Establishing finance-growth linkage for India: a financial conditions index (FCI) approach
International Journal of Emerging Markets
ISSN: 1746-8809
Article publication date: 6 August 2019
Issue publication date: 22 November 2019
Abstract
Purpose
The global financial crisis of 2008 emphasized the need for monetary policy authorities to have a more comprehensive view of the conditions prevailing in the economy before deciding their policy stance. The purpose of this paper is to outline the construction of a financial conditions index (FCI) and investigate the possible co-integrating relationship between the economic growth and FCI.
Design/methodology/approach
The study employs the PCA methodology, with appropriate augmentations to handle the unbalanced panel data-sets and constructs a FCI for India. It tests the growth-predicting power of FCI by applying the auto regressive distributed lags approach to co-integration and verifies if the FCI is co-integrated with real GDP growth. It also discusses construction of a financial development index (FDI) which tracks the financial markets through M3, market capitalization and credit amount to residents.
Findings
The constructed FCI has a quarterly frequency and is available starting 1998q2. The long-run coefficient of FCI while predicting the real GDP growth is significant at 10 percent. The results confirm that a more-broader index FCI outperforms a narrower index FDI in growth prediction.
Research limitations/implications
By showing that FCI is a better growth predictor than FDI, the study establishes the importance of including the foreign exchange markets, bond markets and stock markets while summarizing the conditions in the economy. The authors hope that the FCI would be helpful to the monetary authorities in their policy decisions.
Originality/value
The paper adds to the few existing studies studies dealing with FCI for Indian economy and constructs a more comprehensive index which tracks multiple markets simultaneously. It also fills the gap in literature by evaluating the correlating relationship between FCI and economic growth.
Keywords
Acknowledgements
This paper is a part of the research work undertaken during the scholarship to faculty by Reserve Bank of India. The authors would like to thank DEPR, RBI, for providing financial assistance, and also thank the parent organization, BITS, Pilani, which provided us with all the required resources for this study. Any errors and omissions in this paper are of the authors only.
Citation
Giri, A.K. and Bansod, D. (2019), "Establishing finance-growth linkage for India: a financial conditions index (FCI) approach", International Journal of Emerging Markets, Vol. 14 No. 5, pp. 1032-1059. https://doi.org/10.1108/IJOEM-10-2017-0422
Publisher
:Emerald Publishing Limited
Copyright © 2019, Emerald Publishing Limited