The Financial Trilemma in China and a Comparative Analysis with India

Abstract

A key challenge facing most emerging market economies today is how to simultaneously maintain monetary independence, exchange rate stability and financial integration subject to the constraints imposed by the Trilemma, in an era of widespread globalization. In this paper we overview and contrast the Trilemma policy choices and tradeoffs faced by the two key drivers of global economic growth-China and India. China's Trilemma configurations are unique relative to other emerging markets in the predominance of exchange rate stability, and in the failure of the Trilemma regression to capture a consistently significant role for financial integration. In contrast, the Trilemma configurations of India are in line with choices made by other emerging countries. India like other emerging economies has overtime converged towards a middle ground between the three policy objectives, and has achieved comparable levels of exchange rate stability and financial integration buffered by sizeable international reserves.

The open economy trilemma in Latin America: A three‐decade analysis

“…INF-inflation rate. A key variable for trilemma analysis (see Aizenman et al, 2008Aizenman et al, , 2010Aizenman & Sengupta, 2013;Hutchison, Sengupta, & Singh, 2012). There is no doubt that lower inflation correlates with better economic performance.…”

“…IR-international-reserves-to-GDP ratio. International reserves affect directly the trilemma configuration (Aizenman et al, 2010;Aizenman & Sengupta, 2013). MI, ES, and KO-trilemma indices (tlm) as proposed by Aizenman et al (2008Aizenman et al ( , 2010.…”

Is China or India more financially open?

“…Like Gupta Sen (2010), Patnaik and Shah (2012, p 195), rightly criticise Chinn-Ito for "not adequately captur [ing] the gradual easing of capital controls, since it continues to give the same score unless all restrictions [in any dimension] 2 See Bernanke et al (2011); on capital controls, see Ostry et al (2010Ostry et al ( , 2011a and Magud et al (2011). 3 See Glick and Hutchison (2009), Aizenman et al (2010Aizenman et al ( , 2011, Kohli (2011), Hutchison et al (2012) and Patnaik and Shah (2012). 4 See Lane and Schmuckler (2007) and Aizenman and Sengupta (2011). Capital account openness of China and India: de jure and de facto measures Graph 1 Chinn-Ito indices of de jure openness International assets and liabilities (% of GDP)…”

“…3 See Glick and Hutchison (2009), Aizenman et al (2010Aizenman et al ( , 2011, Kohli (2011), Hutchison et al (2012) and Patnaik and Shah (2012). 4 See Lane and Schmuckler (2007) and Aizenman and Sengupta (2011). Capital account openness of China and India: de jure and de facto measures Graph 1 Chinn-Ito indices of de jure openness International assets and liabilities (% of GDP)…”

China's Capital Controls Through the Prism of Covered Interest Differentials

“…According to the monetary policy trilemma, China with a preference for stable exchange rate has to choose between capital mobility and policy independence. In reality, we observe that China imposes capital controls and exercises monetary policy independence (Aizenman and Sengupta, 2013). The effectiveness of restrictions on capital flows, thus, has substantial implications for China's ability to manage and stabilize its domestic economy.…”