INTERNATIONAL FINANCIAL FLOWS ON INDIAS ECONOMIC GROWTH IN VIEW OF CHANGING FINANCIAL MARKET SCENARIO

Narayan Sethi*
The international capital flow such as direct and portfolio flows has huge contribution to influence the economic behavior of the countries positively. Countries with well developed financial markets gain significantly from Foreign Direct Investment (FDI). The huge volume of capital flows and their influence on the domestic financial markets understanding the behaviour of the flows becomes very important especially at time liberali!ing the capital account. The study attempts to e"amine the impact of international financial flows on India#s financial markets and economic growth. The study also e"amines trends and composition of capital inflows changing pattern of financial markets in view of globali!ation ascertain the impact of domestic financial policy variables on international capital flows and suggest policy implication thereof. $y using monthly time series data we found that Foreign Direct Investment (FDI) is positively affecting the economic growth direct contribution while Foreign Institutional Investment (FII) is negatively affecting the growth alb its in a small way and make a preliminary attempt to test whether the international capital flows has positive impact on financial markets and economic growth. The empirical analysis using the time series data between %pril &''( to December )**+ shows that FDI plays unambiguous role in contributing to economic growth. ********* Key Wor !" # Capital flows, financial crisis, capital account and global financial markets

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INTERNATIONAL FINANCIAL FLOWS ON INDIAS ECONOMIC GROWTH IN VIEW OF CHANGING FINANCIAL MARKET SCENARIO
Narayan Sethi* INTROD/CTION
International capital flows have significant potential benefits for economies around the world. Countries with sound macroeconomic policies and well-functioning institutions are in the best position 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. International capital flows have increased dramatically since the 1 !"s. #uring the 1 "s gross capital flows between industrial countries rose by $"" per cent, while trade flows increased by %$ percent. &uch of the increase in capital flows is due to trade in e'uity and debt markets, with the result that the international pattern of asset ownership. (he integration of debt and e'uity markets should have been accompanied by a short period of large capital flows as investors re-allocated their portfolios towards foreign debt and e'uity. )fter this ad*ustment period is over, there seems little reason to suspect that international portfolio flows will be either large or volatile. (he prolonged increase in the size and volatility of capital flows observed that the ad*ustment to greater financial integration is taking a very long time, or that integration has little to do with the recent behavior of capital flows 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 1 national border seeking out the highest return. #uring 1 "+s. (his resulted in the 1 to 1 % there was a integration of global financial markets. )s a result, capital started flowing freely across spectacular rise in net capital flows from industrial countries to developing countries and transition economies. (his 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 'Sin3h+ 45567 8998*. (he global financial markets can gradually create a virtuous circle in which developing and transitional economies ,

strengthen the market discipline that enhances financial system soundness. )t present, however, there are important informational uncertainties in global market as well as ma*or gaps and inefficiencies in financial system of many developing countries. -ooking at the composition of capital flows, net foreign direct investment represents the largest share of private capital flows in the emerging markets. .et portfolio investment is also an important source of finance in the emerging markets, though these flows were more volatile after 1 / 'Ran3ara:an+ 8999*. 0ntil 1 1 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. 2oreign #irect Investment 32#I4 is the most stable capital. 5oth net portfolio investment and banking flows were volatile. 6ortfolio flows are rendering the financial markets more volatile through increased linkage between the domestic and foreign financial markets 'Koh&i+ 8994+ 899;*. Capital flows expose the potential vulnerability of the economy to sudden withdrawals of foreign investor from the financial market, which will affect li'uidity and contribute to financial market volatility. 7ne opinion that could be explored in the face of capital inflow surge is absorption by the external sector through capital outflows. 2inancial markets are thrown open to 2oreign Institutional Investors 32II+s4 and there is convertibility of the rupee for 2II+s both on current and capital account. 7ver the years, Indian capital market has experienced a significant structural transformation. 2inancial markets are significantly different from other markets8 market failures are likely to be more pervasive in these markets and there exists 9overnment intervention. 9overnment interventions in the financial markets that promoted savings and the efficient allocation of capital are the central factor to the efficiency of financial markets 'A3ar<a&+ 455=7 >ernan 455=*.

O>?ECTIVES OF ST/D@
(he study broadly examines the impact of international capital flows on economic growth in view of changing India+s financial markets. :pecifically, the ob*ectives are; 3i4 3ii4 (o examine trends and composition of capital flows (o examine the changing pattern of financial market after liberalization $

3iii4 3iv4

(o examine the impact of financial flows on economic growth. (o suggest policy implication thereof.

MODEL DESIGN
5efore going to use 7-: techni'ue one should test the stationary properties of the variable in case of time series data. )s our data is time series in nature, the study first of all test stationarity of the variables using different unit root tests, namely #icky- 2uller 3#24, )ugmented- #icky 2uller 3)#24 and 6hillips-6erron 3664 31 !!4 test. (hese tests are shown in table-$. (o show the #icky-2uller 3#24 test, the )< 314 process is shown. =t > ?@ A.=t-1@Bt Chere A and ? are parameters and Bt is a white noise. = is stationary, if 1DAD1. if A> 1, y is non stationary. (he test is carried out by estimating an e'uation with = t-1 subtracted from both sides of e'uations. E=t > ?@ F =t-1 @ Bt Chere, F > A G 1 and the null and alternative hypothesis are H" ; F > " H1 ; F I1 (he t-statistics under the null hypothesis of a unit root does not have the conventional t-distribution. #icky-2uller 31 1 4 shows that the distribution is nonstandard, and simulated critical values for the selected sample. -ater &ackinnon 31 14 generalizes the critical values for any sample size by implementing a much larger set of simulations. 7ne advantage of )#2 is that it corrects for higher order serial correlation by adding lagged difference term on the right hand side. 7ne of the important assumptions of #2 test is that error terms are uncorrelated, homoscedastic as well as identically and independently distributed 3iid4. 6hillips-6erron 31 !!4 has modified the #2 test, known as 66 test, which can be applied to situations where the above assumptions may not be valid. )nother advantage of 66 test is that it can also be applied to fre'uency domain approach, to time series analysis. (he derivations of the 66 test statistic is 'uite involved and hence not given here. (he 66 test has been

shown to follow the same critical values as that of #2 test, but has greater power to re*ect the null hypothesis of unit root test. :ymbolically, the model on the impact of 2#I, 26I and 2II on India+s economic growth can be written as; II6t > " @ 1 2#It @ , 26It @$ 2II @ut Chere, II( > Index of Industrial 6roduction G a monthly index. (his has been taken as a proxy variable for 9ross #omestic 6roduct 39#64 since the monthly data for 9#6 are not available. (he monthly index of industrial production includes all the three sectors i.e. industry, agriculture and service sector. FDI > 2oreign #irect Investment in <s Crores. (he actual data are given in 0.: J &illions. (he conversion as fixed of J into <s has been made as per the Kxchange rates of the respective year. F(I A 2oreign 6ortfolio Investment in <s Crores. (he actual data are given in 0.: J &illions. (he conversion as fixed of J into <s has been made as per the Kxchange rates of the respective year. FII > 2oreign Institutional Investment in <s Crores. (he actual data are given in 0.: J &illions. (he conversion as fixed of J into <s has been made as per the Kxchange rates of the respective year. ------------------ 314

DATA AND (ERIOD OF ST/D@

(he data for the study have been collected from the handbook of statistics in Indian Kconomy 3<5I4 and International 2inancial :tatistics 3I2:4, 3I&24. (he monthly data have been taken for the period )pril 1 L to #ecember ,""/. 2oreign #irect Investment 32#I4 is the ma*or part of the direct flows into India, which contribute the direct contribution to growth. 2oreign 6ortfolio Investment 326I4 and 2oreign Institutional Investment 32II4 are portfolio flows into India since :eptember 1 are available only from )pril 1 L. ,. However, the data

Tren ! an Co.,o!ition o- Finan%ia& F&o<! into In ia

(he 1 "+s saw a radical transformation in the nature of capital flow into India. , 3expect those by .on2rom a mere absence of any private capital inflows till 1

<esident Indians4, today such inflows represent a dominant proportion of total flows. (he official flows shown as external assistance, i.e grants and loans from bilateral and L

multilateral sources represented 1L-!" per cent of flows till 1 'ChaBra1arti+ 8994*)

1. 5y 1

/, this has come "s

down to about ," per cent and has further fallen to below L per cent by late 1

TA>LE#4
CA(ITAL FLOWS INTO INDIA AFTER 4559S '@ear&y* /S C .i&&ion
Year 1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 LGR FDI 97 129 315 586 1314 2144 2821 3557 2462 2155 4029 6130 5035 4673 16.99482 FPI 6 4 244 3567 3824 2748 3312 1828 -61 3026 2760 2021 979 11377 13.38278 FII 1 1665 1503 2009 1926 979 -390 2135 1847 1505 377 10918 19.60015 NRI 42 89 171 169 135 202 179 171 67 35 NA NA -7.09713 GDR 240 1520 2082 683 1366 645 270 768 831 477 600 459 0.416859

,ource: Hand Book of Statistics, Reserve Bank of India (RBI) M 2IIs, .<I, and 9#< are introduced in :eptember 1 , and annual data before the 1 $ are not available and monthly data are available only from )pril 1 L. .ote; - -9<- -inear 9rowth <ate #uring the last 1" years, India has attracted more than 0: J /" billion of foreign investment 3(able-14. )t a time, when the flow of private capital to developing countries has shrunk considerably, private flows to India have strengthened, and are currently running at 0: J to 1" billion per year, of which more than LL per cent constitute 2#I and portfolio flows. )s a matter of fact, there has been limited recourse to bank borrowing or floating of bonds abroad by Indian corporate sector, as <5I and government tried to limit access to such borrowings to few large private companies with high credit ratings, in a policy of limiting debt creating inflow. In some years though, such debt creating flows were significant and constituted about /" per cent of inflows. (he liberalization of the portfolio investment led to a surge in inflow of capital for investment in the primary and secondary market for Indian e'uity and corporate 3and subse'uently sovereign4 bond market. )bout /%" foreign institutional investors 32IIs4 have been allowed to enter the Indian market and together have brought in more than 0: %

J 1/ billion 9#< and )#< floated by Indian corporate sector brought in the remaining portfolio inflows. (able-1 provides an overview of the total foreign capital that India attracted during the 1 ,-,""/ period. )s the (able shows, India has attracted about J ,, billion $- / and more than J1! billion in 2#I. (hese portfolio ! $ when India attracted more than JL billion in few months and in portfolio investments since 1 flows began in 1

continued at the level of J ,-$ billion per year till the )sian crises. (he year 1 back to the 0: J ,-$ billion per year level.

witnessed a marginal out flow from the Indian stock market but soon the inflows went

TA>LE#8
INDIA" COM(OSITION OF CA(ITAL FLOWS
Nariable (otal Inflows 3net4 of which; 3In percent4 .on #ebt creating inflows a4 2oreign #irect investment b4 6ortfolio investment #ebt creating inflows a4 Kxternal assistance b4 Kxternal commercial 5orrowing 3KC54 1 $- / 1 /- L 1 /"! L- % 1 %- 1 1 1- ! !// 1 !1 -"" ,"""-"1 1""1!

'/S C .i&&ion*
,""1-", 1"L1$ ,"",-"$ 1,11$ ,""$-"/ ,,11,

!! L

!L",

1,""%

!/$L

1"///

/1.% %.% /1 ,1.$ ,1./ %.!

L1. 1L.! /,.1 ,L 11. 1,.1

111.L L,./ %L.1 L1.1 ,1.% $1.,

L1.$ ,$.1 ,1.% %1.1 ., ,$.1

L/.! $%., 1!.% L,./ ., /".%

,!.% , ./ -".! L/./ .1 L1.1

/ .1 ,".1 , ,$.1 !.% $

%1.! /"., ,1.% L ./ /.$ $1.,

11.1 L!." 1 .1 ., 11./ -1/.

/%.% $!.L !.1 -1".1 -,"." -1 ./

1,.L ,1.1 L1./ 1./ -1,." -!./

c4 :hort term Credits -!.% d4 .<I #eposits 3J4 1$.L e4 <upee #ebt:ervice -11.! 7ther Capital (otal &emo Item; :table flows $1.1 1"" %1.%

/% , -11.% 11.1 1"" L$.$

1., ,1 -,$.$ -1L., 1"" $$.1

1 ,1. -%.1 -1$ 1"" %L./

-1 11./ -1.! -1., 1"" !,./

-!. 11./ - .L 11 1"" 1" .1

$.% 1/.1 -%.! ,1., 1"" %1./

1." ,$.1 -%., -,1., 1"" %!.,

-!./ ,%." -/. 1$.1 1"" !!.1

!.1 ,/.% -$. %/.1 1"" !/.L

1.1 1%./ -1.1 ,%.1 1"" !L.%

,ources Hand Book Statistics of Indian Economy, RBI, 2004

(he first phase of stock market liberalization also saw many Indian companies issuing 9#< and listing them on Kuropean exchanges like -uxembourg. )s (able-, shows the composition of capital flows during 1 $- L more than half of the portfolio

investments were the 9lobal #epository <eceipts 39#<4 floated by the Indian companies while the other half was 2II investments. (he 2II investment was initially limited to a selected group of stocks and they were excluded from the growing market for bonds, and government securities. (heir entry into the latter was permitted only in the late 1 "s.

(he total amount of funds raised by India through 9#< constituted roughly /" percent of total inflows. However, during the second half of the 1 "s there was a sharp declined in

the funds raised through 9#< and 2II investment in the Indian e'uity 3and recently bond market4 became the main form of portfolio inflows 'Khanna+ 8998*.(hus in a span of less than a decade, private foreign investment to India constitute more than LL per cent of all flows. (he total inflow of J ,, billion as portfolio investment also constitutes a significant proportion of the total market capitalization in India. (he Indian economy faced first time a comfortable foreign exchange position. (he rising reserves also reduced the vulnerability of the economy to minor shocks and also brought in large amount of investments from .on-<esident Indians 3.<Is4. (he liberalization of gold imports and over all trade liberalization led to a sharp decline in capital flight and the black market premium on foreign exchange disappeared. (his led to a diversion of transfer payments 3mainly remittances from workers abroad4 from illegal to banking channels. (he transfer payments rose sharply from J ,-$ billion in 1 J 11-1$ billion by the end of the decade 1 -,""". 1- , to

1"

GRA(H#I
TRENDS OF INTERNATIONAL CA(ITAL FLOWS

International capital flows into india

12000 10000 FDI,FPI,, NRI, GDR AND FII 8000 6000 4000 2000 0 1990-91 1999-00 2002-03 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 2000-01 2001-02 -2000 2003-04 FDI FPI FII NRI GDR

Year (he trend of capital flows has been shown in the 9raph-I. (he trends different segment of capital flows such as 2#I, 26I, 2II, .<I and 9#< are positive except the year 1 !, where the 26I, 2II, .<I and 9#< are negative. (he 2#I is stable and positive after the liberalization. :o 2#I is only capital inflows into India is stable in nature.

CHANGES OF FINANCIAL MARKETS IN INDIA AFTER LI>ERALIDATION+ 4554

2inancial structure evolves over time with market practices earlier reflecting government policies and five years plan priorities. (he stock market in India has been fairly well developed. Its role in financial markets had increased during the 1 !"+s with household savings in corporate securities increasing between 1 !L to 1 !% and 1 / - L. 5ut an important feature of the pattern of stock holding had been8 the large proportion of share belongs to government owned financial institution e.g. 0(I 'GoBarn+ 455E*.

11

9overnment was capable, indirectly influencing the financial markets because of these implications. ) distinctive feature of the financial reforms of 1 financial sector reforms. (ill the reforms in the early 1 "+s had been accent on "+s pricing was not determined

by market conditions. (hough the volume of transaction was very high, securities continued to exist in the physical form creating uncertainties for the investor, and increasing transaction cost. -ong and uncertain settlement cycles created serious problem for clearing houses. International capital flows to the participant were also defiant. <aising of capital from the securities market before 1 , was regulated. 0nder the capital issues 3control4 act, 1 /1, firms were re'uired to obtain the approval from the Controller of Capital Issues 3CCI4 for raising resource in market. .ew companies were allowed to issue shares only at par. In 1 ,, the capital issues 3control4 act of 1 /1 was renewed and , to undertake the with this ended all controls relating to raising resource from market. :ecurities and Kxchange 5oard of India 3:K5I4 was given statutory powers in 1 tasks of regulations and supervision 'Khanna+ 4555*. (he most important fall out of the reform was the free pricing and setting up of new guidelines regarding new issues. Initially, only fixed price mechanism of floating new capital issues were followed. )n alternative mechanism of book building4 was introduced in 1 )lthough the book building guidelines were prescribed in 1 L giving the issuer the choice to raise resources either through this or through the fixed price mechanism. L, no issue was floated due . (he book building to certain restrictive guidelines, which were modified in 1

mechanism of floating new capital issues has been devised in such a way that those small investors will also be able to subscribe to securities at a price arrived at, through transparent process. Issuers of capital are re'uired to meet the guidelines of :K5I on disclosure and investors protection 'Re In :eptember 1 y+ 455=*. ,, 2oreign Institutional Investor+s 32II+s4 were allowed

unrestricted entry in terms of volume of investment in both primary and secondary markets. In the secondary market, ma*or reforms were the laying down of capital ade'uacy ratio for brokers8 the banning of inside trading and the introduction of computer OOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOO
4

5ook building mechanism is a method through which an offer price of an initial public offering 3I674 is based on investor+s demand.

1,

based trading system '(a&+ 4556 an %hitre+ 455E*) (ill recently, trading on the Indian stock exchanges took the place through open outery system baring .:K and 7C(KI, which adopted screen based trading system from the beginning 3i.e. 1 / and 1 ,, respectively4. )t present all other stock exchanges have adopted on-line-screen-based electronic trading. It has replaced the open outery system of the two large stock exchanges8 the 5:K, which provides a combination of order and 'uote driven trading system, and .:K, which has only an order driven system. )ll stock exchanges operating in India have over !""" terminals spread wide across the country. In 1 -"", the :K5I issued guidelines for opening and maintaining the trading terminals abroad, while no trading terminal could be opened abroad due to high cost of connectivity. 2or ensuring greater market transparency, the :K5I has recently banned, negotiated and crossed deals 3where both the buyer and the seller operate through the same broker4 in :ept. 1 . )ll private off market deals in both shares, as well as listed corporate debts were banned. )ll such deals were now rotated only through the trading screens. (here were three main advantages of electronic trading over floor-based trading as observed in India, viz. transparency, more efficiency price discovery and reduction in transaction costs. It also reduces the segmentation of markets '>ho&e+ 4555*) (hus, emphasis has been on disclosure of information, safeguarding of investor+s interest and opening up to foreign investors. (he result of this has been a dramatic increase in the number of new issues and amount of capital raised after 1 1- ,. Chile traditionally8 mainly two instruments viz., debt and e'uity were traded, a large number of new and hybrid instruments were introduced in the first half of nineties through an increase in the new issues 'ChaBra1rati+ 8994 an Sa.a&+ 455=*. &arkets have widened with an increase in the number of players such as mutual funds and 2oreign Institutional Investors 32II+s4 8. ) ma*or implication of this resulted in giving the firms a position to substitute one source of funds for another, depending on relative costs. Chen the foreign markets were modest this enabled the firms to diversify their source of funds 'Mi!hra+ 455=*. OOOOOOOOOOOOOOOOOOOOO
8

(here are now $/ mutual funds operating in country with total asset base of over <s one lakh cr. )t the end of the .ovember there were 1$L1 2IIs registered with the :K5I. (hey made investment to the extent of about of 0: J 11.L billion in e'uity. Cith large investment and acting trading operation, 2IIs now significantly impact on Indian financialmarkets.

1$

TEST OF STATIONARIT@
5efore going to apply 7-: techni'ue the first step is test the stationary of the variables. (he results of various unit root tests namely #2, )#2 and 66 test are shown in table-$ below. )ll the three tests suggest that not all the variables are having unit root at level. (hat means they are stationary at level. (he #2, )#2 and 66 test are carried out using without trend and with trend option. In both the cases, results suggest that all the variables are stationary. However, the story is somewhat different in case of II6 variable. (he )#2 test for II6 suggest that it is stationary at level with trend, where as #2 and 66 tests indicate it is stationary. However, #2 and 66 tests suggest that the II6 variable is stationary at level when trend is allowed, where as )#2 test does not support it.

TA>LE#;
/nit Root Te!t! Re!F&t" WithoFt Tren With Tren

Nariable 2#I 26I 2II II6

#2 - .,1!P -L.!L,P -L./,1P 1.,$/

)#2 - .,1!P31,4 -L.!L,P31,4 -L./,1P31,4 ,.1$!PPP31,4

66 - .1L P3%4 -L.!L,P3"4 -L.$/!P 314 -".$!!3%4

#2 - .,1/P -%.,L1P -L. 1 P -%./L%P

)#2 - .,1/P31,4 -%.,L1P31,4 -L. 1 P 31,4 1.$!131,4

66 - .1L P3%4 -%.,L1P3"4 -L.!1 P 3,4 -%.%!LP3$4

Note!; -*: Significant at ! "eve", **: significant at #! "eve" and ***: significant at 0! "eve"$ %&e critica" va"'es for 'nit root tests are ($4)!, 2$))! and 2$#)! *it&o't trend and 4$0(!, ($44! and ($ 4! *it& trend at !, #! and 0! "eve" res+ective"y$ %&e n'm,ers in +arent&eses re+resent o+tima" "ags, *&ic& are se"ected a'tomatica""y ,y E.ie*s 'sing Sc&*ar/ info 0riterion for 123 test and ne*"y *est met&od for 44 test$ Hence, it can be concluded that II6 is stationary at level as two tests namely8 #2 and 66 indicate that it is stationary when trend is allowed. )s the tests of stationarity

1/

show that all the variables are stationary at level, the study uses these variables without taking any difference for regression analysis.

EM(IRICAL RES/LTS
(his section of the study presents the empirical results of the impact of international capital flows on India+s economic growth after post liberalization era. (he result is based on 7-: regression analysis. (he study regress II6 on 2#I, 26I and 2II to find out the impact of capital flows on economic growth of after liberalization. (he models are using 7-: techni'ue, but the result can be considered as the #urbin-Catson 3#C4 statistic is very low with the 3presence of auto-correlations4, which violates 7-: assumptions. (o solve the problem of auto-correlation of error term, we have allowed an )< 314 term of residuals. (his result is shown in table G / in model-,.

TA>LE# G
Impact of Capital Flows on Growth
Varia1&e!
C FDI F(I FII AR '4* 'AR '8*

Mo e&#4
46G)8E55 'G)==E4** 9)995594'8)8;69** 9)94E854 'G)4H;9** #9)94G95E ';)8E64**
#

Mo e&#8
8GG)55=E'4)8EGH** 9)94944H '8)48H9** 9)94;9=9 ';)95=5** #9)995;4;'#8)9H=9** 9)5=89G9';G)569=** #

Mo e& #;
8GG)55=E'4)8EGH** 9)94944H'8)48H9** 9)94;9=9';)95=5** # 9)995;4;'8)9H=9** 9)H;;E=E 'H)66** 9)GH;G8;'H)995E**

R8 A 9)545+ A :F!te R# SIFare A 9)54E -or Mo e& 8 an R8 A 9)5;8+ A :F!te R# SIFare A 9)586 -or Mo e&#;) DW#Stati!ti%A 8)=4G+ AIC A E)=68 -or Mo e& 8 an DW#Stati!ti% A 8)98=+ ABaiBe In-o Criterion 'AIC* A E)E49 -or Mo e&#;)

.otes; - 2igure in brackets of table relate to t-value ; P Indicates the t values are significant at 1 percent level 1L

(he results show that #C statistics as ,.11 which means still there is the presence of auto-correlations in the error terms. (o get better result, we have estimated the model allowing )< 314 and )< 3,4 terms of the residuals. (he results are presented in the following table-/ in model-$. (he #C statistics is ,.", in &odel-$, which means there is absence of auto-correlation in the error term. (he <, of this model is comparatively higher 3". $4 in model-$ then the &odel-, 3<, > ". 14. )nd also )kaike Info Criterion 3)IC4 which is used for the selections of better model suggest this model G$ as 3table-/4 better than the &odel-, 3table-/.4, as )IC %.%1" for the model-$ where as )IC > %.1!, for the model-,. (herefore, we consider the model-$ reported in table-/ for our analysis. (he coefficient of the variables shows the effect on economic growth. In table-/ the coefficient of 2#I 3Q14, 26I 3Q,4 and 2II 3Q$4 are statistically significant. (he t-values reported in the table to test the significance of Q1, Q, and Q$ respectively are greater than ,. (hat means the coefficients are significantly different from zero 3"4. (herefore, all the independent variables 32#I, 26I and 2II4 have significant effect on economic growth. 2#I and 26I are affecting II6 positively as the coefficients are "."1" and "."1$ respectively. (his supports our theory that capital flows are affects economic growth positively. In the case of 2II the coefficient is negative that is -"."" $ that means 2II affects II6 negatively and the effect is very negligible. (he empirical analysis showed that 2II negatively affect the economic growth, where as 2#I and 26I positively affect the economic growth in India. 2II are more volatile in nature into Indian capital market. )fter some years and month 2II is negative in India, due to the more volatility in Indian capital market. Nolatility of 2II flows probably has negative effects on economic growth. :omewhat surprising, the coefficient for the level of total capital flows is significant with negative sign of 2II on economic growth in India 'Len!iB+ et) a& 899;*

POLICY AND CONCLUSION

6ortfolio capital flows are invariably short term and speculative and are often not related to economic fundamentals but rather to whims and fads prevalent in international 1%

financial markets. (here are three-policy implications, which emerge from this analysis. 2irst India should move to influence both the size and composition of capital flows. :econd India should focus on strengthening they+re banking system rather than promoting financial markets. 5anks can provide the surest vehicle for promoting longterm growth and industrialization. (hirdly since financial markets in India are here to stay, 9overnment should try to shield the real economy from their vagaries. (he trends of total international capital flows into India are positive, where portfolio investment flows are negative in the year of 1 !. (he 2oreign #irect Investment 32#I4 does not reveal stable trend so far in India. (he composition of capital inflows in India makes a significant size both in terms of impact and smooth management. (he impact of total capital flows on economic growth is positive in India. (he 2oreign #irect Investment 32#I4 that has huge contribution to influence the economic behaviour is also positively affecting the economic growth. (he 2oreign 6ortfolio Investment 326I4 is indirectly affecting the economic growth, which has less impact on economy. (he 2oreign Institutional Investment 32II4 has negative impact on growth, but it is very negligible.

Note" # Finan%ia& -&o<! an %a,ita& -&o<! are !i.F&taneoF!&y F!e in the ,a,er a! the !a.e .eanin3

11

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