International | Jun 22 2006
By Chris Shaw
One feature of the Asian financial crisis of the late 1990s was its unexpectedness, as financial indicators available at the time failed to identify its emergence.
With this in mind the ANZ Bank has developed what it terms an "Early Warning Indicator" or EWI, which it suggests should help identify any changes in the health of economies in the Asian region significant enough to warrant closer attention.
The bank’s EWI has been developed to provide an indicator of risk as perceived by those in the market and is a combination of a number of variables it believes give warning of an increase in an economy’s vulnerability, as indicated by a shift in the indicators away from normal levels based on historical data.
To account for the fact different economies in the region are at different stages of both development and the economic cycle the bank has used a number of variables, applying to each economy only those variables it believes are more appropriate for that country’s economic structure and situation.
The variables include the real exchange rate against the US dollar, which is a measure of competitiveness; and the level of equity markets, as a decline in asset prices reflects a withdrawal of capital which in turn increases perceived risk.
Changes in liquidity are also factored in via the Reserve and Credit/GDP ratios, which provide a measure of the pressure resulting from changes to liquidity levels; while movements in bond yields in both domestic currency terms and compared to a foreign currency bond index are also included as the bank suggests these offer an indication of both sovereign risk and inflationary expectations.
Applying these indicators on data taken monthly gives a trend for each country’s EWI, the bank then using standard deviations from previous figures to determine the significance of any changes in the readings. It notes the advantage of using standard deviations in the calculation is it better accounts for protracted periods of strength and weakness, so providing a more accurate indication of when any change is significant.
Applying the EWI to figures available for May produces some interesting results for countries in the Asian region. While Asia generally scores a stable rating in terms of risk perception with only moderate volatility, figures for both Australia and Hong Kong indicate the perception of risk in each economy was increasing.
In Australia the change reflected ongoing strength in the Credit:GDP ratio thanks to strong business lending and a stable housing market, while in Hong Kong the outcome reflected a depreciation of the exchange rate against the US dollar in real terms. Volatility in the Hong Kong figures remains low though, while in Australia it is moderate.
Both Japan and New Zealand showed stable levels of risk with low volatility, while China was also stable but with moderate volatility. The biggest improvements in the month were in Indonesia, where the risk appears to be decreasing rapidly, and in the Philippines. While in Indonesia the rate of change has pushed volatility higher, it remains at moderate levels in the Philippines.
As the bank points out, the measures achieved in each country cannot be directly compared to each other as the inputs for each country’s EWI are different. The bank’s goal in constructing the index is not to identify whether one economy is riskier than another by a comparison of their respective EWI indicators, but to assist in identifying factors that suggest a particular economy may be under threat from changes in underlying economic conditions.
