Capital flow in India: facts, features, and analysis

Abstract

Capital flows have become an integral part of the Indian economy. The last two decades have witnessed an increasing volume of capital inflows. It is in this background that this paper delves into the more fundamental aspect which needs to be understood before evaluating the impact of capital inflows and efficacy of alternative policy instruments. To be specific, the paper makes an attempt to explore several characteristics of capital inflows to India. Here, we have focused on the six alternative dimensions of capital inflow, namely, composition of capital flow, behaviors of net and gross flows, volatility, substitutability across flows, persistence, and cyclical behavior. We find that foreign investment is the key component of capital inflows, followed by loan and banking capital inflow. On the disaggregated level, capital inflows to India are dominated by FPI, banking capital, FDI, and commercial borrowing. Moreover, short-term credit inflow has accelerated in recent times. Gross flows behave differently from net flows. By focusing on total capital inflow, it is found that gross flows are voluminous, more volatile, and more persistent than net inflow. FPI and banking capital are found to be the most volatile components, followed by FDI and commercial borrowing. There are complementarities across the net flows of different types and also between the gross inflow and outflow. Net total capital inflows to India have become more persistent during the last decade. However, the degree of persistence largely differs across the types of flow. FDI and short-term credit are found to be the most persistent components. Banking capital seems to be the “most volatile and least persistent” in nature, followed by FPI. FPI and short-term credit inflows are procyclical in nature.