Current Account Reversals and Currency Crisis-Empirical RegularitiesWP/98/89-EA WP/98/89 Are external crises characterized by large nominal devaluations invariably followed by sharp reductions in current account deficits? Or do reductions in external imbalances occur even without a sharp exchange rate devaluation? And what is the impact of crises and reversals in current account imbalances on economic performance? Our paper addresses these questions by characterizing real and nominal aspects of sharp external adjustments in low- and middle-income countries. It presents stylized facts associated with sharp reductions in current account deficits (reversals) and with large nominal devaluations (currency crises), and studies empirically what factors help predict crises and reversals and what factors explain macroeconomic performance following such events. Econometric analysis of leading indicators of reversals in current account imbalances shows that these are more likely to occur in countries with persistent deficits, low reserves, and unfavorable terms of trade, and are less likely to occur in countries that receive high official transfers and whose debt is largely concessional. Growth after reversals tends to be faster in more open economies and in countries whose real exchange rate was less appreciated prior to the reversal. Currency crises are more likely to occur when reserves are low, the real exchange rate is appreciated, and external conditions are unfavorable--high interest rates and low growth in industrial countries. Growth tends to decline the year of the crisis, and to recover thereafter. A comparison of currency crises and current account reversals shows that these are distinct events. Less than one-third of all current account reversals are preceded by a currency crisis, suggesting that the conventional wisdom that large nominal depreciations precede a turnaround in the current account is not accurate. This points to the need of looking more closely at current account reversals, distinguishing between those that reflect an external crisis and those that do not. |