Central and East European countries: prone to currency crisis?

In: Veröffentlichung / Wissenschaftszentrum Berlin für Sozialforschung, Forschungsschwerpunkt Technik - Arbeit - Umwelt, Forschungsgruppe Transformation und Globalisierung

Abstract

"Central and East European Countries (CEECs) have liberalised foreign trade almost completely and capital flows quite extensively. All have balance of trade deficits. Experts are worried because in some the current account deficit is high and still rising. Current account deficits could be an indicator of domestic companies' low competitiveness. However, also the contrary could be the case: The country's more dynamic industries may try to increase their position vis-a-vis foreign competitors through massive import of advanced technology, in this way enlarging the trade deficit. Not surprisingly, there are no clear indicators to warn of imminent crisis. Nor is there a generally accepted strategy for reducing proneness to crisis. During the financial crisis in East Asia, analysts identified current account deficits and the banking systems' fragility as the main financial problems. These can also be observed in CEECs. It is not just these current account deficits which continue to plague CEECs, but also relatively high inflation, weak financial systems and structural deficiencies. In fact, the preconditions for far-reaching financial market liberalisation were hardly met in the CEECs. Reversing this step now would be difficult, however, so governments and central banks are targeting ex post improvement of the preconditions. It was not possible within just a few years to create ownership structures in the CEECs enabling companies to modernise rapidly. The decisive exception was privatisation relying an FDI. For this reason, the Hungarian economy now seems quite sound. Capital flows have become an important factor in CEECs, both at company level and macroeconomically. Massive inflow can even more than offset the current account deficit, so increasing currency reserves and lessening vulnerability to currency crisis. It also means availability of additional funds, better capital allocation and capital transfers. On the other hand, if the net inflow continues for a longer period, then it also tends to expand the monetary basis and may feed inflation. It might be primarily attracted by expectation of quick gains thanks to high interest rates. This can push up the exchange rate and may ultimately elevate the real exchange rate to a level causing an unsustainable deficit in the current account. As experience from the Czech Republic illustrates, high interest rates may fail to protect the economy against a currency crisis. Another example is Russia, where in Summer 1998 a dramatic increase in interest rates did not prevent a currency crisis." (author's abstract)