India's external commercial borrowing: Pulled by domestic fundamentals or pushed by global conditions?

Abstract

External commercial borrowing (ECB) has assumed growing prominence in the Indian economy. This paper analyzes the trends and determinants of ECB flows to India using monthly data for the period 2004M1 to 2015M12. Employing the Johansen cointegration and error correction techniques, our analysis suggests that both domestic factors and global economic conditions have influenced India's ECB inflows. Regulatory changes in the capital account were found to have the greatest effect on ECB flows among variables considered. While the long-term trend has been toward greater openness, the regulatory authorities have also intervened with an eye to macroeconomic and exchange rate stabilization resulting in sometimes unwitting changes in the composition of capital flows. Other factors found to be significant are the rupee to US dollar exchange rate, the economic growth differential between India and the OECD, the interest rate differential between the domestic lending rate and LIBOR, international credit conditions, and India's sovereign credit risk rating. Structural break analysis suggests that the global financial crisis of 2008 reduced ECB inflows significantly. Given the impact of changing capital account regulation on the volatility of ECB flows, we recommend simplifying and consolidating India's regulatory framework without compromising the macro-prudential principles of capital account management.