Foreign Portfolio Investment in India and Plausible Exchange Rate and Interest Rate Regimes: Policy Options Open to the RBI
In order to protect the export and the import-competing sector of the economy, RBI often intervenes in the foreign-exchange market. Also, through daily operation of Liquidity Adjustment Facility (LAF), RBI regulates the interest rate. In this theoretical paper, I access the impact of Foreign-Portfolio Investment on real macro-variables under different plausible exchange rate and interest rate regimes. Using the Mundell-Fleming framework, I analyze the impact of FPI under fixed and flexible exchange rate without and then with interest rate regulation, under imperfect and perfect capital mobility regime. Comparing all these cases, I conclude that the correct package for the country is the one that RBI embarks. However this regime will be unsustainable during massive FPI exodus. This paper then analyzes the essential parameters that RBI must consider in maintaining an adequate forex reserves to make this system work during any massive capital exodus.
Foreign Portfolio Investment, Output, Investment