Early warning system for risk of external liquidity shock in BRICS countries

ABSTRACT

The early-warning system (EWS) is recognized in the literature as a method of detecting crises prior to events and to reduce false alarms of possible crises. This study constructs an EWS for BRICS (Brazil, Russia, India, China, and South Africa) countries to examine the risk of an external liquidity shock. The EWS index incorporates the sources, channels, and effects of shock in order to capture the key aspects of shock within the past 18 years. The findings show that the index peaks during financial crises. We then assess the predictive power of the EWS using an ARMA-GARCH model, which shows that Brazil, India, and South Africa are at great risk of shocks whereas China and Russia have relatively moderate risk in the coming years. The overall results highlight the importance of establishment of an EWS for countries such as Brazil, India, South Africa and other developing countries that have been struggling to cope up with the Covid 19 pandemic.