Forewarned is Forearmed : Configuring an Early Warning Mechanism for Macro-Financial Space in India

This paper makes attempts to identify a set of early warning indicators for Indian macro-financial space and estimates the efficacy of chosen indicators in signaling the crises. The results showed that a few indicators (such as ‘credit to GDP gap', ‘output GAP', ‘Credit growth', ‘Deposit growth', ‘CRAR', ‘Gross NPA Ratio' and ‘ROA') performed well in identifying the financial distress with good signal and low noise ratios. As it is difficult to monitor movements of several indicators individually, that too pertaining to different sectors, while predicting crises, an attempt is also made to construct three composite indices, viz., Index of Speculative Pressures, Index of Macroeconomic Vulnerability and Index of Banking Sector Vulnerability and finally an overall Systemic Financial Stability Index. Results corroborate that composite indices performed better in signaling the crises well in advance. The noise ratio too looks better for them