Global Shocks and Local Fragilities: A Financial Stress Index Approach to Pakistan’s Monetary and Asset Market Dynamics

Kinza Yousfani, Hasnain Iftikhar (), Paulo Canas Rodrigues, Elías A. Torres Armas and Javier Linkolk López-Gonzales
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Kinza Yousfani: Department of Management Sciences, Isra University, Hyderabad 11622, Pakistan
Hasnain Iftikhar: Department of Statistics, University of Peshawar, Peshawar 25120, Pakistan
Paulo Canas Rodrigues: Department of Statistics, Federal University of Bahia, Salvador 40170-110, Brazil
Elías A. Torres Armas: Instituto de Investigación de Estudios Estadísticos y Control de Calidad, Universidad Nacional Toribio Rodríguez de Mendoza, Chachapoyas 01001, Peru
Javier Linkolk López-Gonzales: Escuela de Posgrado, Universidad Peruana Unión, Lima 15024, Peru

Economies, 2025, vol. 13, issue 8, 1-27

Abstract: Economic stability in emerging market economies is increasingly shaped by the interplay between global financial integration, domestic monetary dynamics, and asset price fluctuations. Yet, early detection of financial market disruptions remains a persistent challenge. This study constructs a Financial Stress Index (FSI) for Pakistan, utilizing monthly data from 2005 to 2024, to capture systemic stress in a globalized context. Using Principal Component Analysis (PCA), the FSI consolidates diverse indicators, including banking sector fragility, exchange market pressure, stock market volatility, money market spread, external debt exposure, and trade finance conditions, into a single, interpretable measure of financial instability. The index is externally validated through comparisons with the U.S. STLFSI4, the Global Economic Policy Uncertainty (EPU) Index, the Geopolitical Risk (GPR) Index, and the OECD Composite Leading Indicator (CLI). The results confirm that Pakistan’s FSI responds meaningfully to both global and domestic shocks. It successfully captures major stress episodes, including the 2008 global financial crisis, the COVID-19 pandemic, and politically driven local disruptions. A key understanding is the index’s ability to distinguish between sudden global contagion and gradually emerging domestic vulnerabilities. Empirical results show that banking sector risk, followed by trade finance constraints and exchange rate volatility, are the leading contributors to systemic stress. Granger causality analysis reveals that financial stress has a significant impact on macroeconomic performance, particularly in terms of GDP growth and trade flows. These findings emphasize the importance of monitoring sector-specific vulnerabilities in an open economy like Pakistan. The FSI offers strong potential as an early warning system to support policy design and strengthen economic resilience. Future modifications may include incorporating real-time market-based metrics indicators to better align the index with global stress patterns.

Keywords: financial stress index; emerging markets; principal component analysis; macroeconomic stability; exchange market pressure; banking sector risk; asset price volatility; Pakistan (search for similar items in EconPapers)
JEL-codes: E F I J O Q (search for similar items in EconPapers)
Date: 2025
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