Is Capital flow in India expansionary or contractionary?

The standard model of open economy macroeconomics suggests that the capital inflow hurts the export of the country through the appreciation pressure. On the other hand, there is a vigorous belief that the capital inflow into the developing countries helps to mitigate the saving-investment gap, encourage the technology transfer, fuel the credit boom, liquidates the stock market and thereby finally increases the output. This paper aims to investigate whether the capital inflow in India is expansionary or contractionary. In doing so, we focus on the different typologies of capital inflow, components of GDP and the absorption capacity of the domestic economy. The empirical strategy adopted by the paper takes care of the issue of the non-linearity and also the endogeneity problem. Analysing the data from 1996 Q2 to 2019 Q4 we find that the capital flow into India could be expansionary as well as contractionary depending upon the nature of inflow and the absorption capacity. Net total capital inflow has no direct impact on growth. But it can accelerate the growth in conjunction with the higher financial depth of the economy, negative output gap, lower country risk and better stock market condition.