Financial Contagion and its Effects on the Indian Economy

Abstract

This thesis conducts a comprehensive empirical analysis of the transmission mechanisms of global financial shocks, focusing on the 2008 Global Financial Crisis and the 2020 COVID-19 pandemic, within the Indian economy. This study utilizes various macroeconomic and financial indicators from 2001 to 2024 to quantify contagion effects via trade, financial, and confidence channels. The study utilizes cross-correlation functions, regression models incorporating crisis-period dummy variables, and vector autoregression (VAR) techniques to analyze both immediate and lagged responses in variables. The findings indicate that India's GDP demonstrates increased sensitivity to external demand slowdowns during crises, highlighting the significance of the trade channel. Simultaneously, domestic financial markets exhibit significant spillovers from global benchmarks, with equity and money market rates reacting sharply to changes in international risk sentiment, underscoring the financial channel. Cross-correlation analyses and dummy-variable regressions indicate that these linkages intensify during crisis periods. The confidence channel is reflected in the swift responses of India's VIX to the CBOE VIX, as sentiment-driven selloffs and increased volatility exacerbate market stress. A comparative analysis indicates that the Global Financial Crisis significantly impacted India through and sudden capital outflows, while the COVID-19 crisis involved both external and domestic elements, with nationwide lockdowns exacerbating the effects of declining global demand. VAR IRFs indicate that shocks from global indices or volatility measures produce significant, however not consistently long-lasting, fluctuations in India's primary macro-financial variables. The findings suggest that India's increasing global integration has heightened its susceptibility to external shocks.