A Financial Conditions Index for South Africa

Miss Nombulelo Gumata, Mr Nir Klein and Eliphas Ndou

No 5119, Working Papers from South African Reserve Bank

Abstract: The main purpose of this paper is to construct a financial conditions index (FCI) forSouth Africa. The analysis extracts the index by applying two alternative approaches(principal component analysis and Kalman filter), which identify an unobservablecommon factor from a group of external and domestic financial indicators. Thealternative estimated FCIs, which share a similar trajectory over time, seem to havepowerful predictive information for the near-term gross domestic product (GDP)growth (up to four quarters), and they outperform the South African Reserve Banks(SARB) leading indicator, as well as individual financial variables. Their recentdynamics suggest that following a strong recovery in late 2009 and 2010, reflectingin part domestic factors such as systematic reductions in the policy rate, the reboundin real economic activity and a benign inflationary environment, the financialconditions have deteriorated in recent months, though not as sharply as in end-2008. Given their relatively high predictive power regarding GDP growth, a furtherdeterioration may imply that economic activity is likely to slow in the period ahead.

Date: 2012-08-30
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