.38-0.44) throughout.
e. Real exchange rate variability increased significantly, and nominal exchanged
rate more than doubled between 2002 and 2011.
6. Development of financial markets has accompanied FG although it may not be
attributed just to it as many other policy efforts also took place simultaneously.
a. Stock markets first to be opened to foreign investors grew in size; market
capitalization rising from 3 fold between 1991 and 2000 and 7 times
thereafter to US$ 1 trillion, in other words, it has acquired depth and
liquidity.
b. But India’s bond market – mostly closed to foreign investors who hold less
than 5% of the public debt stock –is neither very deep nor liquid and has
remained underdeveloped.
c. The government bond market is well developed – at about 30%of GDP,
comparing well with countries like the US and the Singapore (48% and 28% of
GDP) – and has a liquid yields curve, high turnout volumes and market
liquidity.
d. The corporate bond market remains small – at about 3% of the GDP.
7. Macro-financial Stability: Financial volatility and hence macro-financial stability risks
have risen due to increased transmission of external financial shocks from abroad.
a. It is not just the aggregate exposure of the economy that is relevant here; the
composition of the flow matters too.
b. Figure 8.5 presents the inflow of capital into India in three time periods that
roughly correspond to
i. tranquil,
ii. turbulent, and
iii. crisis time
c. By all measures and at all times FDI is far more stable than non FDI flows.
d. Within the non-FDI flows, it is the portfolio capital that is most volatile.
e. Non resident deposits and foreign loans are relatively more stable.
f. Volatility has increased over time too, going up significantly during the crisis.
8. The Indian stock market is highly correlated and impacted by global events,
especially the USA and Europe and the stock markets – the most open segment of
the financial system - are (all over the world) increasingly the conduit for the
transmission of external shocks.
9. In turn stock market volatility also explains a larger part of bond yield volatility in
recent times, although real activity still remains relatively insulated.
10. The question is how to manage these risks – we turn towards it in the next section.

MANAGING THE CHALLENGE

 1. India’s macroeconomic conditions have shaped the pattern of its FG and according
to Kohli this provides a framework for managing it too.
1. Both design and fortune allow Indian a structure that supports an intermediate
exchange rate regime in which we have -
a. A partially-closed capital account
b. A reasonable absorptive capacity (i.e. ability of absorb foreign resources that
exceed the outflow of resources
2. The two factors together mean that a current account deficit enabled resolution of
the trilemma (impossible trinity), i.e. inability to realize the three goals of
a. Free capital mobility (or Full Capital Control) -Vertex A of triangle
b. A fixed exchange rate (or Pure Float) - Vertex B of triangle
c. Sovereign Monetary policy i.e. policy devoted to domestic objectivese.g.
controlling inflation (or Monetary Union) – Vertex C of triangle

Capital Mobility 4. Free Capital Mobility

Monetary Independence

Exchange rate stability

3.
Sovereign Monetary Policy Fixed Exchange Rate
Full Financial Integration

3. In other words, a central bank has three policy combination options –

a. Option (a): A stable exchange rate and free capital flows (but not an
independent monetary policy because setting a domestic interest rate that is
different from the world interest rate would undermine a stable exchange
rate due to appreciation or depreciation pressure on the domestic currency),
e.g. Euro Zone
b. Option (b): An independent monetary policy and free capital flows (but not a
stable exchange rate).(e. g. most countries of the world)
c. Option (c): A stable exchange rate and independent monetary policy (but no
free capital flows, which would require the use of capital controls).( Dani Rodrik,
a left leaning economist, advocates the use of the third option (c) in his book,The
Globalization Paradox, emphasising that world GDP grew fastest during the Bretton Woods
era when capital controls were accepted in mainstream economics. Rodrik also argues that
the expansion of financial globalization and the free movement of capital flows are the
reason why economic crises have become more frequent in both developing and advanced
economies alike.
4. The Indian macro-monetary framework is characterised by significant capital
controls, notably on debt flows, which help maintain the domestic -foreign interest
rate wedge (difference).
5. Controls also provide a policy tool for calibrating short term capital flows.
6. The second structural feature that supports simultaneous balancing of the exchange
rate and price stability goals is adeficit on the current account.
a. This helps moderate real exchange rate appreciation pressures
 b. Conversely exchange rate flexibility assists adjustment of the deficit.
7. These structural settings play a key role in policymakers’ ability to dynamically iterate
between the 3 objectives of
a. Capital mobility
b. Exchange rate flexibility
c. Price stability
8. The chief elements in managing capital flows can be summarized as: -
a. An explicitly stated active capital account management framework based on
encouraging non-debt creating and long term capital inflows, discouraging
debt flows
b. Retaining the policy space to use multiple instruments – quantitative limits
(Quotas), price based measures (tariffs) as well as administrative measures
(permits)
c. Allowing short term debt only for trade transactions
d. Avoiding the ‘original sin’ – excessive foreign currency borrowing by domestic
entities, especially the sovereign
e. Prudential regulations to prevent excessive dollarization (foreign currency
dependency) of balance sheets of financial sector intermediaries, particularly
banks
f. Caution towards liability dollarization by domestic entities
g. Significant liberalization of permitted outward investments by residents.
9. Under this approach, Indian policymakers have managed capital flows through a
combination of policy responses –
a. Reserved accumulation (in excess of absorptive capacity) -cum-sterilization
with part feedback into the money supply
b. Exchange rate flexibility
c. Liberalization of outflows
d. Occasional use of capital controls in extreme situations (but only for domestic
residents so as to not impact foreign investments)
e. The sterilization of the foreign currency inflow
i. Almost 43% of the foreign currency inflows were sterilized by the
central bank (between March 2007 and December 2007) with partial
feedback into the money supply.
10. Monetary Manangement: There is a cost associated with thesterilization of foreign
currency inflow – the interest rate differential between the foreign and the domestic
currency
a. As foreign currency is sterilized, a partial feedback into money supply leads to
inflation.
b. To reduced inflation, interest rates have to be raised - that devolves on the
government balance sheet (as it pays interest on loans it has taken).
 c. Sterilization cost was 0.42% of the GDP (US$ 4.9 billion) in March 2008, up
from a tiny 0.02% of the GDP in January 2006.
11. Exchange rate flexibility or adjustment through a change in value of the currency has
been another tool.
a. India’s exchange rate regime has been progressively flexible (partial
convertibility/full convertibility on current account etc.) this has assisted
managing the increasing financial integration of the economy.(an index
measuring the exchange rate flexibility has increased from 0.85 in April 2006
to 0.91 May 2007 onwards).
12. Monetary management and exchange rate flexibility are supplemented by Macro-
prudential measures and occasionally, capital controls.
13. Macro-prudential tools range from
a. Varying risk weights and provisioning requirements for bank credit to the
property sector;
b. Sector exposure limits for bank credit to sensitive sectors e.g. capital market
c. Loan to value ratio applying to real estate
d. Margin requirements and the build up of foreign currency liabilities in
segments vulnerable to sharp price fluctuations
14. These tools were especially used ahead of the 2008 crisis to restrain asset price
inflation and a credit boom and were effective in preventing build up of financial
vulnerabilities.When the crisis struck, banks in India emerged unscathed with
healthy balance sheets; households and firms were neither overleveraged nor
overtly hit by the fall in the stock prices that followed.
15. Capital controls have also been used after other options have been exhausted or
overused. These include
a. Curbs on residents’ access to overseas borrowing
b. Capping conversion to domestic currency
c. Restricting participatory notes (an offshore derivatives product allowing
overseas retail investors exposure to the Indian stock markets) etc.
16. Question:How effective have these controls been?
17. According to Kohli, different controls have been effective in different degrees, e.g.
a. Encouraging outflows by measures like easing restrictions on financial
investments abroad by residents hadlittle or no impactdue to pro-cyclicality
of such flows.
b. But counter-cyclical macro prudential restrictions on banks succeeded in
insulating balance sheets from the financial shock that followed.
c. Likewise limiting overseas loans taken by residents led to some moderation in
residents’ foreign borrowings.
18. Balancing the two objectives of exchange rate and price stability, has not been
without its share of problems, notably of retaining monetary control .
 a. Some feel that India’s de facto openness undermines the efficacy of its capital
controls.
b. According to Kohli this ought to be verified by checking if capital mobility was
successful in bridging the domestic foreign market segmentation, in other
words, is it true that as long as the wedge is maintained, capital controls are
binding.
i. Evidence shows that while the convergence with the international
markets is increasing, it is as yet incomplete.
ii. Incomplete financial integration is due to restricted presence of
foreign investor in the bond market, which provides a degree of short
term monetary autonomy to the central bank.
19. In other words, imperfect mobility of capital can resolve the trilemma (Obstfeld
2009)
20. Besides the conflict between the monetary and exchange rate objectives, capital
controls have implications for trade policy. For example,
a. export earnings’ repatriation,
b. quantitative caps,
c. end-user restrictions on residents’ foreign borrowings and investments, and
d. foreign investments in assets and some goods’ markets do influence real
economic activity.
21. Finally, on the flip side, market participants are tempted to take on more risk in the
presence of capital controls, like
a. Exploitation of temporary opportunities for cross border arbitrage for rupee-
dollar trade that have arisen in Singapore and Dubai
b. disguised re-entry of foreign loans raised by domestic firms as portfolio
equity inflows, non-resident Indian deposits and so on.

CONCLUSION AND APPRAISAL

1. In wake of the 2008 crisis many international organizations have changed their
approach towards handling global financial flows.
2. Once an anathema, capital control is now not only acceptable, it is now
recommended along with macro-prudential measures (IMF 2011).
3. It is noteworthy that the current international advice closely mirrors India’s capital
account management framework.
4. Another perspective is of ‘limited FG’(in this context we have already discussed Dani
Rodrik’s viewpoint).
5. In the same vein, some economists like McCauley, feel that throwing ‘sand in the
wheels of finance’ helped Asian countries like India, China, South Korea and Thailand
insulate them from the crisis.
6. Among the tools they identify are
a. limited roles of foreign banks
 b. restrictions of cross-border arbitrage in currency, bond, money and equity
markets
7. Yet another measure of appraisal is counter-factual.
a. India has typically followed an interventionreserve accumulationlimited
exchange rate appreciation strategy.
b. Question is how India has fared when it has or does deviate from this
strategy?
c. Table 8.2 illustrates such a departure from 2009.
i. Despite a recovery in capital flows in 2009-11 after the crisis, Indian
reserve increase was US$ 72 billion over a negative change of US$ 139
billion, i.e. the US$ 58 billion erosion in reserves in 2008-09, was
never fully recouped.
ii. This happened because the central bank (RBI) followed a hands-off
exchange rate policy from 2009, reversing a policy of managed float.
iii. Consequently, the currency adjusted fully to heavy capital inflow
(equity + debt).
iv. Exchange range appreciation led to a steadily expanding current
account deficit that doubled in 2009-11 over 2008-09 levels.
v. This was fed excessively by short term capital, which reversed
suddenly as the risk sentiment deteriorated over feeble US and euro
zone recoveries in mid 2011 and the currency depreciated by more
than 20% with adverse macroeconomic consequences.
8. This experience is illustrative of the challenges that financial globalization poses for
India.
a. It shows the external financial risk that India may face a hands off exchange
policy at a stage of development when it is unable to finance its import needs
through sufficient export earnings.
b. Its long term fiscal position precludes long-term, stable financing of its
internal and external deficits.
c. It also highlights the severity of risks arising from short-term speculative
capital flows that are destabilizing, excessively volatile and disruptive to real
economic activity.
d. Finally, it underlines the importance of reserves’ accumulation as an essential
tool in the armoury to tackle foreign capital purely driven by risk sentiments
that can switch suddenly.

CONCLUSION
1. It would be fair to say that a cautious gradual attitude towards FG that balances the
financial and real development of the economy is the best course for India.
9. This approach is the pre-crisis approach that helped protect the country from too
adverse a hit.
10. This now needs supplementing with enough policy space to combat the increased
risks to financial instability from global financial flows.
11. The policy range includes fiscal and monetary responses for which both fiscal deficit
and inflation need to be kept under control, alongside building the reserves.
12. Some capital controls notably on debt flows need to be retained until such time
when India’s macroeconomic foundations are sustainably strong and financial
markets reach the sophistication levels of advanced countries.
13. Finally, international regulations to restrict short-term, speculative capital
movements may be desirable.