Linkages Between Financial Integration and Economic Stability in India: An AR–Garch Approach

Abstract The 2008 global financial crisis highlighted that financial instability can arise even under price stability and sound macroeconomic conditions, emphasizing the critical role of financial stability as a core objective of monetary policy. Financial integration, defined as the increasing interconnection of domestic markets with global financial systems, has a dual impact: it improves market efficiency, facilitates access to foreign capital, and strengthens risk management practices, while simultaneously increasing exposure to external shocks and cross-border contagion risks. This study employs secondary data covering annual macroeconomic variables from 2000 to 2023 to examine the relationship between financial integration, financial stability, and economic performance. Co-integration analysis confirms a long-run equilibrium between stock indices (Sensex and Nifty) and key macroeconomic variables, including IIP, M3, WPI, gold and oil prices, exchange rates, and the S&P 500. AR (1)–GARCH (1,1) models and their variants reveal persistent volatility in stock returns influenced by past shocks and deviations from long-run equilibrium. The findings indicate that financial integration supports growth and efficiency but also increases vulnerability to global shocks. Policy recommendations include strengthening macro-prudential frameworks, enhancing regulatory coordination, promoting financial inclusion, diversifying capital inflows, and adopting global best practices to sustain financial stability and support long-term economic growth in India.