Abstract
This article constructs financial condition indices (FCIs) for India and explores their predictive ability of business cycle. The estimated FCIs indicate substantial tightening in financial conditions in India since the global financial crisis barring a brief phase during 2010–11. Unlike in the literature, it shows the importance of standardising the financial variables by removing the influence of unit of measurement and not purging the influence of past economic activity as that improves the forecasting ability of FCI about business cycle. In predicting GDP growth, principal component analysis-based FCI outperforms vector autoregression-based FCI but both are better than OECD composite leading indicator, and indicate an upturn in business cycle in India in 2015–16.
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