Capital mobility, intertemporal current account balance and currency crisis

From the perspective of the intertemporal balance model, we investigate how capital mobility affects the current account for six developing countries from the mid-1970s to the end of 1999. We find that after 1989, when capital liberalisation became prevalent, the causal relationship from the financial account to the current account is quite significant, while prior to 1989 the direction of causality is reversed for most of these countries. An exception is Taiwan, in which the current account retains dominance over the financial account. An impulse response analysis illustrates that due to the laggard response of the current account to a financial account shock, capital flows can drive the current account out of a sustainable path. Without a sound financial system and well-managed macroeconomic policies to channel inflowing capital, countries recklessly liberalising capital restrictions are susceptible to a currency crisis.