Prof. Jayanth R. Varma’s Financial Markets Blog

A blog on financial markets and their regulation

RBI on India and the Global Financial Crisis

The Report on Currency and Finance 2008-09 published by the Reserve Bank of India this month is on the “Global Financial Crisis and the Global Economy.” Well over two-thirds of this 380 page report is about the global crisis itself and does not contain anything new. But about a hundred pages are devoted to the impact of the global crisis on India and to the policy responses in India.

There are a number of interesting empirical analyses in these two chapters of the report. Well, there is an occasional piece of silly econometrics like the regression in levels between trending variables in footnote 9 on page 277; the absurdly high r-square of 0.9981 should have alerted the authors to the possibility (near certainty?) that this is a spurious regression. However, most of the empirical analyses do appear to be sound econometrically.

A few results that I found interesting:

  • “An empirical analysis confirmed that the regional stock markets in Asia including India, Hong Kong, and Singapore and global markets such as the US, UK, and Japan shared a single long-run co-integrating relationship in terms of stock price indices measured in US dollars rather than the local currencies (Table 5.10). The Indian market held the key to this integration process. This was evident from the analysis that, excluding India, the other five stock markets did not show a co-integrating relationship. The coefficients of the long-run co-integration vector showed that the impact of the global markets on the Indian stock market was more pronounced than the impact of the regional markets.” (page 213-214)
  • “a bivariate VAR model revealed that there was a significant Granger causal relationship from FII flows to the Indian stock market. The feedback causality from the BSE index to FII flows was also significant, albeit at a 10 per cent level of significance. … FII investment and money supply do exert significant influence on the movements of stock markets in India; while the relationship is the other way round in the case of investments by mutual funds wherein stock markets cause their variations.” (page 216-217). I am aware of some earlier studies that indicated Granger causality ran the other way, so it would be useful to replicate this result over longer time periods. Unfortunately, here as in most of their other regressions, the RBI does not indicate the sample period used.
  • The report asserts that the financial stress index (FSI) for India “exhibited synchronised movements with that of the US, Western Europe, Japan and aggregate advanced economies (Figures V.20 & V.21). This either shows that financial stress in India and other advanced countries is driven by a common factor or that transmission of stress to Indian markets from advanced markets is contemporaneous.” (page 231-232). Unfortunately, the report does not present any statistical analysis regarding this and relies on the visual evidence of a chart plotting the FSI in India and other countries. Looking carefully at this chart, however, it appears that the only synchronized movement was in October 2008 (after Lehman). Neither before nor later, do I see a synchronized movement in the chart.

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