Capital Inflows and Economic Growth in India

—Effectiveness of Capital Controls on the Economy—

Abstract

India has achieved substantial economic growth with stability even under the past several external shocks, including the Asian Crisis (1997/8) and the Global financial crisis (2008/9). In this paper I evaluate the causality and correlation between the capital inflow variables (FDI, portfolio, other investment) and the GDP growth, as well as domestic saving and investment rates, using several analytical methods of regression and VAR (Vector Auto Regressive) model, including Granger causality tests and impulse response functions. The overall results of the analysis show that India could avoid several risks of short-term capital flows that would normally cause unstable economic growth. Particularly, portfolio investment has positive association with economic growth rather than FDI in India. The analysis also confirmed that the domestic saving rate is closely associated with the GDP growth, rather than the capital inflows in India. The results indicate that while cautious liberalization of capital account is to be continued, further promotion of raising domestic saving rates would be required to meet with the increasing demand for infrastructure development to accelerate the economic growth in the country.