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The main purpose of this paper is to construct a financial conditions index (FCI) for South Africa. The analysis extracts the index by applying two alternative approaches (principal component analysis and Kalman filter), which identify an unobservable common factor from a group of external and domestic financial indicators. The alternative estimated FCIs, which share a similar trajectory over time, seem to have powerful predictive information for the near-term gross domestic product (GDP) growth (up to four quarters), and they outperform the South African Reserve Bank's (SARB) leading indicator, as well as individual financial variables. Their recent dynamics suggest that following a strong recovery in late 2009 and 2010, reflecting in part domestic factors such as systematic reductions in the policy rate, the rebound in real economic activity and a benign inflationary environment, the financial conditions have deteriorated in recent months, though not as sharply as in end-2008. Given their relatively high predictive power regarding GDP growth, a further deterioration may imply that economic activity is likely to slow in the period ahead.

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