Evaluating Indian economy’s vulnerability to currency crisis

Abstract

This paper examines India’s exposure to currency crisis for the period 1986 to 2015 using KLR (Kaminsky, Lizondo and Reinhart) methodology. Focus of the study is on evaluating currency crises and building an Early Warning System (EWS) to anticipate future crises. Using KLR methodology we explain the phenomenon of currency crises over three stages – identification of the crises periods, selection of the variables causing the crisis based on previous literature and economic structure, and estimating indicators’ ability to forecast the crisis. The following are identified as crisis periods: 1991, 2008-2009 and 2012. Among these crises, 1991 crisis was attributed to fiscal mismanagement, global financial crisis caused the 2008 currency slump whereas 2012 crisis occurred due to domestic macroeconomic imbalances. A surprising finding is that there were no common indicators issuing signals in these three spells of crises.

Keywords

• currency crisis
• three generations of currency crises models
• signal extraction: early warning system
• noise-to-signal ratio