Effects of Exchange Rate Changes on Capital Flows

The behaviour of the capital movements with respect to changes in exchange rate has not been studied so far in the Indian literature. The purpose of this paper is, therefore, to study the effects of changes in exchange rate on capital movements by using the Portfolio Equilibrium Model (PEM) and Macroeconomic Model (MEM) developed by Kouri and Porter (1974) and to examine the comparative performance of both these models in this respect. The paper attempts a detailed analysis of the capital flows in India's BoP vis-a-vis exchange rate changes during the period 1960-61 to 1984-85. The results indicate a very strong relationship between trade flows ad short-term capital movements. Another interesting aspect of the results is that income is highly significant in explaining the capital flows in all the cases. In India PEM seems to be more helpful in estimating the short-term and long-term capital movements. The reduced form of MEM does not appear to be useful.