Policy Imperatives For Managing Indian Domestic Investment Under Effect Of Capital Flight.

Abstract

Capital flight means the assets transferred outside the Indian Frontiers with the purpose of reduction in loss of principal, returns, or loss of control on financial wealth due to government-sanctioned activities". This paper explores the relationship between capital flight and domestic capital formation in India, defining capital flight as the transfer of assets abroad to reduce loss of wealth due to government-sanctioned activities. It emphasizes the negative impact of capital flight on domestic investment and discusses the vital role of these undeclared transfers in depriving capital-scarce economies of critical financial resources. The study uses data from 2003 to 2023 and applies the Augmented Dickey-Fuller (ADF) test, VAR, and Granger Causality test to evaluate the relationship between capital flight and gross capital formation. It concludes that capital flight and gross capital formation influence each other in India, with the growth of capital flight in the previous year causing a casual effect on the current year's domestic investment growth, and vice versa. Furthermore, the document delves into the measurements and methods for estimating capital flight, categorizing them into direct and indirect methods such as the residual method, Dooley method, and trade mis-invoicing method. It emphasizes the adverse impacts of capital flight, including a reduction in domestic investment, a signal to foreign private investors about risks involved, erosion of the domestic tax base, and negative effects on equality due to wealthy citizens evading higher taxation by channeling funds abroad. The study also discusses the hypotheses related to the causal effects of previous year's capital flight growth on the current year's domestic investment growth and vice versa.

The research methodology involves defining variables, conducting stationarity tests, and using VAR and Granger Causality tests to examine the short-run relationship between capital flight growth and gross capital formation growth. The results indicate that both variables affect each other in the short run, with lagged capital flight growth causing effects on current year's gross capital formation growth, and vice versa. The document concludes by emphasizing the need to reduce the country's vulnerability to capital flight and the importance of policy imperatives to redirect lost funds into productive areas and reduce income inequalities.

In summary, this study sheds light on the significant impact of capital flight on India's domestic investment, providing insights into the causal effects between capital flight and gross capital formation, and highlighting the necessity of addressing the country's vulnerability to capital flight through policy interventions aimed at promoting productive investments and reducing income inequalities