Examining the impact of domestic monetary policy on foreign portfolio investment flows to India

Abstract While the determinants of foreign portfolio investment (FPI) flows to India have been extensively analyzed, research has largely failed to document the impact and the relative importance of domestic monetary policy shock vis‐à‐vis other variables in causing FPI flows to India. This study adds to the literature by empirically examining the impact of the domestic monetary policy shock on FPI flows to India using the structural VAR methodology. It further disaggregates the analysis of FPI flows into portfolio equity flows (PEF) and portfolio debt flows (PDF) to investigate whether a domestic monetary policy shock affects the two flows similarly or differently. The study finds that domestic monetary policy shock (measured through shocks to interest rate differential and domestic money supply growth) significantly influences FPI flows to India, explaining about 10.1% of the total variation in these flows. The disaggregated analysis of FPI also reveals similar results for both portfolio equity flows and portfolio debt flows; however, the impact of the domestic monetary policy shock is greater on the debt component of FPI (portfolio debt flows) than on the equity component of FPI (portfolio equity flows).