Description
Abstract: This article examines the determinants of currency crises in developing countries. It asks two basic questions: (a) are currency crises linked to economic fundamentals? and (b) is there any evidence of a contagion effect after controlling for the potential effects of economic fundamentals? Using a panel of annual data for 19 developing countries spanning the period 1977-97, it demonstrates that, among the macroeconomic fundamentals considered as predictors of currency crises, the current account deficit is the only variable that can be consistently linked to currency crises. Economic fundamentals such as the growth rate of domestic credit, lending booms, inflation, foreign debt, output growth and high fiscal deficits are generally not significant. In cases where a significant relationship is found, the result is not robust, in the sense that the relationship becomes insignificant when there is a change in the sample size, the model specification or the definition of the crisis index. The article also provides empirical support for the idea that currency crises could be contagious. The results of the study suggest that currency crises cannot be explained solely by looking at economic fundamentals and that regional contagion effects as well as the speculative behaviour of investors may be important determinants. The article is organised as follows. The following section presents a brief summary of the theoretical literature on currency crises, while the next section contains a survey of the empirical literature. The definition of currency crises and contagion is then presented, followed by a discussion of the data, variables of interest, and the methodology used in the research. The results are then analysed, followed by a discussion of their policy implications.