As most of the emerging-market economies, South Africa is facing turbulences in foreign exchange markets, which appear in the form of high volatility in prices of its domestic currency, the South African rand. The increased volatility of exchange rates in emerging markets is usually attributed to the smaller size of their economies and consequently the smaller size of the market for their currency. Under these conditions transactions have a greater impact on exchange rates than in larger and more mature economies.
Additionally, a generally higher risk of investment projects and macroeconomic, as well as political, stability are recognized as reasons for a higher variance in currency markets. Higher exchange rate volatility in emerging market countries is therefore an understandable expectation and reflects fundamental differences in the structure of economies.
However, if exchange rate volatility increases drastically it can evolve into a currency crisis, which results in significant depreciation of the domestic currency. These depreciation episodes are often accompanied by interventions of central banks in the form of raising interest rates and buying domestic currency with their foreign-exchange reserves. If interventions are not successful, currency crises may cause microeconomic distortions mainly in the financial sector but also in the import and foreign finance-dependent sectors of the economy.
On a macroeconomic level currency crises may result in instability of further aggregates such as the domestic price level and also lower economic growth. Furthermore, the costliness of exchange rate interventions is one of the reasons why a number of central banks, including the South African Reserve Bank since 2000, opts against regular intervention on foreign-exchange markets and rather take the crises as given evils.
In any case, central banks and the private sector are dependent on evaluating the future risk of currency crises in order to prepare policy measures or to either hedge or stay away from certain types of transactions. The literature describes different concepts of how to signal or forecast currency crises. One line of concepts are signals approaches (Kaminsky and Reinhart, 1996, 1998). This paper employs such a signals approach for the case of South Africa in order to inquire into country-specific determinants of currency crises.
The paper is structured as follows: In the following section the definition of currency crises is discussed resulting in the identification of an appropriate measure of currency crises. The third section aims at identifying currency crises in South Africa. The fourth section introduces the concept of the signals approach. The fifth section employs the signals approach to South Africa. The sixth section concludes.
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