Sharp Reductions in Current Account Deficits: An Empirical AnalysisWP/97/168-EAWP/97/168 .Sharp Reductions in Current Account Deficits: An Empirical Analysis. by Gian Maria Milesi-Ferretti and Assaf Razin The European Monetary System (EMS) crisis of 1992-93, the Mexican experience and, more recently, the currency crisis in Thailand have put the causes of sudden reversals in the direction of capital flows and of currency crises at the center of the policy debate in both industrial and developing countries. For developing countries in particular, an important issue is whether large and persistent current account imbalances are a sign of future external problems. The episodes mentioned above have been the subject of a large number of studies; however, no comprehensive cross-country study of sharp reductions in current account imbalances has so far been undertaken. The research project on which this paper is based attempts to fill that gap. This paper reports early results from a study of determinants and consequences of reversals in current account imbalances in low- and middle-income countries over the period 1971-92. Two key questions are addressed: First, what triggers sharp reductions in current account deficits? Second, what factors explain how costly such reductions are? The main findings of the paper are that both domestic variables -- such as the current account balance, openness to trade, and the level of reserves -- and external variables -- such as terms of trade shocks, U.S. real interest rates, and growth in industrial countries -- seem to play important roles in explaining reversals in current account imbalances. It is also found that reversals are not necessarily associated with a slowdown in growth. Countries that before the event had a less appreciated real exchange rate, higher investment, and more trade openness tend to grow faster after a reversal occurs. |