Kirby Leyshon, Robert Peroutka, & Emma Volk The Effect of Current Account Deficits on Financial Crises: The Cases of Malaysia and Singapore EC344 – Economics of International Finance April 16, 2014 Kirby Leyshon, Robert Peroutka, & Emma Volk

Impact of the East Asian Financial Crisis East Asia and Pacific GDP Growth Rate 1980-2010 Source: Trading Economics 2/16

Theoretical Framework Current Account Deficit: when the value of goods and services imported by a country exceeds the value of goods and services it exports “Early crisis signal” (Jordà et al. 2011) Currency crises associated with current account deficits (Roubini & Wachtel 1998) Unsustainable imbalances 3/16

East Asian Current Account 1990-1997 As Kirby mentioned, we’ve decided to use two East Asian countries as case studies to explain how current account deficits are a source of disruptive tensions in financial markets. This table depicts the current account deficits or surpluses in each of the East Asian countries leading up to the financial crisis in 1997. You can see that some countries had significantly negative current account balances or a current account deficit entering the crisis, while others had current account surpluses. From our research and as this table illustrates, we’ve determined that Thailand and Malaysia were the two countries with the largest and most persistent current account imbalances. Since one of the other groups are focusing on Thailand, we chose to use Malaysia as one of our case studies. For the other, we choose a country that experienced very large current account surpluses, and in this case that was Singapore. 4/16

Case Study Source: Trading Economics 5/16

Theoretical Framework (Roubini & Wachtel 1998) Symptoms of Unsustainable Current Account Deficit Symptom #1: Current account deficit to GDP ratio > 5% Symptom #2: Declining GDP Symptom #3: Fixed exchange rate and appreciation Symptom #4: Low foreign reserves Outcome of Crisis with Current Account Deficits Outcome #1: Capital flight Outcome #2: Currency depreciation Outcome #3: Current account reversals Currency appreciation under fixed exchange rate Capital Inflows from private foreign direct investors and banks or hot money short-term debt accumulation, IMF loans (non-sustainable crisis intervention) short-term portfolio investments capital inflows lead to nominal depreciations Currency is depreciation is bad – more difficult to pay down foreign debt, inflation Capital flight -> reduction of exchange rate reserves -> exchange rate crisis (can’t prevent exchange rate fluctuations – liquid money assets cant be converted into foreign exchange) 6/16

Symptom #1: Current Account Deficit to GDP Ratio > 5% ✔ Malaysia 7/16 Source: Trading Economics

Symptom #2: Declining GDP ✔ Malaysia 8/16 Source: World Bank World Development Indicators

Symptom #3: Fixed Exchange Rate and Appreciation Malaysia: Exchange rate fixed to the USD Singapore: Flexible exchange rate targeting 9/16 Source: Trading Economics

Symptom #3: Fixed Exchange Rate and Appreciation ✔ Malaysia 10/16 Source: World Bank World Development Indicators

Symptom #4: Low Foreign Reserves ✔ Malaysia 11/16 Source: World Bank World Development Indicators

Outcome #1: Currency Depreciation 0.4 2.25 ✔ Malaysia 12/16 11/14 Source: Trading Economics

Outcome #2: Capital Flight ✔ Malaysia 13/16 Source: World Bank World Development Indicators

Outcome #3: Current Account Reversals ✔ Malaysia 13/14 14/16 Source: Trading Economics

Summary Malaysia Singapore Symptoms: Outcomes: #1: Current account deficit to GDP ratio > 5% #2: Declining GDP #3: Fixed exchange rate and appreciation #4: Low foreign reserves Outcomes: #1: Capital flight #2: Currency depreciation #3: Current account reversals ✔ ✔ ✔ ✔ ✔ ✔ ✔ Malaysia and Singapore provide evidence that current account deficits are associated with the magnitude of financial crisis. 15/16

Bibliography Thank you! Questions? Barro, R. J. (2001). Economic growth in East Asia before and after the financial crisis (No. w8330). National Bureau of Economic Research. Corsetti, G., Pesenti, P., & Roubini, N. (1998). What caused the Asian currency and financial crisis? Part I: A macroeconomic overview (No. w6833). National Bureau of Economic Research. Jordà, Ò., Schularick, M., & Taylor, A. M. (2011). Financial crises, credit booms, and external imbalances: 140 years of lessons. IMF Economic Review, 59(2), 340-378. Roubini, N., & Wachtel, P. (1999). Current-account sustainability in transition economies (pp. 19-93). Springer US. Thank you! Questions? 16/16