To derive the uncovered interest parity (UIP) condition we assume, among other things, that there is free movement of capital across countries.

But this cannot be directly applied to India because of capital controls. While foreigners are relatively free to hold Indian assets, Indians are in general forbidden to hold foreign assets.

Is there a variant of the UIP that we can expect to hold (given the other assumptions) under such asymmetric restrictions on asset holding?


1 Answer 1


In principle it shouldn't really matter that a sub-population (in this case the locals) have capital restrictions, so long as the unrestricted population is sufficiently large. The UIP model only needs that the capital can flow - it doesn't mind who is doing it.

In this case, so long as the foreign investors have not completely left, then in aggregate the restriction shouldn't make a difference.

Furthermore, if foreign investors are able to short sell to locals (which I think they can?), then you can even create extreme capital outflows.


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