Currency Crises in Transition Economies: Some Further Evidence
Liargovas, Panagiotis, Dapontas, Dimitrios, Journal of Economic Issues
One of the biggest desires of policy makers around the world is to develop a warning system of currency crisis. Such a task requires their ability to analyze potential causes and symptoms of currency crises. Since the 1970s there have been numerous theoretical and empirical efforts to accomplish this task. Most of the empirical research focuses either on the developing Latin American and Asian countries or on the developed economies of the European Monetary System.
The recent transformation of communist economies to market economies coincided, in many of them (e.g., in Central and Eastern Europe, in the Commonwealth of Independent States and in the Baltic states), with the occurrence of currency crisis. But there is not much research of currency crises within the unusual environment of transition economies. Therefore, the predictive power of first, second or third generation models is questionable in the case of transition economies. The present work tries to cover this gap by concentrating on a subgroup of eight transition economies: Albania, Belarus, Bulgaria, Croatia, Macedonia, Moldova, Romania and Ukraine. A better understanding of the interrelationships between macroeconomic and other institutional, political and external factors provides transition economies with better understanding and guidance as to the type of policy needed to avoid currency crises.
The paper is constructed as following: the next section reviews previous theoretical and empirical research. This is followed by a discussion of the main macroeconomic problems and policy outcomes in the countries concerned. A description of the data and the variables used is provided in the fourth section. Section five presents the set of models and the results. Finally, in the last section we offer some concluding remarks.
Previous Theoretical and Empirical Research
The models of currency crises were built based on real events. The first generation models were developed after the balance of payments crisis in Mexico (1973-82), Argentina (1978-81), and Chile (1983). The second generation models were developed after speculative attacks in Europe and Mexico in the 1990s. Finally, the third generation models started after the Asian crisis in 1997-98. Transition economies in Central and Eastern Europe and the former Soviet Union offer additional empirical input that allows for re-examination of the existing theoretical models and accumulated empirical observations and verification of policy conclusions and recommendations proposed by other authors.
The research on currency crises first emerged in the economic literature in the late 1970s pioneered by Krugman (1979). According to him, under a fixed exchange rate system domestic credit creation in excess of money demand growth leads to a gradual but persistent loss of international reserves and, ultimately, to a speculative attack on the currency. The process ends with an attack because economic agents understand that the fixed exchange rate regime will ultimately collapse, and that in the absence of an attack they would suffer a capital loss of their holdings of domestic assets. Therefore, the first generation crisis occurs as a result of an expansionary macroeconomic policy incompatible with a pegged exchange rate. The collapse may happen when the "shadow floating exchange rate" becomes equal to the exchange rate peg. This is the equilibrium exchange rate prevailing after the full depletion of foreign reserves and forced abandoning of the peg.
A number of papers have extended Krugman's basic model in various directions (see, for example, Agenor, Bhandari and Flood 1991; Eichengreen, Rose and Wyplosz 1995; Blackburn and Sola 1993; Garber and Svenson 1994; Flood and Marion 1999; Edwards 1989; Grilli 1990; Cumby and Wijnbergen 1988; Harris and Raviv 1989; and Kamisky, Lizondo and Reinhart 1998). Some of these extensions concern active governmental involvement in crisis management and sterilization of reserve losses (Flood, Garber and Kramer 1996). Other extensions have shown that speculative attacks would generally be preceded by a real appreciation of the currency and a deterioration of the trade or current account balance, by an upward pressure of real wages and by higher interest rates (see survey in Garber and Svenson 1994). Extensions also include target zone models (Krugman 1991), post-collapse exchange rate systems other than permanent float, the possibility of foreign borrowing, capital controls, imperfect asset substitutability, and speculative attacks in which the domestic currency is under buying, rather than selling pressure.
The second generation models suggested by Obstfeld (1986; 1994; 1996), Cole and Kehoe (1996), Eichengreen, Rose and Wyplosz (1996), Sachs, Tornell and Velasco (1996) and Drazen (1998) are particularly useful in explaining self-fulfilling contagious currency crises. They show that a crisis may develop without a significant deterioration in the fundamentals. The idea of second generation models is based on the fact that defending exchange rate parity can be expensive (through higher interest rates) if the market believes that it will ultimately fail. This set of assumptions opens the possibility for multiple equilibria and self-fulfilling crises. Second generation models also tend to focus on political factors, such as political cost of high unemployment or foregone output.
A third generation of models gives a key role to financial structure fragility and financial institutions. Microeconomic problems, such as weak banking supervision, corruption etc., trigger capital outflows and finally currency attack. The proponents of this view use data from the Asian crisis to support the main ideas (Corsetti, Pesenti and Roubini 1998a; 1998b). Stops of capital inflows are explained as a byproduct of bank runs due to the internationally illiquid banking sector. Krugman (1999), Aghion, Banarjee and Baccetta (2000) and Aghion, Baccetta and Banarjee (2001) examine the effects of monetary policy on currency crises (such as moral hazard and resulting over-borrowing). Vaugirard's (2007) explanation of contagion involves real (trade and financial) linkages between countries. Successful .speculative attacks against the currency of a country, which exports goods that are substitutive to goods sold by a not-attacked country forces the latter also to devalue in order to maintain its competitiveness.
The empirical literature as regards currency crises is also vast. Most of the empirical studies ("warning system" approach and "stylized facts," "single-country and "multi-country") emphasize variables that were found as leading indicators of crises. All the studies were driven by the desire of authors to analyze potential causes and symptoms of currency crises and to develop a warning system of currency crisis.
The "warning system" approach is strongly associated with the work of Kaminsky, Lizondo and Reinhart (1998), Kaminsky (1998), Kaminsky and Reinhart (1999) as well as Wu, Yen and Chen (2000). The basic idea behind the "warning system" approach is that currency crises usually do not happen, i.e., that pure self fulfilling attacks are rare, but that most crises are preceded by deteriorations in the economic fundamentals of the economy.
"Stylized facts" studies focus on specific episodes of financial turmoil. While these models are less geared toward predicting the exact timing of financial crises, rather, they aim at explaining the severity of financial crises. Papers by Blanco and Garber (1986), Sachs, Tornell and Velasco (1996) or Bussiere and Mulder (1999) are notable examples for this kind of model class.
The main findings of "single country" studies (for a review see Kaminsky, Lizondo and Reinhart, 1998) is that macroeconomic indicators (foreign reserve losses, expansionary fiscal and monetary policies and high interest rate differentials) play a significant role in determining currency crises. The problem with these studies is that their results are limited since they are obtained from a small number of countries during very specific situations.
"Multi-country" studies avoid the limitations of the above single country studies (for a review see Esquivel and Larrain 1998, and Kaminsky, Lizondo and Reinhart 1998). Among the most significant determinants of currency crises are the low levels of foreign direct investment, low international reserves, high domestic credit growth, high foreign interest rates, overvaluation of the real exchange rate, output, exports, deviations of the real exchange rate from trend, equity prices, the ratio of broad money to gross international reserves etc. Esquivel and Larrin (1998) represent the first attempt to simultaneously test the main predictions of both the first and second generation models of currency crises. The explanatory variables closely associated with first generation models are seignorage, real exchange rate misalignment, current account balance, and M2/reserves ratio. As far as the second generation model is concerned, they use terms of trade shock, per capita income growth and contagion effects. Their results suggest that the insights developed by second generation models complement rather than substitute for the explanation provided by first generation models.
Empirical studies dealing with currency crises in Central and Eastern Europe are scarce, mainly for the obvious reason of the shortness of time series. Notable examples include BrOggemann and Linne (1999; 2001), Krkoska (2001), Chapman and Mulino (2000), Chiodo and Owyang (2002), Desai (2000), Kharas et al. (2001) Karfakis and Moschos (2004), Dobrinsky (2000), Chionis and Liargovas (2003) and Kemme and Roy (2006).
Bruggemann and Linne (1999; 2001) basically apply the Kaminsky-Lizondo-Reinhart (1998) framework with a few extensions to 13 Central and Eastern European countries (CEECs) and three Mediterranean countries (Cyprus, Malta and Turkey). Krkoska (2001) estimates a VAR-model for four countries (Czech Republic, Hungary, Poland, Slovak Republic) with an index of speculative pressure (comprising changes in exchange rates, international reserves and interest rates) as a dependent variable measuring downward pressure on the exchange rate (in a linear fashion). Chapman and Mulino (2000), Chiodo and Owyang (2002), Desai (2000) and Kharas et al. (2001) argued that the Russian crisis has features in common with "first generation" models emphasizing policy inconsistencies. The collapse of the ruble in August 1998 appeared to be caused by exogenous factors related to the unanticipated financial crisis in Asia, inappropriate fiscal policy and capital inflows. Karfakis and Moschos (2004) concluded that macroeconomic fundamentals played a significant role in explaining speculative attacks in Poland and the Czech Republic. Dobrinsky (2000) examined the currency crisis in Bulgaria emphasizing historic roots, the evolution of fiscal, banking and currency crises, and the political economy of the transition in Bulgaria. Chionis and Liargovas (2003) argued that deteriorating fundamentals underlined the currency crises in Bulgaria, Romania, Russia, and Ukraine over the period 1992-99, while Kemme and Roy (2006) developed a model of the long-run equilibrium real exchange rate, based upon macroeconomic fundamentals, to calculate real exchange rate misalignments for Poland and Russia during the 1990s.
All the above studies suggest that the propagation of financial instability differs in the financial markets of industrialized countries versus transition countries. In industrialized countries, for example, a devaluation does not lead to large increases in expected inflation and hence in nominal interest rates. Also, the institutional features in countries in transition, such as short term maturity of debt, significant amount of debt denominated in foreign currency and lack of credibility or high uncertainty, can interact with currency crisis, which can lead to a full-fledge financial crisis.
Macroeconomic Policies and Outcomes in Transition Economies
We focus our attention on eight transition economies. Five of them are in Southeast Europe (Albania, Bulgaria, Croatia, Macedonia, Romania) and three are former Soviet Union states (Belarus, Moldova and Ukraine). The choice was detected by the fact that each of them had experienced at least one currency crisis incidence (that would allow us enough data observations for a meaningful analysis) as well as by data availability.
The macroeconomic environment before currency crises in transition economies is very different compared to industrialized economies. Contrary to the moderate or low inflation in industrialized countries, countries in transition experience high and variable inflation rates. The result is that debt and contracts are of very short duration. Therefore, a decline in unanticipated inflation does not have the unfavorable direct effect on firms' balance sheets that it has in industrialized countries. In transitional economies the improper management of the government debt plays an important role among factors provoking currency crises. Countries issue different types of debt instruments in foreign or national economies, though the currency denomination is irrelevant if investors lose confidence in the country and in the government. The loss of confidence also includes the currency, which ceases to be the medium of exchange and the unit of account, due to the development of a dual economy. Therefore, when explaining the currency crises in transition economies, one needs to incorporate the critical role often played in these countries by the parallel market for foreign exchange in diffusing speculative pressures on the official rate.
In addition, according to Weller and Morzuch (2000, 647) the macroeconomic environment before currency crises in CEECs has generally been different from that in emerging economies (e.g., Asian and Latin American countries). In their study, they found significant differences between CEECs and other emerging economies, not only as regards economic fundamentals (e.g., differences in default, maturity, interest rate and exchange rate risks) but also as regards the means of public support in case of a crisis. Therefore, an investigation of the factors affecting currency crises in a sub-group of transition economies in Central and Eastern Europe and in the Former Soviet Union (FSU) is an issue of great concern.
A number of studies (e.g., Liargovas and Chionis 2001) suggest that the countries under examination are relatively slower in the process of transformation (with the exception of Croatia and Albania) compared to other CEECs (e.g., Poland, Czech Republic, etc.). The inflow of foreign direct investment (FDI) has in general been less than that directed to Central Europe and it is quite volatile. The development of local capital market has been slow, decreasing the possibility of importing portfolio capital. Most important, the incomplete and highly regulated markets had as a result the volatility of prices and real exchange rates, which used to give wrong signals. Central banks were not independent of the fiscal authorities. Often they were used to finance large budget deficits. Credit policies were highly accommodating and repeatedly subject to direct intervention by the government and the parliament.
Albania faced a severe crisis in early 1997 (Bezemer 2000). It was the result of the collapse of the ponzi (pyramid) schemes. Ponzi schemes had been operating in Albania for some time on an ever increasing scale, and their collapse dragged the country within weeks into anarchy, widespread violence, plundering, and food shortages (Jarvis 1997). In the years 1992-1996, Albania initiated the most free market policies in Europe, and was considered a "model country" (Hall 1994, 276; McAdams 1997; Lyle 1997). In the years 1993-1996, inflation was contained, GDP increased, and unemployment decreased considerably (OECD 1996).
One of the most prominent characteristic of the Belarusian economy is its close dependency on the Russian economy (Antczak et al. 2000). The Russian crisis, which erupted in August 1998, was easily transmitted to Belarus around the same period. Since the election of President Alexander Lukashenko in 1995, the Belarusian authorities implemented expansionist macroeconomic policies (National Bank of the Republic of Belarus 1999; 2000). They supported the priority sectors of the economy such as agriculture, construction, and export to Russia by vast direct financial resources, indirect form of tax and trade subsidies, and depreciation of the official exchange rate. Increasing domestic credit growth resulted in exchange rate instability or loss of reserves and accelerating underlying rate of inflation with tightening price control. Other effects of the expansionary macroeconomic policies were the deterioration of the balance of payments with a growth of debts for the import of energy resources, the low efficiency of domestic investments and the financial deterioration of commercial banks.
Bulgaria represents a country with a sequence of episodes in the 1996-97 period. The crisis was complex, involving drops in output and a financial crash, including a banking crisis and a currency crisis (Dobrinsky 2000). The indicators preceding the crises included unsustainable fiscal deficits, low savings and investment, accumulation of bad debts and accommodating monetary policy. The failure of monetary policy to prevent accelerating inflation until 1997 led to the adoption of a currency board in mid 1997, which legally constrained monetary policy and helped restore confidence (Balyozov 1999; Nenovsky and Rizopoulos 2003).
By the end of the 1990s, Croatia faced considerable economic problems stemming from the legacy of longtime communist mismanagement of the economy. Inflation and unemployment rose and the kuna fell. In September 1998, Croatia experienced a financial crisis (Croatian National Bank 1998; 1999; 2000). According to Krznar (2004, 39), the financial crisis was connected with a high rate of growth of domestic credit, a fall in freely available bank reserves, a fall in the share of foreign assets of the Croatian National Bank in M4, a growth in external debt and a large share of the deficit on the current account in GDP.
Macedonia faced a currency crisis in 1997. After a tough lesson of hyperinflation in 1992-1993, the Macedonian authorities adopted very prudent monetary and fiscal policies that allowed them to accomplish one of the lowest inflation figures among countries in transition, a stable exchange rate (apart from the devaluation in 1997) and an almost balanced budget (National Bank of the Republic of Macedonia, 1998; 1999; 2000). Unfortunately, these achievements were not sufficiently supported by microeconomic, structural, and institutional reforms (see Dabrowski 2000). Among the most important weaknesses, one can mention a delayed privatization dominated by managers and employees, a fragile financial sector subordinated to the interests of big loss-making non-financial enterprises, slow progress in reforming big state firms, lack of the effective bankruptcy mechanism, labor market and other regulatory rigidities.
Moldova faced a severe financial crisis after August 1998 (IMF 1999a). It implied a rapid depreciation of the domestic currency and dramatic changes in the structure of balance of payments. According to Radziwitt (2001, 65), fundamental macroeconomic imbalances, such as the rapid deterioration of the balance of payments after the outbreak of the Russian crisis in August 1998, increased budget deficits and rapid accumulation of external and internal debt, were the main cause of the financial crisis in Moldova. The fiscal problems of Moldova reflected the weakness of state structures, the political climate favorable for populism and rent-seeking, the slow pace of privatization and restructuring and delayed reform in the social sphere. Inefficiencies in the state-controlled energy sector also had profound negative implications for the economic situation before the crisis. While the real sector suffered severely, the banking sector survived the crisis relatively intact (Radziwitt, Scerbatchi and Zaman 1999).
During the first half of 1997, the Romanian currency, leu (ROD, dramatically depreciated (by nearly 100%) following the administrative measure applied to the foreign exchange market. Officially, the central bank kept a managed float as its exchange regime, but since 1997 it has actually begun to use a series of crawling arrangements (Kocenda 2005). Over the past years the Romanian authorities have implemented a number of regulatory and institutional reforms that brought about a significant liberalization of the country's foreign exchange system (National Bank of Romania, 1998; 1999; 2000). After a series of privatizations and reforms in the late 1990s and early 2000s, government intervention in the Romanian economy is somewhat lower than in other European economies (Chionis and Liargovas 2003).
Ukraine faced a financial crisis in August 1998 (IMF 1999b). It implied a sharp devaluation of the hryvna and brought a new wave of inflation. Budgetary policy was mainly responsible for the vulnerability of the economy to changes in portfolio investor's sentiments. Excessive government borrowing led to debt accumulation which resulted in a debt pyramid. When investors decided to leave the Ukranian T-bill market, the National Bank of Ukraine started to spend foreign exchange reserves to defend the exchange rate (see Markiewicz 2001, for a more detailed analysis).
The Data Set and the Main Variables Used
The variables used in the analysis are chosen in light of theoretical considerations and empirical determinants of crises as discussed earlier. We apply a set of variables that have been proven useful by a large number of empirical studies as well as the circumstances specific to the transition economies. In order to enhance the possibility of identifying the crisis factors, the process of evaluating the model applies ten variables, grouped into five groups: variables related to monetary policy, to the real sector, to the external sector, to contagion and to specific institutional variables related to transition economies. The suggested variables are closely associated to either the first, the second, or the third generation models. The data source is the IMF's 2007 International Financial Statistics CD-ROM, unless otherwise stated. Data covers the period 1995-2006 and data frequency is monthly. During this period all countries of our sample had introduced a number of market reforms, but they had not completed the transition process as had other countries in Central and Eastern Europe (e.g., Czech Republic, Hungary etc.). In this aspect, therefore, they represent a homogeneous group of countries. All variables included in our model appear in Table 1. The economic justification of the choice of the variables to be applied to eight transition economies is as following:
A. Variables related to monetary policy
1. Real exchange rate (REER): The Real Effective Exchange Rate of the national currency given by IMF or by calculation of the real exchange rates of major trading partners, against national currency, weighted by their participation. REER is a measure of competitiveness. A decline of REER (overvaluation) has negative effect on competitiveness and vise versa (Kemme and Roy 2006).The choice of this variable was established by Kaminsky, Lizondo and Reinhart (1998). According to them, the real exchange rate is overvalued relative to its equilibrium level or its average level during tranquil times, in periods preceding the currency crash. Therefore, we establish a negative relation between this variable and the incidence of a crisis.
2. International reserves (Reserves): Foreign exchange reserves expressed in U.S. dollars. All the past theoretical or empirical models presented in the second section, used this fundamental as the main (and before first generation models the only) measure of crisis likelihood. It is clear that the lower reserves are, the higher the probability of speculative attacks and currency crisis (negative effect). We should note, however, that the central bank can also keep other reserves beyond foreign exchange (gold, SDR etc.). Therefore, the variable is expected to have negative effect if the reserves are used as a measure of remedy or savings and positive if not.
3. Money (Money): The money offer including quasi money. Previous studies have used the measure of money offered by the central bank (M2) excluding other means of money. According to the first generation models, the months preceding the crisis should be characterized by highly expansionary monetary policy (positive effect). However, according to Copeland (2000, 446447 and 450451), the effect can be negative if the Central Bank's policy aims at preserving the money supply level and continuously finances the foreign reserves demand.
4. Inflation (AP): The change of Consumer Price Index (CPI) over the last month. It is a proxy of macroeconomic mismanagement that is having an adverse effect on a country's economy. It is related positively with the occurrence of a crisis. The inflation rate played a central role in the examined economies and sometimes met Cagan's (1956) definition of hyperinflation: inflation exceeding 50% in at least one month.
5. Lending rate (LR): Official monthly lending rate given by the national bank of the country. Interest rates can play a crucial role if there is a collapse in the confidence in the macroeconomic policy stance. In the case of an expansionary monetary policy for example, a collapse of the confidence of forward looking participants in the foreign exchange market pressures monetary authorities to steeply increase interest rates and devalue the official rate. Therefore, the variable is .expected to have a positive effect.
B. Variables related to the real sector
6. Human Development Index (HDI): The UN Human Development Index indicator on a monthly basis, which consists of three equally weighted indicators: the life expectancy index, the education index and the GDP index. We introduce this indicator because we want to develop a new and more accurate measure of development (economic and social activity) in the countries concerned instead of the GDP growth rate. The UN index is broader and it represents an initial effort to capture social phenomena as well. We expect that HDI will be lower before the crisis. Therefore it is expected to have a negative effect.
C. Variables related to the external sector
7. Current Account (CA): The current account balance expressed in USD. The conventional view is that this variable is expected to have positive effect if the balance is positive and negative if there is deficit (Eichengreen, Rose and Wyplosz 1996). However, the theoretical discussion regarding the effect of current account deficit on the occurrence of a currency crises is not so clear. According to Edwards (2001, 37) deficits "may matter." Sasin (2001) provided an overview of the empirical studies that have tried to provide links between current account deficits and currency crises. Most of the studies reviewed do not provide strong and significant correlation between high current account deficit and currency crises.
8. Gold price (GoldP): The monthly price of fine troy ounce in London exchange market in USD. The variable has to do with the significance that gold has on global market. Even after the gold standard there are central banks keeping gold reserves which can be sold in the international markets for foreign exchange (usually USD). Thus, the gold price has an effect on currency crises and it is connected to the money reserves. The effect depends on central bank policy. If the bank tends to keep gold reserves the effect is positive, if not it is negative.
D. Variables related to contagion
9. Crisis elsewhere (CE): It is a categorical binary variable that denotes the presence of a crisis in another country (1) or not (0). The term "elsewhere" refers to any country in the world. If a country has economic relations with a country hit by an incident it is possible to be infected, no matter how far the two countries are. The main reasons have to do with the economic contagion between the two countries but also with the speculators' behavior. If a major trading partner of a regional economy collapses then the other partners will collapse with a time lag of one or two months. Therefore, we expect a positive effect.
E. Variables specific to transition economies (institutional)
10. Economic Freedom (EF): The Heritage index of economic freedom, is a total score consisting of indicators on trade, fiscal burden, government intervention, monetary policy, foreign investment, banking, wages and prices, property rights, regulation and informal market. It is provided annually by the Heritage Foundation and it represents the progress that countries might have achieved regarding the implementation of structural reforms. (1) Market and institutional reforms (e.g., the establishment of a sound financial and banking system, the well functioning of fiscal institutions, etc.) offer great assistance to the countries in their effort to prevent a crisis. All the countries in our sample (with the exemption of Albania) are characterized as laggards as far as the implementation of structural reforms is concerned. The effect of this variable is expected to be negative.
Based on Esquivel and Larrin (1998), we try to combine variables that represent the main predictions of the first, the second and the third generation models. Variables 1-5 and 7 are closely associated with first-generation models. Variable 6 is associated with second generation models. Variables 8-10 are associated with the third generation models.
Before concluding this section, it is important to acknowledge that any researcher who undertakes empirical research in transition countries is faced with the problems of the availability and the quality of the data. The institutional environment has many implications as regards the quality of the data. For example, the presence of parallel economy undoubtedly influences inflation rates, lending rates and human capital development (the GDP dimension). Therefore, the data used maybe a long way away from what is actually happening on the ground. These problems, however, do not deter us from undertaking this research.
The Set of Models and Empirical Results
We use as the dependent variable, the volatility of the official exchange rate against national currency within two successive months. The empirical literature provides little guidance as regards a generally accepted definition of "currency crisis." The majority of the studies refer to devaluation as large, unique and infrequent or a set of small and repeated incidents (Edwards 1989; Milesi-Ferretti and Razin 1998; Flood and Marion 1999). Others use the weighted average of monthly depreciation compared to depreciation of the previous year (Kaminsky, Lizorno and Reinhart 1998; and Frankel and Rose 1996). Chionis and Liargovas (2003, 184) define as a "currency crash" as the nominal depreciation of the monthly average exchange rate of national currency against the USD of at least 10%, no matter if this comes as result of a speculative attack or not. (2) We follow this definition in the present study. As a result, we had 41 crashes (Table 2).
We use a categorical regression non parametric uniform model (CATREG) where we divide data dependent variables in two categories; whether there is crisis or not. The independent variables are treated as multiplying spline ordinal. This model has not been used before in similar studies. Compared to the logit or probit models the CATREG model has many advantages. First, its optimal scaling method gives the best possible result because the model has no unexplained constant. Second, this model deploys non parametric uniform distribution where every observation can be unique and independent instead of following normal distribution (for an overview of the advantages of the CATREG model see Van der Kooija, Meulmana and Heiserb 2006; and Hussain, Cholette and Castaldi 2007). We run various combinations of independent (one month lagged) variables, taking into account any presence of multicolinearity and we ended up with the suggested model because this had the best performance. We also experimented with logit models on the same dataset, but the results, although similar, were not as good as in the case of CATREG models. Overall, the results appear in Table 2.
Interestingly, variables associated with the first and second generation models appear to be significant, as expected. Among them, money supply seems to be associated with the likelihood of a crisis in Belarus, Bulgaria, Moldova, and Romania; and CPI inflation seems to be associated with the likelihood of a crisis in Albania, Belarus, Romania and Ukraine. Likewise, in Bulgaria, Croatia and Ukraine interest rates are also associated with the occurrence of currency crises; and in Albania, Moldova, and Ukraine HDI is associated with the occurrence of currency crises. In all cases they have the expected sign.
International reserves appear significant and positive in Bulgaria and negative in Croatia and Moldova. The negative (and significant) signs in the case of Croatia and Moldova implies that the international reserves were used as a measure of remedy or savings in these countries. The real exchange rate variable appears to be significant and negative (as expected) in Bulgaria and Ukraine. The current account variable appears to be significant and with the expected sign in only one case (Belarus), confirming the conclusions reached by Sasin (2001) that most empirical studies do not provide strong and significant correlation between high current account deficit and currency crises.
The results obtained so far indicate the significant role of the fundamentals, i.e, first and second generation models. But the suggested models cannot fully explain what has happened in the countries of our sample. In Belarus and Moldova, for example, currency crises were significantly affected by variables related to the external sector (e.g., gold price), to contagion (e.g., crisis elsewhere) and to institutional environment (e.g., economic freedom)) Gold price also appears to be significant in the cases of Bulgaria, Croatia and Romania, whereas contagion and economic freedom are also related to currency crises in Ukraine.
This paper examined whether macroeconomic indicators as well as other institutional, social and external indicators provide a systematic explanation of currency crisis incidence in transition economies. With the use of CATREG models and the experiences of eight transition economies in Southeast Europe and the former Soviet Union, it is found that economic fundamentals especially CPI inflation, international reserves, interest rates and money supply--do have a significant predictive power with regard to crisis occurrence.
In addition, other variables, like those capturing structural reforms, might prevent the occurrence of currency crisis. The butterfly effect is importing the crisis to a country with one or two months delay, as happened in the rubble crisis of 1998. Overall, our results indicate that the insights developed by second and third generation models complement rather than substitute for the explanation provided by first generation models in the case of transition economies.
Understanding financial crises in transition economies is a difficult task. This paper represents an effort to give some answers regarding the causes of currency crises in the awkward environment of the transition economies. Further research is needed on developing more accurate models examining other similar sets, using advanced forecast methods. The present work can be a starting point for implementing new methods on financial crises forecasting in transition economies.
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(1.) Since this index is calculated on an annual basis there is no change from month to month.
(2.) Ninety-five percent of the international money transfer is powered by speculation.
(3.) Both countries were affected by the Russian crisis.
Panagiotis Liargovas is an Associate Professor and Dimitrios Dapontas is a PhD candidate in the Department of Economics at the University of Peloponnese in Tripolis, Greece. They are grateful to the comments made by three anonymous referees and the editor of this journal on previous versions of this paper. All errors remain their responsibility.
Table 1. List of Independent Variables Variable Association with: A. Variables related to monetary policy 1. Real exchange rate (REER) First generation models 2. International reserves (Reserves): First generation models 3. Money (Money): First generation models 4. Inflation (AP): First generation models 5. Lending rate (LR First generation models C. Variables related to the external sector 6. Human Development Index (HDI Second generation models 7. Current Account (CA): First generation models 8. Gold price (GoIdP): Third generation models D. Variables related to contagion 9. Crisis elsewhere (CE) Third generation models E. Variables specific to transition economies (institutional) 10. Economic Freedom (ER Third generation models Table 2. Empirical Results Variables Albania Belarus Bulgaria Croatia LREER 0.096 0.226 -0.409 * -0.127 2. Reserves 0.260 0.264 0.563 * -1.524 * 3. Money -0.128 0.379 * -1.3 * 1.128 4. AP 0.578 * 0.295 * 0.106 -0.008 5. LR -0.116 0.245 0.341 * 0.386 * 6. HDI -0.187 * 0.197 0.227 0.233 7. CA 0.171 0.159 * 0.074 -0.273 8. GoldP 0.095 0.401 * 0.499 * 1.059 * 9. CE 0.1 0.389 * 0.019 0.079 10. EF 0.078 0.449 * -0.252 -0.419 Number of 145 143 143 143 Observations Crisis 3 14 10 1 incidents [R.sup.2] 0.717 0.581 0.79 0.129 Variables Macedonia Moldova Romania Ukraine LREER 0.900 -0.034 0.071 -0.399 * 2. Reserves 0.116 -1.052 * 0.136 0.238 3. Money 0.082 -0.403 * -0.722 * 0.402 4. AP 0.112 -0.17 0.342 * 0.453 * 5. LR -0.098 0.047 -0.618 0.321 * 6. HDI -0.162 -0.520 * -0.084 -0.4 * 7. CA 0.103 -0.163 -0.225 0.187 8. GoldP 0.040 0.573 * -0.377 * -0.167 9. CE 0.142 0.25 * 0.032 0.245 * 10. EF 0.440 -0.503 * 0.220 -0.359 * Number of 143 145 144 144 Observations Crisis 1 5 4 4 incidents [R.sup.2] 0.154 0.535 0.7 0.311 Note: * denotes statistical significance at 5% level.…
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Publication information: Article title: Currency Crises in Transition Economies: Some Further Evidence. Contributors: Liargovas, Panagiotis - Author, Dapontas, Dimitrios - Author. Journal title: Journal of Economic Issues. Volume: 42. Issue: 4 Publication date: December 2008. Page number: 1083+. © 1999 Association for Evolutionary Economics. COPYRIGHT 2008 Gale Group.
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