AN ASSESSMENT OF THE FELDSTEIN–HORIOKA PUZZLE FOR INDIA: A MARKOV REGIME SWITCHING APPROACH

Abstract

The study aims to examine the Feldstein–Horioka puzzle in the Indian context during 2002Q2 to 2019Q4 to unearth nonlinear patterns in the data. Findings from an augmented Markov regime-switching model reveal two distinct, yet random regimes for correlations between savings and investment-GDP ratios, with higher correlation between the variables persisting for a longer duration. In the low correlation regime, trade-related factors, policy uncertainty and global shocks have a significant impact on the correlation. Fiscal shocks and trade costs explain high correlations in regime 2, while global shocks act to decrease the correlation in this regime. The high correlation regime dominates the study period and indicates that the Feldstein–Horioka puzzle of limited capital mobility persists in India. Economic agents appear to respond rapidly to changing domestic and global policy conditions, besides being affected by incomplete integration of goods markets, explaining the pattern of correlations.