Domestic Causes of Currency Crises: Policy Lessons for Crisis Avoidance

Abstract

Summary Reisen stresses that domestic causes of currency crises can be endogenous to the international financial system. Net capital transfers imply current account deficits on the recipient side. Sustained capital inflows produce a real appreciation which diverts investment away from export-oriented sectors. There were common structural weaknesses. Fixed exchange rates understated the investment risk. Liberalised, under-regulated financial sectors made misdirected international investment possible. The ratio of foreign denominated liabilities to reserves is the best vulnerability indicator, yet the crisis was unanticipated: information was deficient but not all available information had been used. For capital inflows to be sustainable they must be stable and must be invested efficiently in tradeable sectors. These conditions were not met in Southeast Asia.

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