External Vulnerability in Emerging Market Economies: How High Liquidity Can Offset Weak Fundamentals and the Effects of Contagion
IMF Working Papers, July 1, 1999
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- External Vulnerability in Emerging Market Economies: How High Liquidity Can Offset Weak Fundamentals and the Effects of Contagion
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Bibliographic details
- Authors: Christian B. Mulder, Matthieu Bussière
- Published: July 1, 1999
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781451851144.001
Summary findings
- The paper investigates the factors behind the 1994 and 1997 crises and whether these can explain the 1998 crisis.
- The study reveals that:
- (i) variables used in an Early Warning System model developed by IMF staff scored well in predicting the 1998 crisis out-of-sample;
- (ii) all three crisis episodes can be well explained by a parsimonious set of core fundamentals and liquidity related variables; and
- (iii) the presence of an IMF-supported program significantly reduced the depth of crises.
- The results suggest that as a rule of thumb countries should hold reserves to the tune of short-term debt to avoid contagion-related crises, provided their current deficits are modest and their real effective exchange rates are not significantly misaligned.
Methodology and analytical scope
- Focus on three crisis episodes: 1994, 1997, and 1998.
- Use of an Early Warning System (EWS) model developed by IMF staff; EWS variables were evaluated out-of-sample for the 1998 crisis.
- Emphasis on a parsimonious set of core fundamentals and liquidity-related variables to explain crisis episodes.
Policy implications and recommendations
- Maintain foreign exchange reserves roughly equal to short-term debt as a rule of thumb to mitigate contagion-related crises.
- Ensure current account deficits are modest to make high reserves effective in preventing contagion.
- Avoid significant misalignment of the real effective exchange rate to reduce vulnerability.
Subjects and keywords (as stated)
- Subject: Balance of payments, Credit, Current account deficits, Early warning systems, Financial crises, Foreign exchange, Money, Real effective exchange rates, Real exchange rates
- Keywords: Africa, Asia and Pacific, Credit, crisis index, Current account deficits, Early warning systems, economic crises, economic crisis, emerging markets, EWS variable, exchange rate, exchange rate appreciation, lending boom variable, Real effective exchange rates, Real exchange rates, reserve, reserves variable, short-term debt, short-term debt debt ratio, Vulnerability indicators, WP