International Journal of Business and Social Science

ISSN 2219-1933 (Print), 2219-6021 (Online) DOI: 10.30845/ijbss

Measuring the Degree of Cross-Country Capital Mobility
Deergha Raj Adhikari

Economic growth achieved by countries such as Japan, South Korea, and China through the pursuit of an export-led growth and an open-door capital market policy, has inspired many newly emerging economies, prompting them to revise their tax and other laws to create conducive environment for foreign direct investment into their countries. But any such attempt by a host country cannot unilaterally promote foreign direct investment into the country if capital is immobile internationally. There have been several studies to measure the degree of international capital mobility based on above four definitions. Studies, so far, on the measurement of the degree of international capital mobility basically fall into one of the following four categories: (a) measuring the degree of correlation between savings rate and investment rate, (b) testing the fulfillment of the covered interest parity condition, (c) checking to see if the uncovered interest parity condition is met, and (d) checking to see if current-account surplus and saving surplus parity condition is met. But our study takes a different approach, in it, we measure the degree of international capital mobility by measuring the degree of responsiveness of exchange rate between two currencies to the change in relative rate of return in domestic countries. We applied our model on the data on annual average exchange rate of Indian rupee with the U.S. dollar, and on annual average real interest rate in both the United States and India for the period, 1990 – 2015, obtained from the World Development Indicators, 2015. Our study found that both the dependent and the independent variables had a unit root and were integrated of order one. So, we applied the co integration test on the variables of our model to see if any long-run relationship existed between them. We found that the two variables were integrated. So, we estimated our model using OLS. Our estimate shows that our independent variable, the relative real interest rate in India, that is the variable Zt, dose have negative effect on the percentage change in rupee-dollar exchange rate, the variable et. This implies that as the relative real interest rate in India rises, the exchange rate – defined as the number of Indian rupees needed to purchase one U.S. dollar – falls, which is logical. Because, as the relative real interest rate in India rises, it will cause capital outflows from the U.S. to India, increasing the demand for Indian rupee by U.S. investors causing the value of Indian rupee to appreciate, thereby, lowering the exchange rate. This in turn implies that capital is mobile internationally or at least between the U.S. and India.

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