An Evaluation of the Predictive Capabilities of the Yield Curve in India

Abstract

This paper proposes an evaluative study of the predictive capabilities of the yield spread on economic performance in India. While literature on the subject is vast, studies so far have centered primarily on the U.S. and other developed European economies. In line with previous literature, we choose the spread between the 3-month and 10-year treasury bonds to conduct our analysis, using data from the beginning of 1995 till the end of 2019. We use the probit model to check whether curve inversions predict recessions within the country, finding the spread to be a significant determinant either immediately or 2-quarters ahead. However, in terms of predicting economic performance, the spread shows much weaker capabilities, containing minimal information on changes in real GDP, inflation rates or industrial production. With the yield curve being an easy to track monetary policy indicator, proving its forecasting potential should prove an aid to policymakers and sheds light on the importance of monetary policy for developing countries, establishing the need for further academic research on the subject in the developing and underdeveloped countries of the global east.