Current-Account Sustainability in Transition Economies

Abstract

Recent episodes of currency crisis have been associated with large, growing, and eventually unsustainable current-account imbalances. The Mexican peso crisis of 1994 and the 1997 currency turmoil in a number of Asian countries (in particular Thailand, Malaysia, and the Philippines) appear to have been partly triggered by unsustainable current-account imbalances. Following the Mexican peso crisis of 1994, the IMF devised a warning mechanism aimed at an early recognition of potentially unsustainable current-account imbalances. In this regard, a large number of Eastern and Central European countries in transition were experiencing large and growing current-account imbalances in the 1996 to 1997 period. Deficits in excess of 5 percent of GDP (an in many cases closer to 10 percent of GDP) were observed in Croatia, the Czech Republic, the Slovak Republic, Poland, Estonia, Latvia, Lithuania, and Moldova. Moreover, similar to the crisis episodes in Mexico and East Asia, a number of Central and Eastern European countries had weak financial systems, had adopted in the 1990s semifixed exchange-rate regimes aimed at controlling inflation and were experiencing significant real appreciation of their currencies. As a combination of fixed-rate regimes, real appreciation, current-account worsening, short-term foreign debt accumulation, and weak financial systems had contributed to the earlier currency crises in Mexico and Southeast Asia, it is important to study whether the current-account imbalances in Central and Eastern Europe would be sustainable or whether there are significant risks that currency crises would also occur in the transition economies.