Causal relationships between the capital account and the current account: an empirical investigation from India

Abstract

This article provides an empirical investigation of the causal relationship between the current account (CA) and the capital account (KA) in the case of Indian economy. The results indicate the non-existence of causal relationship between the CA and the KA. Furthermore, we examine the causal relations between the components of the KA and the CA along with exchange rate as the linking factor between them. The causal findings, in the above mentioned case, show different results. Our finding suggests that there exist a causal relationship from Non debt flows to the CA via the real effective exchange rate. This implies that decomposition of the KA helps in identifying the source of flows that drives the CA the most. The results also indicates that volatile capital flows may deteriorate the CA balance and therefore, emphasis should be laid on improving the soundness of the financial sector before moving towards the full KA convertibility.3

Estimating the Relationship Between the Current Account, the Capital Account and Investment for India

“…Faroque and Veloce (1990) in their study of the Canadian economy also find a feedback relationship between the CA and the long-term KA. Garg and Prabheesh (2015) in their study on India do not find any causal relationship between the two accounts.…”

“…The results have implications for financial and macroeconomic stability and for policy. A previous multivariate causality study of the CA and the KA for India (Garg & Prabheesh, 2015) included the real exchange rate. It did not find any causal relationship between the two accounts, but found FPI flows to affect the exchange rate and, therefore, the CA.…”

An examination of the causality relationship between current and financial accounts in Turkey

“…Therefore, to reduce the risk caused by high current account deficits, policies aiming for financial balance should be prioritised. Garg and Prabheesh (2015) empirically investigate the causal relationship between current and financial accounts in the Indian economy. They utilise quarterly data from 1990 to 2011 and apply the Modified Wald Granger causality test proposed by Toda and Yamamoto.…”

“…This means that the causality relationship runs from the current account to the financial account. Another group of economists argues that financial capital inflows to a country lead to the expansion of domestic demand and growth of the current account deficit (Calvo et al 1996;Yan 2005; "Mastroyiannis 2012; Garg and Prabheesh 2015;Yalta and Sağlam 2016). The surge in capital inflows tends to be channelled into enlarging basic components of total demand in the host countries.…”

On the Relation between Capital Flows and the Current Account

“…Their relation to the current account might therefore differ. 5 Studies in the literature analysing the relationship between the current and financial account mainly focus on the difference between developing and developed countries (Fry et al 1995, Sarisoy-Guerin 2003, Yan 2005, Yan and Yang 2012 or provide applications to emerging market economies (Yan and Yang 2008, Kim and Kim 2011, Lau and Fu 2011, Garg and Prabheesh 2015. Generally, findings suggest that the Granger-causality runs from the current account to the financial account in developed countries, while it is the reverse case in developing countries.…”