Shocks, Financial Soundness and Currency Crisis in Emerging Market Economies
DOI:
https://doi.org/10.52461/sabas.v4i2.1546Keywords:
Currency Crisis, Exchange Rate, Financial Soundness, Productivity Shocks, Capital Controls, Foreign LiabilitiesAbstract
A currency crisis is identified as a significant decline in a currency's exchange rate within a short time. Every time the crisis emerges, it severely affects the economic stability and well-being of larger populations, not only for the affected country but across the world. A currency crisis is mainly initiated by weak macroeconomic conditions and speculative attacks that depreciate the domestic exchange rate. Moreover, an economy's exchange rate is sensitive to a country's external and internal economic conditions; therefore, its stability is of significant concern for monetary authorities. They are compelled to switch exchange rate regimes to stabilize the currency's value. Several economies have suffered from a currency crisis. However, its negative consequences are more frequent and prolonged for emerging market economies. This research analyzes the nature and mechanism of currency crises in the backdrop of shocks, financial instability, foreign liabilities, and capital controls. Annual data for the period of 2000 to 2017 for a panel of 43 emerging economies is used for analysis. It is found that countries with high liabilities are more likely to experience depreciation in currencies. In this context, an overvalued exchange rate creates speculative pressure and sudden currency depreciation. The shocks to productivity and risk premium of a country also amplify the chances of depreciation. In emerging economies, capital controls do not significantly reduce the chances of a currency crisis. However, the financial soundness is likely to keep the currency value stable. Effects of global shocks on the exchange rate depreciation are mixed subject to the fact that a country is a major importer or exporter of oil. The findings of this study are consistent with existing literature on emerging economies and currency crisis models. Given these empirical results, it is recommended that authorities focus on managing the size of foreign liabilities, export growth, and productivity levels. Monetary authorities should manage policy rates only to attract investors and must not overvalue the exchange rates and abandon the managed float to avoid speculative pressure.
References
Agénor, P.-R. (1991). Output, devaluation and the real exchange rate in developing countries. Review of World Economics, 127(1), 18–41.
Agénor, P.-R., & Aizenman, J. (1999). Financial sector inefficiencies and coordination failures: implications for crisis management. The World Bank.
Aghion, P., Bacchetta, P., & Banerjee, A. (2000). A simple model of monetary policy and currency crises. European Economic Review, 44(4–6), 728–738.
Alesina, A., Devleeschauwer, A., Easterly, W., Kurlat, S., & Wacziarg, R. (2003). Fractionalization. Springer, 8(2), 155–194.
Anderson, T. W., & Hsiao, C. (1981). Estimation of dynamic models with error components. Journal of the American statistical Association, 76(375), 598-606.
Antczak, R. (2000). Theoretical Aspects of Currency Crises. In SSRN Electronic Journal (No. 211; Antczak, Rafal, Theoretical Aspects of Currency Crises (2000). CASE Network Studies and Analyses No. 211.
Arellano, M., & Bond, S. (1991). Some tests of specification for panel data: Monte Carlo evidence and an application to employment equations. The review of economic studies, 58(2), 277-297.
Balakrishnan, R., Brooks, P., Leigh, D., Tytell, I., & Abiad, A. (2009). What’s the damage? Medium-term output dynamics after financial crises. World Economic Outlook, 121-151.
Banerjee, A. V. (1992). A simple model of herd behavior. The quarterly journal of economics, 107(3), 797-817.
Basistha, A., & Teimouri, S. (2015). Currency Crises and Output Dynamics. Open Economies Review, 26(1), 139–153.
Blackburn, K., & Sola, M. (1993). Speculative currency attacks and balance of payments crises. Journal of Economic Surveys, 7(2), 119-144.
Bezemer, D. J. (2009). No one saw this coming: Understanding financial crisis through accounting models. MPRA paper 15892.
Breuer, J. B. (2004). An exegesis on currency and banking crises. Journal of Economic Surveys, 18(3), 293-320.
Burnside, C., Eichenbaum, M., & Rebelo, S. (2001). Prospective deficits and the Asian currency crisis. Journal of political Economy, 109(6), 1155-1197.
Burnside, C., Eichenbaum, M., & Rebelo, S. (2007). The returns to currency speculation in emerging markets. National Bureau of Economic Research.
Burnside, C., Eichenbaum, M., Kleshchelski, I., & Rebelo, S. (2011). Do peso problems explain the returns to the carry trade?. The Review of Financial Studies, 24(3), 853-891.
Bussiere, M, & Fratzscher, M. (2006). Towards a new early warning system of financial crises. Journal of International Money and Finance, 25(6), 953–973.
Calvo, Guillermo A, & Mendoza, E. G. (1997). Rational herd behavior and the globalization of securities markets. Institute for Empirical Macroeconomics, Federal Reserve Bank of Minneapolis.
Calvo, G. A., & Reinhart, C. M. (2002). Fear of Floating. The Quarterly Journal of Economics, 117(2), 379–408.
Candelon, B., Dumitrescu, E.-I., & Hurlin, C. (2014). Currency crisis early warning systems: Why they should be dynamic. International Journal of Forecasting, 30(4), 1016–1029.
Chang, R., & Velasco, A. (2001). A Model of Financial Crises in Emerging Markets. The Quarterly Journal of Economics, 116(2), 489–517.
Chari, V., & Kehoe, P. (2000). Financial crises as herds. Federal Reserve Bank of Minneapolis Working Paper, 600.
Chui, M. K. (2002). Leading indicators of balance-of-payments crises: A partial review. Bank of England Working Paper, 171.
Das, U. S., Quintyn, M., & Chenard, K. (2004). Does regulatory governance matter for financial system stability? An empirical analysis. IMF Working Paper 04/89.
Derkach, M. (2010). Currency Crisis in Developing Countries: Role of Weak Fundamentals. International Journal of Arts and Sciences, 3(13), 106-154.
Diaz-Alejandro, C. (1985). Good-bye financial repression, hello financial crash. Journal of Development Economics, 19(1-2), 1-24.
Djebbar, M. (2009). Predicting Financial Crises: Myth and Reality. In group-global.org. http://group-global.org/sites/default/files/publications/FinCrisis2012.docx.
Dooley, M. P. (2000). A model of crises in emerging markets. The economic journal, 110(460), 256-272.
Eichengreen, Barry, Rose, A. K., & Wyplosz, C. (1995). Exchange market mayhem: the antecedents and aftermath of speculative attacks. Economic Policy, 10(21), 249–312.
Eichengreen, B. J., Ötker, I., Hamann, A. J., Jadresic, E., Johnston, R. B., Bredenkamp, H., & Masson, P. R. (1998). Exit strategies: policy options for countries seeking exchange rate flexibility. In Exit Strategies. International Monetary Fund.
Eichengreen, B., & Arteta, C. (2000). Banking crisis in emerging markets: presumption and evidence. Centre for International Development Economics Research Working Paper, No. 115, Haas School of Business. University of California Berkeley.
Esquivel, G., & Larrain, F. (1998). Explaining currency crises (Working Paper R98-07). John F. Kennedy Faculty Research.
Feenstra, R. C., Inklaar, R., & Timmer, M. P. (2015). The next generation of the Penn World Table. American economic review, 105(10), 3150-3182.
Flood, R. P., & Garber, P. M. (1984). Collapsing exchange-rate regimes: some linear examples. Journal of international Economics, 17(1-2), 1-13.
Frankel, J. A., & Rose, A. K. (1996). Currency Crashes in Emerging Markets: Emprirical Indicators (NBER Working Paper No. 5437). National Bureau of Economic Research
Friedman, M., & Schwartz, A. J. (Anna J. (1963). A monetary history of the United States, 1867-1960. Princeton University Press.
Gerlach, S., & Smets, F. (1995). Contagious speculative attacks. European Journal of Political Economy, 11(1), 45-63.
Ghosh, S. R., & Ghosh, A. R. (2003). Structural Vulnerabilities and Currency Crises. 50(3), 481–506.
Ghosh, M. A. R., Ostry, M. J. D., & Tsangarides, M. C. G. (2011). Exchange rate regimes and the stability of the international monetary system. International Monetary Fund.
Glick, R., & Hutchison, M. M. (2013). Models of currency crises. The evidence and impact of financial globalization, 3, 485-497.
Goldstein, M. (1997). Presumptive indicators of vulnerability to financial crises in emerging economies. Creating resilient financial regimes in Asia: Challenges and policy options. Oxford University Press: 79œ132.
Gurtner, B., & Bruno. (2010). The Financial and Economic Crisis and Developing Countries. Revue Internationale de Politique de Développement, 1(1), 189–213.
Jeanne, O. (1997). Are currency crises self-fulfilling?: A test. Journal of international Economics, 43(3-4), 263-286.
Kaminsky, G., Lizondo, S., & Reinhart, C. M. (1998). Leading indicators of currency crises. Staff Papers, 45(1), 1-48.
Kaminsky, G. L., & Reinhart, C. M. (1999). The twin crises: the causes of banking and balance-of-payments problems. American Economic Review, 473–500.
Kaminsky, G. L. (2006). Currency crises: Are they all the same? Journal of International Money and Finance, 25(3), 503–527.
Kindleberger, C. P. (1978). Manias, Panics, and Crashes: A History of Financial Crises. New York: Basic Books.
Krugman, P. (1979). A model of balance-of-payments crises. Journal of Money, Credit and Banking, 11(3), 311–325.
Krugman, P. (1996). Are currency crises self-fulfilling?. NBER Macroeconomics annual, 11, 345-378.
Krugman, P. (1999). Balance sheets, the transfer problem, and financial crises (pp. 31-55). Springer Netherlands.
Krugman, P. (2001). Crises: the next generation. In Conference Honoring Assaf Razin, Tel Aviv.
Kumar, M., Moorthy, U., & Perraudin, W. (2003). Predicting emerging market currency crashes. Journal of Empirical Finance, 10(4), 427–454.
Masson, P. R. (1998). Contagion: monsoonal effects, spillovers, and jumps between multiple equilibria. International Monetary Fund.
Mendoza, E. G., & Calvo, G. (1997). Rational Herd Behavior and the Globalization of Securities Markets (Vol. 120). Discussion Paper No.
Nakatani, Ryota. (2018). Real and financial shocks, exchange rate regimes and the probability of a currency crisis. Journal of Policy Modeling, 40(1), 60–73.
Minsky, H. P. (1972). Economic issues in 1972: A perspective. In Notes from a Presentation to a Symposium on The Economics of the Candidates sponsored by the Department of Economics at Washington University, St. Louis, Missouri, October (Vol. 6).
Mishkin, F. S. (1996). Understanding financial crises: a developing country perspective. NBER
Obstfeld, M. (1996). Models of currency crises with self-fulfilling features. European Economic Review, 40(3), 1037–1047.
Ötker, I., & Pazarbaşioǧlu, C. (1997). Speculative attacks and macroeconomic fundamentals: evidence from some European currencies. European Economic Review, 41(3–5), 847–860.
Sachs, J., Tornell, A., & Velasco, A. (1996). Financial Crises in Emerging Markets: The Lessons from 1995 (No. 5576; National Bureau of Economic Research).
Salant, S. W., & Henderson, D. W. (1978). Market anticipations of government policies and the price of gold. Journal of political economy, 86(4), 627-648.
Schwartz, A. J. (1987). Real and Pseudo-Financial Crises (pp. 271–288). University of Chicago Press. https://www.nber.org/chapters/c7506
Sell, F. L. (2001). Contagion in financial markets. Edward Elgar Publishing.
Tularam, G. A., & Subramanian, B. (2013). Modeling of Financial Crises: A Critical Analysis of Models Leading to the Global Financial Crisis. Global Journal of Business Research, 7(3), 101–124.
Downloads
Published
How to Cite
Issue
Section
License
Copyright (c) 2022 Nadia Hassan, Abdul Jabbar, Asad Zaman
This work is licensed under a Creative Commons Attribution-NonCommercial 4.0 International License.
The authors submitting and publishing in SABAS agree to the copyright policy under Creative Commons CC-BY-NC 4.0 International license (Attribution-Non Commercial 4.0 International). Under this license, the authors published in SABAS retain the copyright including publishing rights of their scholarly work and agree to let others remix, tweak, and build upon their work non-commercially.
