Leading Indicators and Financial Crisis: A Multi-Sectoral Approach Using Signal Extraction

Abstract

Using signal extraction, this study identifies leading indicators of financial crisis over the period 1980-2015 in developing and advanced economies. The study evaluates vulnerability in the external, public and financial sector in developing countries. The results postulate that the level of imports is the principal leading indicator for detecting a forthcoming crisis in developing nation’s external sector. In the public sector, the best indicators for predicting a crisis in South Africa are in the order: maturity of debt; external debt; debt-GDP ratio; interest rate payments; short-term debt and government expenditure. In Namibia, the best indicator for predicting crisis is total expenditure and interest rate payments. Comparatively, Russia’s crises are better predicted by the following variables: debt ratio; interest rate payments; short-term debt; expenditure and external debt. The two best indicators were debt ratio and interest rate payments. In the financial sector, the common risk indicator among developing economies is the lending rate. The external balance sheet assessment shows that in developed countries, predictors of a financial emanate from portfolio investments and direct investments. For the UK, the best indicators of a looming financial crisis are: direct investment liabilities; portfolio debt liabilities and direct investment debt instruments.