This paper examines the early warning system of currency crisis in the context of Global Financial Crisis 2008. The monthly data has been taken for the period 2005- 2009 for leading indicators related to external exposure (short-term debt/reserves and growth of foreign exchange reserves), external competitiveness (REER overvaluation, current account as percentage of GDP, trade balance as percentage of GDP, and trade balance as percentage of growth rate in GDP) and domestic real and public sector (real GDP growth rate, inflation rate, and growth in M1 or M2 to growth in reserves) for a sample of randomly selected seven countries. The binomial panel probit model and ordered probit panel model have been applied to model currency crisis. The forecasting ability of the two models are compared in which one model takes into account the post-crisis bias. It is observed that during the crisis, external exposure and external competitiveness variables were significant predictors, whereas domestic economic indicators were not the leading indicators. The short-term debt to reserves has been the most important leading indicator during this period. Further, taking post-crisis bias into account improves the signal-to-noise ratio of the model.

A financial crisis is structural breakdown of economic system and can be due to either currency crisis, balance of payment crisis, debt crisis or banking system/financial system crisis. The currency crisis is sudden high loss in the value of the currency of the country. This loss in the value of currency can lead to another crisis like debt crisis, balance of payment crisis, and/or banking crisis. The currency crisis can be due to domestic economic fallout or can be due to international linkages of an individual economy. Due to movement towards free float of currency, market determined exchange rate and increasing global financial linkages, the currency crisis is more contagious and affects not only the domestic economy but other economies as well. The economic loss to the country due to currency crisis and thereafter the cost of restructuring of financial system necessitate the need for a system of early warning. The Early Warning System (henceforth EWS) based on leading indicators generates a signal prior to currency crisis. The empirical literature on currency crisis has provided evidence that certain macroeconomic indicators depict unusual behavior before the onset of currency crisis which shows that deterioration in indicators related to real and financial domestic sector and external sector leads to pressure on exchange market and further leads to currency crisis.

The IMF has taken a lead in putting significant efforts into developing EWS models not only for developed countries, but for emerging market economies as well. The influential paper by Kaminsky et al. (1998) and further work in this area by Berg and Pattilo (1998), Edison (2000), Bussiere and Fratzcher (2002), and Kumar et al. (2003) have provided valuable models.

Applied Economics Journal, Multiple Indicators Multiple Causes (MIMIC), Global Financial Crisis 2008, Early Warning System, Currency Crisis, Global Financial Crisis.