Signaling currency crises in South Africa - South African Reserve Bank

SARB Conference 2006Figure 13: Conditional probabilities with 18-month time windowConditional probabilities10.80.60.40.201994/011994/071995/011995/071996/011996/071997/011997/071998/011998/071999/011999/072000/012000/072001/012001/072002/012002/072003/012003/072004/012004/072005/012005/072006/01Source: Own calculations. Note: Dotted line shows unconditional probabilityWhile some difference between the composite indices and the respective conditionalprobabilities can be observed, the general picture remains the same after changing the timewindow. While the index provides indications of the 1996, and in particular the 1998, crisis, itfails to clearly indicate 2001 as a crisis. For the time after 2001 there exists no indication ofextraordinary risk of currency crises. However, as the figure of the unconditional probabilities forcurrency crises shows, the overall risk that any month of the period of observation is followed bya crisis within 24 or 18 months is 0,57 or 0,43, respectively. Thus, the risk of currency crises isthere and the change in policy in South Africa resulted in less indicated crisis probability due toless risk or to lesser indication of risk.ConclusionThe evaluation of the risk of currency crises in South Africa by the use of a signals approach,considering the crisis episodes of 1996, 1998 and 2001 as reference, indicates low current riskfor currency crises. The approach leads to a correct prediction of the currency crises of 1996and 1998, but fails to predict the currency crisis of 2001. The changing nature of currency crisesand the change in exchange rate policy of the SARB suggest that crises of the 2001-type aremore likely to occur in future than crises of the 1996/1998-type. The crisis indicator, asdeveloped above, must therefore be treated with caution and should be updated frequently. Ashift in the period of observation can lead to the detection of new crises, previously notconsidered as crises and also to a failure of detecting events previously called a crisis. Thechanging volatility of potential signal variables may lead to different signal thresholds and to theinclusion or exclusion of variables in the composite index and may therefore change not onlythe index itself but also the calculated conditional probabilities of crises. Further research onSouth African currency crisis risk should also consider the use of other methods as has beenmentioned in the section “Signalling currency crises – a literature review”.ReferencesAbiad, A. 2003. Early-Warning Systems: A Survey and a Regime-Switching Approach. IMFWorking Paper. 03/32. Washington: International Monetary Fund.Ahluwalia, P. 2000. Discriminating Contagion – An Alternative Explanation of ContagiousCurrency Crises in Emerging Markets. IMF Working Paper WP/00/14, International MonetaryFund.Angkinand, A, Li, J and Willett, T. 2006. Measures of Currency Crises: A Survey. Forthcomingin: International Interaction.Aron, J and Muellbauer, J. 2000. Estimating Monetary Policy Rules for South Africa. CentralBank of Chile. Working Papers 89.214Knedlik