A global balancing act: South Africa's susceptibility to economic crises
Abstract
Motivation: The recent financial crises indicated that countries are susceptible to external shocks. Global imbalances have become a central point of discussion in the cause of financial crises (see among others: Obstfeld & Rogoff, 2009, Merrouche & Nier, 2010, Borio & Disyatat, 2011, Obstfeld, 2012). Persistent large imbalances raise two main concerns. The financial flows required to finance the large and sustained deficits may become less easily available. This could trigger a disorderly adjustment. Sustained large trade imbalances could also call for increased protectionist trade measures, if the domestic industry does not adjust successfully to the import competition. A main concern with the imbalances is whether the current pattern of global imbalances is sustainable, and also which factors would lead to, accelerate or delay the reversal thereof. The sustainability of the imbalances is also of concern as the duration of the imbalances has increased with the increase in the imbalances (IMF, 2008). The study of imbalances is therefore of significance as imbalances are a main source of crises. Being able to measure and monitor these imbalances may therefore assist in predicting crises and possibly to prevent crises from occurring. Objectives: The overall aim of this study was to determine the susceptibility of South Africa to economic crises and how imbalances might contribute to such crises. This was investigated by determining the resilience of the South African economy to withstand external shocks, and whether there are early warning indicators that would be useful in predicting severe crises for South Africa. In order to achieve this aim, the following specific objectives were specified: Manuscript 1— South Africa’s susceptibility to financial crises • Extend a resilience indicator developed by Rojas-Suarez (2015) to the case of South Africa. • Determine the South African economy’s resilience to external shocks before and after the 2008 global financial crisis. • Compare South Africa’s resilience to that of its emerging market peers before and after the 2008 global financial crisis. Manuscript 2— Economic resilience: the usefulness of early warning indicators for South Africa • Apply a set of vulnerability indicators, proposed by (Röhn, Sánchez, Hermansen, & Rasmussen, 2015), to the case of South Africa. • Apply the Bry and Boschan (1971) algorithm and determine severe recessions for South Africa for the period 1970—2015 using GDP per capita. • Apply the signalling approach, an early warning indicator method, to the vulnerability indicators. • Determine the usefulness of these vulnerability indicators in predicting severe crises for South Africa by calculating various performance measures. Method: Manuscript 1— South Africa’s susceptibility to financial crises • Following Rojas-Suarez (2015:17), we constructed a simple indicator of countries’ resilience to financial crisis consisting of 7 indicators. • We constructed this resilience indicator for South Africa and 22 of its emerging market peers. • It is a relative measure of resilience among countries in a particular sample. • We could therefore compare the resilience of South Africa against the other 22 countries both before and after the 2008 global financial crisis. Manuscript 2—Economic resilience: the usefulness of early warning indicators for South Africa • A set of vulnerability indicators, proposed by (Röhn, Sánchez, Hermansen, & Rasmussen, 2015), is applied to the case of South Africa. • The Bry and Boschan (1971) algorithm is applied to GDP per capita of South Africa for the period 1970—2015 in order to identify severe recessions. • The signalling approach is then applied to the indicators; and • Various performance measures are calculated to determine the usefulness of the indicators in predicting severe recessions for South Africa. Results and Conclusions: The results and conclusions of the two manuscripts prepared for this dissertation are as follows: Manuscript 1—South Africa’s susceptibility to financial crises In the first manuscript, the susceptibility of the South African economy to external shocks was determined using a resilience indicator proposed by Rojas-Suarez (2015). The findings were that: • South Africa became less resilient to an external shock than many of its emerging market peers. • South Africa lost 6 positions on the resilience index ranking between 2007 and 2013. • South Africa is, therefore, less resilient after the global financial crisis of 2008, and more vulnerable to an external shock than most comparable emerging market economies. Manuscript 2—Economic resilience: the usefulness of early warning indicators for South Africa The second manuscript evaluated the usefulness of early warning indicators in predicting severe recessions for South Africa. The results demonstrated that: • 14 vulnerability indicators were found to be useful in predicting severe recessions for South Africa. • These indicators provide a signal on average 8 quarters before a severe recession occurs. This provides adequate time for policymakers to implement changes in order to mitigate or avoid potential severe recessions. • The following types of imbalances provided the most relatively useful indicators: global imbalances, asset market imbalances, and external imbalances. General conclusion: The recent financial crises indicated that countries are susceptible to external shocks and South Africa has not been an exception. Comparing South Africa’s resilience in 2013 to 2007 it can be seen that South Africa’s position has worsened by 6 places on the resilience index. It is, therefore, in a worse position to withstand external shocks than before the financial crises. South Africa is also relatively worse off than most of its 22 emerging market peers included in this study, ranking 20th out of 23 emerging market countries. In order to protect South Africa from severe crisis we can use early warning indicators, or vulnerability indicators, to warn of an imminent severe recession. From this study 14 indicators were found to be useful in predicting severe recessions for South Africa. These indicators also issue a warning signal on average 8 quarters before a crisis occurs. This leaves adequate room for policymakers to implement changes in order to avoid a crisis or mitigate the consequences if a crisis is to occur. The conditional probability for these 14 indicators is relatively high. If a signal has been issued there is an 11%—33% probability of a severe recession occurring, depending on the indicator having issued the signal. Being aware of the fact that South Africa is less resilient than many other emerging market economies, it is important to monitor indicators useful in signalling crises, such as the 14 indicators identified in this study. These may be used to affect policy changes in order to avoid costly financial crises.