Analytical Framework for Assessing a Country’s Macroeconomic and Financial Vulnerabilities

Abstract

This paper presents a simple framework to classify different countries according to their macroeconomic environment and their financial environment. By macroeconomic environment we mean the economic, political, institutional and regulatory situation of a country. For this purpose, the Principal Component Analysis (PCA) methodology was used. This enabled us to summarize most of the developments that would otherwise been characterized by a large number of variables within two single indicators. Indeed, our analysis shows how the actual situation of these countries can be fairly accurately described using their scores along these two measures. Hence, this enables us to rank countries according to their relative strengths, and to identify any specific weaknesses within their macroeconomic or financial environment that would need to be addressed. This is not only true for different countries at a given point in time, but especially when considering a particular country and its evolution across time. Although - a priori - this analysis is not meant as a forecasting tool of future developments of the country scores along the above two measures, it can provide useful insights when analyzing important trends, which are obtained by conducting this analysis over a certain number of time periods.