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Measures of de facto capital account openness for China and India raise the question whether the Chinn-Ito measure of de jure capital account openness is useful and whether the Lane-Milesi-Ferretti measure of de facto openness ranks the two countries correctly. We examine eight dimensions of de facto capital account openness. Four measures based on onshore and offshore prices test the law of one price. Among the four quantity measures, we introduce two new ones into the debate: the openness of consolidated banking systems and the internationalization of currencies. Generally, the measures show both economies becoming more financially open over time. In six of the eight dimensions, the Indian economy appears to be more open financially. Nevertheless, policy continues to segment onshore and offshore markets in both and policymakers face challenges in further financial integration.

The world has a huge stake in China's and India's integrating their finances into global markets. Any mishap akin to the 1990s’ Asian financial crisis would hurt the world economy. These economies are travelling a road lined with memorials to victims of previous accidents. The role of capital inflows in enabling a credit and asset price boom and bust in the United States and the interest-rate and balance-sheet responses of major central banks have renewed interest in capital controls.2 Recent research places them in a broad policy context.3 Much analysis uses the Chinn and Ito (2008) index, an interval, de jure measure derived from four on-off variables in the IMF Annual Report on Exchange Arrangements and Restrictions ( Fig. 1, left-hand panel). For de facto openness, “the most widely used measure” ( IMF (2010, p 51)) is the ratio of the sum of international assets and liabilities to GDP ( Lane and Milesi–Ferretti, 2003 and Lane and Milesi-Ferretti, 2007), Fig. 1, right-hand panel). Full-size image (40 K) Fig. 1. Capital account openness of China and India: de jure and de facto measures. Figure options We question whether these measures appropriately track the progress and relative position of China and India on the road to international financial integration.4 We disagree with Chinn-Ito that China and India are both stalled on the road and agree with Lane-Milesi-Ferretti that both are moving forward, that is, opening up. Like Gupta Sen, 2010 and Patnaik and Shah, 2012, p 195), rightly criticize Chinn-Ito for “not adequately captur[ing] the gradual easing of capital controls, since it continues to give the same score unless all restrictions [in any dimension] are removed”. Moreover, we question whether Chinn-Ito (tied) or Lane-Milesi-Ferretti (China ahead) gets their relative position right. We reach these conclusions by gathering in one place six existing de facto measures and by proposing two new measures. These new measures of internationalization of consolidated banking systems and currency internationalization both use BIS data. For our four price-based measures, we analyse average deviations from the law of one price. For most of the measures, we offer cross-country benchmarks as well as bilateral comparisons. We advance three hypotheses, two in the time series (ts) and one in the cross-section (xs): • Hts1: Lane-Milesi-Ferretti is right: both China and India are opening. • Hxs1: Chinn-Ito and Lane-Milesi-Ferretti are wrong: India is more open than China. • Hts2: Both China and India remain some distance from financial openness. Sections 2–9 present evidence on each dimension. Sections 2–5 measure integration based on onshore and offshore prices: currency forwards, money, bond and equity markets. Sections 6–9 compare the links between investment and savings flows, ratios of external positions and flows to activity, foreign bank shares and currency internationalization. Section 10 assembles the measures; Section 11 concludes.

We challenge Chinn and Ito's index, which suggests that China and India restrict capital flows to a similar extent. And we question Lane and Milesi-Ferretti’s ranking of China as the more open economy. We hope that researchers will use these measures with greater care, even scepticism, and will look for new measures. The Chinn-Ito measure in particular is not clearly fit for the purpose to which it is often put. Moreover, there is little reason to think that “the most finely gradated” (Quinn et al. (2011 p 492)), measure of Schindler (2009) does not suffer from the same fundamental drawback. Looking at types of regulation does not reveal how restrictive they are, much less how restrictive they are in practice. De facto is the way to go. Why is India more financially open than China? Part of the answer must be a mix of policy aspiration and necessity. For instance, the Indian authorities may have sought to improve their equity market by opening it to foreign investors, but clearly the permitted inflows have, with great variability, financed India's current account deficits. Another part of the answer may be the rigour with which the controls are enforced. Structurally, the long-standing multinational operations of Indian private firms can use intra-firm transactions, including the leads and lags of trade finance, to arbitrage onshore and offshore markets, albeit evidently with a lag (Subramanian (2009, p 224)). China's state-owned firms are only at an early stage of going global, and their managers may be subject to different discipline. Similarly, the larger footprint of global banks in Indian banking gives them bigger balance sheets to arbitrage markets. Future research could weigh these explanations. Whatever the cause of this long-standing difference, our evidence suggests that the Chinese economy has of late been moving faster and more consistently in the opening direction. As a policy intention, the paced internationalization of the renminbi has no counterpart in India. By creating a pool of renminbi bank accounts and bonds outside of the Chinese mainland and allowing for offshore delivery of the renminbi, this policy is also punching holes in the capital controls through which arbitrage transactions can pass. An important conclusion of our study, however, is that on most measures both economies have a way to go. Policymakers would not be safe in the assumption that impediments to onshore/offshore arbitrage no longer bind. Instead, policy continues to segment onshore and offshore markets in both cases. Policymakers in each country face challenges in further financial integration.