Ebook Economic Reforms, Capital Flows And Macro Economic Impact On India
The recent wave of financial globalization and its aftermath has been marked by a surge in international capital flows among the industrial and developing countries, where the notions of tense capital flows have been associated with high growth rates in some developing countries. Some countries have experienced periodic collapse in growth rates and financial crisis over the same period. It is true that many developing economies with a high degree of financial integration have also experience higher growth rate. Low Developing Countries (LDCs) are eager to welcome any kind of foreign capital inflows to overcome the debt crisis situation. They are facing the challenges from the foreign capital and the invisible resource. From the supply side also there are some strong inducing factors, which led the international investors towards the financial market of the developing countries. The correlation between the movements in developed and developing countries financial market, the deceleration in industrial economy markets and high growth prospects of the less developed market are some of the important reasons, which made them an attractive option for portfolio diversification.
It is fact that international capital flows on financial market can be very volatile. However, different countries experienced different degree of volatility of financial market and this may be systematically related to the quality of macro economic policies and domestic financial governance. In this context high volatility of capital flows has affected the macro economic variables such as exchange rate, interest rate, money stock (M3) and inflation negatively. Even in countries where a conducive atmosphere is created for the free flow of capital and authorities don’t operate with any current account deficit complicates the assessment of integration in financial market. Capital flows have significant potential benefits for economies around the world. Countries with sound macroeconomic policies and well-functioning institutions are their best to reap the benefits of capital flows and minimize the risks. Countries that permit free capital flows must choose between the stability provided by fixed exchange rates and the flexibility afforded by an independent monetary policy.
Capital flows have particularly become prominent after the advent of globalization that has led to widespread implementation of liberalization programme and financial reforms in various countries across the globe in 1990’s. This resulted in the integration of global financial markets. As a result, capital started flowing freely across national border seeking out the highest return. During 1991 to 1996 there was a spectacular rise in net capital flows from industrial countries to developing countries and transition economies. This development was associated with greatly increased interest by international asset holders in the emerging market economies to find trend toward the globalization of financial markets. The global financial markets can gradually create a virtuous circle in which developing and transitional economies strengthen the market discipline that enhances financial system soundness. At present, however, there are important informational uncertainties in global market as well as major gaps and inefficiencies in financial system of many developing countries.
Looking at the composition of capital flows, net foreign direct investment represents the largest share of private capital flows in the emerging markets. Net portfolio investment is also an important source of finance in the emerging markets, though these flows were more volatile after 1994. Until 1997 a market shift, in the composition of capital flows to domestic financial market with a significant increase in net private capital inflows to financial markets and a decline in the share of official flows. Foreign Direct Investment (FDI) is the most stable capital. Both net portfolio investment and banking flows were volatile. Portfolio flows are rendering the financial markets more volatile through increased linkage between the domestic and foreign financial markets. Capital flows expose the potential vulnerability of the economy to sudden withdrawals of foreign investor from the financial market, which will affect liquidity and contribute to financial market volatility. One opinion that could be explored in the face of capital inflow surge is absorption by the external sector through capital outflows.
Financial markets are thrown open to Foreign Institutional Investors (FII’s) and there is convertibility of the rupee for FII’s both on current and capital account. Over the years, Indian capital market has experienced a significant structural transformation. Financial markets are significantly different from other markets; market failures are likely to be more pervasive in these markets and there exists Government intervention. Government interventions in the financial markets that promoted savings and the efficient allocation of capital are the central factor to the efficiency of financial markets.
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