Can an Inter-temporal Model Explain India’s Current Account Balance?

Employing an inter-temporal model on a constructed private consumption series, the paper finds that the current account balance in India during 1950-51 to 2005-06 is inter-temporally solvent. This is primarily a reflection of the developments that have taken place during the post-reform period, when restrictions on capital flows have been significantly liberalised. We do find some evidence of asymmetry between capital flows, which is on expected lines as restrictions on capital outflows from India are more than those on inflows to India. The study finds that the optimal current account balance has been larger than the actual current account balance. This is intuitively appealing as there were severe foreign exchange restrictions in the pre-reform period which restricted the smoothing of private consumption up to the optimal level. With further liberalisation of capital flows, both inflows and outflows, it would be possible for agents to further smoothen their consumption to desired optimal level, allowing scope for higher current account deficit to attain potentially higher growth