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The authors are grateful to John McDermott and Catherine Pattillo for help in conducting some of the simulations reported in the paper; to Poonam Gupta, Christopher Towe, Peter Wickham, and officials at the Reserve Bank of India for useful comments; and to Ivan Guerra and Aung Win for valuable research assistance. All remaining errors and omissions are the responsibility of the authors.
The fiscal year in India runs from April 1 to March 31; accordingly, 1990/91 refers to the period from the beginning of April 1990 to end-March 1991.
For the purpose of the empirical implementation, a quadratic utility function is chosen
Given that the current account is composed of smoothing and tilting components, the tilting component is equal to
From equation (4), the optimal level of capital flows is that which allows rational agents to fully smooth their consumption in the presence of shocks to output net of investment and government spending. Output temporarily below its long-run discounted average (that is, its expected annuity value at the prevailing interest rate), or investment or government spending temporarily above its long-run discounted average, all else held constant, will each result in agents smoothing consumption by borrowing foreign savings (running a higher current account deficit), rather than lowering contemporaneous consumption.
National accounts data for 1950/51-1998/99 are used in the empirical work in this section. Hence the estimates of the actual current account differ slightly from those in other sections, which are on a balance of payments basis. Further, while the CSO has recently released revised national accounts data (rebased to 1993/94), we have chosen to use the old series in the estimation work given the lack of a comprehensive breakdown on the expenditure side of the accounts in the new data. The old series was updated for the most recent years by applying growth rates from the new series. As the revised series raised the estimated level of nominal GDP by around 10 percent relative to the old series, the ratios to GDP presented in this section need to be scaled down by about 10 percent to achieve ratios consistent with those in other sections. All nominal series were deflated by the implicit GDP deflator. Consistent with earlier work by Sheffrin and Woo (1990), r was set at 4 percent for all calculations reported below.
Without an explicit model of intergenerational welfare it is not possible to decide whether deferring/bringing forward consumption (that is, consumption tilting) is desirable. However, as long as the economy’s objective function is of a form like equation (1), there will be avoidable deadweight costs from a failure to smooth consumption.
In India, transfers from abroad are an important component of income available for domestic consumption. So while in the standard set-up of the intertemporal model transfers are usually excluded from the definition of national cash flow (see, for example, Obstfeld and Rogoff, (1996)) we include them here in cash flow
Phillips-Perron (1988) unit root tests (with an intercept) reveal that
The Phillips-Ouliaris (1990) cointegration test result was -4.39; the 5 percent critical value for this test (with an intercept) is -3.37. Both the Phillips-Hansen FM estimation method and the Phillips-Ouliaris cointegration test were computed using the Bartlett kernel and the automatic bandwidth selector developed by Andrews (1991).
Hansen’s (1992) mean-F, sup-F and Lc tests have values of 3.86, 7.28 and 0.33; the relevant critical values at the 5 percent level of significance are 4.57, 12.4 and 0.58, respectively.
Expression (5) is valid as long as the infinite sum in equation (4) converges. This requires that the variables appearing in the W matrix of the VAR system be stationary. Assuming that zt is I(1), then Δzt will be I(0) and since under the null hypothesis the smoothed current account is a discounted sum of Δzt then it will also be I(0).
The presence of capital controls may also affect agents’ ability to tilt consumption given their lack of access to world capital markets.
Given that controls on outflows exist, this is still not an ideal characterization of India’s capital account regime.
For the standard (unconstrained) model, anF-test of the null hypothesis of the absence of Granger causality from
The constrained current account imbalance for 1958/59 far exceeds the actual and unconstrained imbalance, most likely reflecting an overestimate of the magnitude of the temporary positive shock to national cash flow.
The derivation of the Wald test of the nonlinear restrictions in the VAR of equation (7) is described in White (1984, p. 77).
Similarly, for the standard (unconstrained) intertemporal model, the null hypothesis of a close association between the actual and unconstrained (smoothed) current accounts (the joint restriction that Γ = [0 1] in equation (5)) is again unable to be rejected, due most likely to the lack of precision with which the model is estimated.
The sample countries comprise: Argentina, Bolivia, Brazil, Chile, Colombia, India, Indonesia, Israel, Jordan, Korea, Malaysia, Mexico, Pakistan, Peru, Philippines, South Africa, Sri Lanka, Taiwan, Thailand, Turkey, Uruguay, Venezuela, and Zimbabwe.
The model’s dating of the third crisis of March 1993 can be explained by that month’s unification of the dual exchange rate system previously in place, which resulted in a large effective devaluation of the rupee.
At end-1998, around 11 percent of India’s external debt was denominated in rupees (Government of India (1999)). In the following sustainability scenarios, we assume that this ratio also applies to total external liabilities.
While official estimates of external debt are regularly published, no estimates of equity liabilities are readily available. To derive an estimate of the outstanding stock of NEL, we therefore added the stock of external debt (23 percent of GDP at end-1998/99) to an estimate of the stock of equity liabilities calculated by accumulating (from 1970 onward) the flows of foreign direct and portfolio investment flows in the capital account of the balance of payments. This methodology obviously does not allow for valuation changes that have occurred since the flows were received. Using this method, the outstanding stock of equity liabilities was estimated at about 8 percent of GDP at end-1998/99.