Foreign Finance, Real Exchange Rate, and Macroeconomic Performance in India

The paper examines whether financial inflows cause economic contraction in India through appreciation of the rupee. To this end, it formulates a structuralist macroeconomic model and calibrates it to India’s national income accounts. It then simulates and analyses an alternative scenario involving greater inflow of foreign finance. It is seen that real exchange rate appreciation, despite its negative effect on trade surplus, stimulates real wages and consumption demand. The paper does not endorse complete capital account convertibility but warns against a blanket approach towards different forms of foreign finance.