Consumption Smoothing and Current Account Balance in India: Further Evidence

This study has used more recent data for 2006-07 and 2007-08 which are now available.Employing more recent data, we find that the earlier robust results that we had foundin the context of India are reaffirmed. Employing an inter-temporal model on a constructedprivate consumption series, the paper finds that the current account balance in Indiaduring 1950-51 to 2007-08 is inter-temporally solvent. This is an outcome of thedevelopments during the post-reform period since the current account balance during theperiod leading up to the payment crisis of 1991 was insolvent. Capital flows, however,still remain restrictive and appears to be biased against outflows. As a result, volatilityin capital flows is less than what the expected change in fundamentals warrants and agentsare not able to fully optimize and smooth their consumption. This involves loss ofwelfare and also restricts running of a higher but solvent current account deficit that canraise the level of investment and growth, while at the same not guarantying the sustainabilityof an otherwise technically solvent current account balance. Thus, there appears to becase for further liberalization of capital flows, particularly outflows. India’s approachtowards liberalising the capital account has been one of gradualism, treating the liberalizationas a continuous process rather than a single event. In this context, it is important to notethat the Reserve Bank has significantly liberalized capital outflows in the recent period.