The Current Account crisis is a particular type of external debt crisis that affects mostly low-income developing countries. It is characterized by a huge deficit in the current account balance which provokes a Balance of payments deficit and a currency crisis. A current account crisis occurs generally in low-income developing countries. It is most of all the result of bad macroeconomic policies. These countries have a large current account deficit, principally due to a trade deficit because they are mostly net importers - and a fiscal deficit. Moreover, they generally have a high rate of inflation, in part because they try to finance their growing deficit by monetization. That leads to a loss of international price competitiveness. Indeed, they are under fixed exchange rate and the inflation makes the rate overvalued. Furthermore, the government dominates the economy. It is the major borrower; the private sector is underdeveloped and inactive. The consequence is a limited capital flow and the external debt is mostly a public debt.
[...] The country faces an international liquidity shortage and a rapid deterioration of its financial institutions and firms balance sheets. That will lead to a credit contraction and thus to a banking crisis. This twin crisis currency and banking is responsible to the capital account crisis. To sum up, the new financial and economic environment of capital liberalization leads to a capital account crisis due to interest rate differentials and sudden and massive capital flows. This new type of crisis is thus different from a current account crisis because of theses causalities. [...]
[...] Possibility of foreign exchange crises To re-equilibrate their CA balance, low-income countries finance their fiscal deficit through monetization instead of developing an active private sector and cutting in government expenditures. Indeed, we saw in the lecture that this last solution is quite unpopular. Their financial authorities - Central Bank generally - use to print banknotes. This conducts to a high inflation. However, they are under a fixed exchange rate de facto under a United States Dollar peg. The inflation thus makes the rate overvalued. [...]
[...] Moreover, the public saving is too low to finance its investments and the government has to rely on foreign capital inflows, borrowing and FDI. This gap between savings and investments contributes to deteriorate its current account deficit. More generally, the presence of a current account deficit is the proof of exceeding investment compared to saving. It shows that the country is using resources from other economies to meet its domestic consumption and investment requirements. However, foreign investments usually have a positive effect on the local economy. [...]
[...] After its financial and capital liberalization, East Asian countries had a high interest rate. We saw in the lecture that the IT revolution in Asia provoked an interest rate boom and therefore these countries attracted capital flows. This differential with the rest of the world provoked massive short-term capital inflows in these countries. Moreover, we saw that the private sector was an important source of capital inflows. Consequently, despite a high rate of savings, the amount of investments was superior. [...]
[...] Just prior to the crisis, economists were admiring of the “East Asian miracle the “Asian development model” characterized by government intervention in the initial stage of the economic development and a stress on education. These good performances occurred with the emergence of a new economic and financial environment. Emerging market economies conducted a policy of liberalization of their financial market. They perform an interest rate and an entry of capital flows deregulation, along with technologic developments. These countries knew increasing pressure for integration in the global economy but institutional reforms for transparency, accountability, corporate governance and so on take time. [...]
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