Does the contagion effect of the Balance of Payment (BoP) crisis

exist? Ukrainian case

Khomiak Vasylvasylkhomiak@gmail.com,

Taras Shevchenko National

university of Kyiv

Shaping Europe 2020:Socio-Economic Research

Bucharest,November, 2013

DefinitionThe BoP crisis is a sharp decrease of

the national currency in result of speculative pressure or capital outflow and/or decrease of the National reserves of the Central bank.

(Kaminsky, Reinhart 1996)

Research Contribution

• The BoP crisis is formalized for Ukraine by the EMP index;

• Hypothesis of contagion effect impact on Ukraine are tested.

Brief Theory: Models1-st generation: change in macroeconomic

fundamentals is the main reason of crisis (Krugman 1979);

2-nd generation: the BoP crisis is self-fulfilling and pessimistic expectation. Behavior can be a trigger (Obstfield 1994);

3-rd generation: contagion effect as crisis trigger, “twin-crisis” – banking and the BoP crisis (Krugman 1999, Eichengreen 2005, Wyplosh);

Literature Review-1• Eichengreen, Rose, Wyplozh (1997), Contagion

currency crisis• Krugman Paul, (1979), “A Model of Balance-of-

Payment Crisis” (Basement of EWS);• Maurice Obstfeld, (1994),“The Logic of Currency

Crisis” (Models of 2-nd generation); • Kaminsky, Lizondo, Reinhart, (1998), “Leading

Indicators of Currency Crisis”;• Lestano, Kuper (2005) “Currency crises in Asia: a

multivariate logit approach”

Literature Review-2• Reinhart, Rogoff, (2009), “The Aftermath of

Financial Crisis – Set of Indicators”- Asian case;• Cuaresma, Jesýs, Slacik, (2008), “Determinants

of Currency Crises: A Conflict of Generations?”; (Binary variable, Bayesian model)

• IMF WP (2004): Autocorrelation-Corrected Standard errors in panel Probits: An Application to Currency Crisis Prediction;

• ECB (2006): Are emerging currency crisis predictable?

Literature Review-3• Lestano, Kakub, Kuper (2003) “Indicators

of financial crisis do work. An early-warning system for six Asian countries”-PCA;

• The IMF-FSB early warning exercises, design and toolkit, 2010;

• Furceri, Guiochard, Rusticelli, OECD (2011) “Episodes of large capital inflows and the likelihood of banking and currency crisis and sudden stops”

Approaches to model Exchange market pressure index

EMPi Components Authors

Changes in international reserves, exchange and interest rate

Cuaresma, Slacik (2008) Fratzsher (2002), Herrera (1999), Eichengreen, Rose, Wyplosh (1997).

Changes in international reserves and exchange rate

Arias (2004), Chui (2002), Edison (2000), Kaminskyy, Reinhart (1999).

Exchange market pressure index, Ukraine

t i

t i

i t i

t i

e t i

t i

rm t i i

i

rm

rm EMP

,

,

,

,

,

, ,

1 1 1

where rmi,t – reserves of the National bank of Ukraine in international currency; – standard deviation of reserves of the National bank of Ukraine;ei,t – real effective exchange rate; – standard deviation of REER.Ii,t - interest rate of the interbank market - standard deviation of the interest rate of the interbank market

rm

e

i

EMP Index, Ukraine

General Model

credrateerestPFTSGDP

CACPIWTIindexsteelCRU

rateerestusPLNEMPRUSEMPUAEMP

*_int***

***__*

_int_*_*_*_

111098

7654

3210

where emp_rus, emp_pln - exchange market pressure index calculated for Russia and Poland that shows impact of crisis from neighboring countries. 3 month LIBOR interest rate is taken to include interest rate of USA as the one of the main market player on the global level. CRU index represents trend on the metal market that is important to Ukraine as export-oriented country where metal export has the highest share. WTI price is an indicator of the commodity market energy sources. High energy consuming of Ukraine industry means that volatility of energy prices impacts on Ukraine import.Current account deficit measured as percent from GDP is an indicator of the strength of external position. CPI, interest rate and GDP represent fundamentals and internal economic state. PFTS index shows how attractive our market for foreign investors.

Estimation output-1  Model 1 Model 2 Model 3

   P-value  

P-value  

P-value

EMP_Russia(-2) -0.18 0.09        

EMP_Poland 0.10 0.10        

EMP_UA(-1) 0.20 0.13 0.47 0.00 0.13 0.33

D(USA_3M_I(-1)) -0.93 0.02     -1.07 0.01CRU(-3) -0.01 0.01     -0.01 0.00WTI_US 0.04 0.00     0.04 0.00CPI(-2) -0.37 0.01     -0.30 0.02

CA_TO_GDP(-1) 24.91 0.01 9.14 0.25 25.95 0.00

D(LN(GDP(-1))) 2.38 0.01 2.48 0.04 2.33 0.02

D(LN(PFTS(-1))) 0.70 0.50 1.93 0.06 -0.37 0.70

Interest rate(-3) 0.06 0.01 0.02 0.24 0.07 0.00             

Schwarz criterion 3.02 3.28 3.06

Durbin-Watson statistic 2.07 1.75 1.86

Prediction power of estimated models

Exchange market pressure index, Ukraine

-8-6-4-20246

20

00

M1

20

00

M6

20

00

M1

20

01

M4

20

01

M9

20

02

M2

20

02

M7

20

02

M1

20

03

M5

20

03

M1

20

04

M3

20

04

M8

20

05

M1

20

05

M6

20

05

M1

20

06

M4

20

06

M9

20

07

M2

20

07

M7

20

07

M1

20

08

M5

20

08

M1

20

09

M3

20

09

M8

20

10

M1

20

10

M6

20

10

M1

20

11

M4

20

11

M9

20

12

M2

20

12

M7

Years

EMP Model 1 Model 2 Model 3

Estimation output, impact of partner countries

  All period Befotre crisisDuring and after

crisis

Sample2000:5-2012:7

P-value

2000:5-2008:8

P-value

2008:1-2012:7

P-value

EU(-2) 0.05 0.42 -0.09 0.29 0.29 0.00PLN 0.14 0.01 0.09 0.23 0.19 0.01RUS 0.15 0.02 0.04 0.65 0.26 0.04

EMPUA(-1) 0.38 0.00 0.24 0.02 0.50 0.00

D(USA_3M_I(-2)) 0.42 0.26 -0.04 0.93 1.32 0.00

    Schwarz criterion 3.20 3.15 3.10Durbin-Watson stat 2.04 2.10 1.66

Impulse function

Impact of 1 S.D of Polish EMP on Ukraine EMP

-0.3

-0.2

-0.1

0

0.1

0.2

0.3

0.4

0.5

0.6

1 2 3 4 5 6 7 8 9 10

All period Before crisis Crisis and after crisis period

Conclusion-1• Deep integration of Eastern European

countries by trade links and foreign capital entry to banking and real sectors makes such emerging countries as Ukraine, Poland, Romania etc more disposed to be "infected" by the contagion effect of the Balance of Payment crisis.

• Evolution of the BoP crisis shows that fundamentals don't play leading role in its prediction anymore, but investor’s behavior and inflow of capital closely connected with world conjuncture have high prediction power.

Conclusions-2• Any shock of partner countries, especially

who is member of the European Union with high probability would have impact on Ukraine during crisis period.

• If the crisis is not caused by price decline on commodity markets, highly likely that crisis in neighbor country caused by fundamentals or internal behavior expectations would not be imported to Ukraine.