In a bid to enhance real-time monitoring of the country’s financial health, a recent study by the Reserve Bank of India (RBI) has proposed the construction of a Financial Conditions Index (FCI) for India with daily frequency.
The proposed FCI would serve as a composite indicator, designed to capture and reflect the prevailing conditions across key segments of the financial system — including the money market, government securities (G-sec), corporate bonds, equities, and the foreign exchange market.
According to the RBI research study, the index aims to provide a high-frequency gauge of how tight or easy financial market conditions are, relative to their historical average since 2012. By aggregating signals from various market-based indicators, the FCI is expected to offer valuable insights into the broader financial environment, potentially aiding policymakers, analysts, and market participants in decision-making. The proposed construction marks a significant step towards improving the assessment of macro-financial dynamics in India’s rapidly evolving financial landscape.
“The estimated FCI traces movements in financial conditions in India across both periods of relative calm as well as crisis episodes. The index suggests that in the aftermath of the pandemic, exceptionally easy financial condition was driven by the combined impact of amiable conditions across all market segments,” the RBI study said.
Financial conditions continued to remain relatively easy since mid-2023 before firming up from November 2024. In the current financial year, however, it has remained congenial riding on a buoyant equity market and a money market suffused with liquidity, the study said.
“The newly constructed FCI for India assesses the degree of relatively tight or easy financial market conditions with reference to its historical average since 2012. The FCI is based on twenty financial market indicators at daily frequency for a long period and closely tracks the turning points in financial conditions, as observed across major episodes in the sample period,” it said.
The study said a higher positive value of the FCI is indicative of tighter financial conditions. To present our results, we use the standardised FCI. Standardisation helps in interpreting the changes in financial condition in terms of standard deviation units. “For example, within our sample period, financial condition was at its tightest at end-July 2013 during the taper tantrum episode, with the estimated standardised FCI at 2.826 — almost a 3-standard deviation tightening relative to the historical average,” it said.
Story continues below this ad
However, the FCI stood at -2.197 at mid-June 2021 — indicating the exceptionally easy financial conditions post-Covid.
The peaks in FCI are associated with major events like the taper tantrum in 2013, stress in the non-banking financial companies (NBFC) sector during the Infrastructure Leasing and Financial Services (IL&FS) episode and the onset of the COVID-19 pandemic, it said. During May to July 2013, apprehensions of the likely tapering of US bond purchases under quantitative easing (QE) triggered outflows of portfolio investment from EMEs including India, particularly from the debt segment. This prompted an increase in credit risk premiums in the bond market and pressures on the rupee, the study said.
The exceptional tightening of financial conditions during the taper tantrum was primarily driven by the bond and forex market. “During the IL&FS episode, bond and equity markets were the major drivers of tightening financial conditions. Default by IL&FS in September 2018 led to panic in the bond market amidst tight liquidity conditions in the system, thereby increasing the credit risk premium, the study said.
“The next peak in the index is evident during the early COVID-19 period. The onset of the COVID-19 pandemic resulted in seizure of economic and trading activity that triggered market turmoil on an unprecedented scale. The tightening of financial conditions at the beginning of the Covid period was driven by a sharp sell-off in the equity and corporate bond markets,” it said.
Story continues below this ad
The exceptionally easy financial condition that followed this tightening was driven by the combined impact of easing across all market segments, facilitated by the conventional and unconventional measures of the Reserve Bank during 2021-2022, it said.
The conditions continued to remain relatively easy since mid-2023 before firming up from November 2024 on account of the relative tightness in equity, bond and money markets triggered by the rising US exceptionalism after the presidential elections. After peaking in early March 2025, the FCI has since reverted to its historical average, suggesting close to neutral financial conditions. The major drivers of the easing during this period were easy money market conditions due to large liquidity injection by the RBI, change in the policy rate and the stance, followed by a buoyant equity and G-Sec market, the study said.
