Effect of domestic monetary policy on foreign capital flows to India

Virender Kumar

Journal of Economic Policy Reform, 2025, vol. 28, issue 3, 371-391

Abstract: While foreign capital flows to India have increased significantly over time, they have also been highly volatile, posing significant potential risks for the country and requiring India to frame appropriate policies to manage these flows. In this context, this study empirically investigates how a domestic monetary policy shock influences foreign capital flows to India, aiming to assist the central bank in formulating effective management strategies. Employing a structural VAR methodology, the study finds that domestic monetary policy shocks (as measured by shocks to domestic money supply growth and the interest rate differential) have a statistically significant effect on net foreign capital flows to India, explaining about 19.5% of the total variation in such flows. The results suggest that the central bank, through monetary policy, can manage foreign capital flows to India; however, it is likely to face a policy dilemma between managing foreign capital flows and achieving its primary objectives related to inflation-growth.

Date: 2025
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DOI: 10.1080/17487870.2025.2505450

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