Gauging financial conditions in South Africa

This paper investigates the relevance of financial conditions indices (FCIs) as an additional gauge of South Africa’s economic metabolism. As a starting point, a background is provided on FCIs in terms of evolution, methodologies and uses. In general, FCIs were found to have a very broad definition, are used for different purposes and can be calculated with different statistical techniques. The first step in developing an FCI for South Africa was to identify a purpose for it. From the purpose followed the data selection, sourced from regular updated financial data since 2003. The selection was differentiated from other South Afri-can FCIs by including commodity prices, as well as BER financial survey data. The final selection of indicators was tested for unit roots. The second process was the calculation of weights, in which case the principle components method was used. However, to avoid revising the historical data of the FCI each new month, a real-time principle component series was constructed. This method implies that the weights are recalculated every month, based on a rolling window of 60 months historical data, starting from 2005 onwards. In the third and final step, the real-time principle component series was purged from the real-time nominal GDP growth rate (capturing both output and inflation). The purged real-time principle component series was taken as the final FCI. The impact of the global financial crisis and the drastic monetary policy that followed is clearly visible in the FCI. The periodical divergence between the FCI and the real economy also served as an indication on the effectiveness of monetary policy. This FCI was found, over shorter horizons, to lead economic growth by nine months, and it improved on a naive forecast of GDP growth.

G19, E39, C10

financial conditions, principle components, factor models, leading indicator, financial survey, business cycle