Policy tradeoffs in an open economy and the role of G-20 in global macroeconomic policy coordination

Abstract

In this paper we investigate the different nuances of India's capital account management through empirical analyses as well as descriptive discussions. In particular we study the evolution of the capital control regime in India since 1991, and explore the rationale behind liberalizing certain flows, restricting others and the means employed to do so. Increased integration with global financial markets has amplified the complexity of macroeconomic management in India. We analyze the trade-offs faced by Indian policy makers between exchange rate stability, monetary autonomy and capital account openness, within the framework of the well-known Impossible Trinity or Trilemma and find that over time India has adopted an intermediate regime balancing the different policy objectives while at the same time accumulating massive international reserves. We also calculate the exchange market pressure (EMP) index in India, and track its evolution over the last couple of decades. We evaluate the extent to which the EMP index has been influenced by major macroeconomic factors and find that a deteriorating trade balance and decline in portfolio equity inflows are associated with a higher EMP while positive changes in stock market returns lower the EMP.