A Var Approach to Estimate Financial Conditions Indexes for India

Abstract

This paper attempts to construct monthly financial conditions indexes {FC/s) for India using VAR models. The FC/s are expected to reflect financial fragility or soundness of an economy. Two alternative indexes were calculated with data on variables from 6 different markets for a period of 2001:1 - 2016:1. FCI {WP/) was constructed with impulse responses generated through shocks to a real sector variable, WP/ inflation, while FCI {NEER) had responses from shocks to nominal effective exchange rate {NEER). The indexes were assessed in terms of their causal relationship with macroeconomic indicators like GDP and /IP growth rates, and directional predictions with respect to financial variables. Strong bi-directional causality was observed between the indexes and the macroeconomic indicators while good directional predictions were obtained against only SENSEX and NEER, and percentage changes in them. More specifically, FCI {WP/} recorded very good co-movements with respect to SENSEX.