Currency Crises and Fiscal Imbalances. The Transition Countries Perspective

The financial innovations and increased integration of capital markets have made the nature of balance of payments turmoil much more complex, than described by firstgeneration models. The severe financial crises, which erupted in 1990's in many seemingly "invulnerable" economies that in most cases were characterised by a balanced budget and a modest public debt have turned away the attention of analysts and policymakers from fiscal variables towards other determinants. The fiscal factors, nonetheless, still remain among important causes of financial turbulences, especially in emerging markets, what has been manifested by the 1998/1999 crises of FSU (Former Soviet Union) economies. The purpose of this paper is to re-examine the theoretical and empirical links between fiscal sector and the emergence of financial crises, with an emphasis on transition economies. It outlines the main theoretical channels and seeks for the empirical evidence of the influence of fiscal sector on the vulnerability to currency crises in developing and transition countries. Using a large sample of developing and transition countries, it examines the pattern of fiscal variables before and during the crisis, to see whether, on average, the behaviour of fiscal variables during a crisis is different form tranquil periods. The results indicate, that in the case of developing as well as Central European and CIS countries, the crisis is, on average preceded by larger, than in normal times, fiscal deficits and higher level of public debt. The paper also assesses the recent series of financial crises that have emerged in FSU economies. These turbulences, have once again demonstrated the crucial role of fiscal sustainability in the overall vulnerability to negative external developments. The FSU countries, which experienced a crisis, did, on average, exhibit more widespread fiscal weaknesses and/or their external liabilities were more vulnerable to turbulences than other countries in that group. However, the fiscal imbalances of FSU economies were not just a consequence of the conducted fiscal policy. They were also a manifestation of the deeper structural shortcomings and the lack of consistent reforms: soft budget constraints across the economy, weak governments, inefficient tax systems, Soviet-type budget expenditures. Overall, empirical research indicates that in developing and transition countries, fiscal variables remain among factors that increase the likelihood of exchange rate and financial pressures.