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8. The Currency Shake-up in 1997: A Case Study of the Czech Economy
- University of Michigan Press
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CHAPTER 8 The Currency Shake-up in 1997: A Case Study of the Czech Economy Oldrich Dedek The last decade of the departing twentieth century will enter the history of the world economy as a period of increased instability of financial markets, contributing to major declines in the output of emerging market economies. Observers or analysts may find the truly global nature of the mentioned phenomena fascinating. While formerly located mostly in the Latin American region, the virus of currency crisis gradually shifted and affected with the same destructive effects the opposite part of the globe, the countries of the former Asian tigers. The collapse of the ruble in August 1998 added to the range of affected countries the most significant representative of transition economies. Against the background of these spectacular events, which have triggered extensive considerations of the reform of the world financial architecture, the history of causes and consequences of the currency turbulence that hit the Czech economy in 1997 is of somewhat marginal interest. Nevertheless, from a purely professional viewpoint the example of the Czech economy is interesting in a number of ways. First, the Czech Republic at that time had gained the image of a transition economy with a highly progressive reform program oriented toward an extensive liberalization of economic activities. The currency turbulence that dragged the country into a political crisis and economic recession could therefore be easily interpreted not only as a consequence of mistakes in the Czech economic policy but also as a failure of a more general transformation philosophy supported by the International Monetary Fund (IMF) and other prominent financial institutions. Second, measured in absolute terms of key economic variables (e.g., the volume of capital movements, the volume of foreign exchange reserves, and so on), the Czech case can hardly be compared to cases of big countries affected by big crises. On the other hand, measured in relative terms, the Czech economy ranked first several times, be it due to an unprecedented high share of capital inflow to GDP shortly before the currency crisis or an alarming 231 232 International Capital Flows in Calm and Turbulent Times share ofdeficits ofthe current account in GDP, which set offthe currency crisis . These relative values ultimately determine the degree of the absolute relevance of the problem. Third, the aftermath of the currency crisis in the form of political instability and declining economic performance had many traumatic effects. However, in the light of international comparison, the impact of the crisis was far from that dramatic. The Czech authorities did not have to ask for IMF or other official loans, the withdrawal of foreign investors did not reach the stage of uncontrolled panic, and the exchange rate did not record a dive. The scope of losses caused by the crisis would have to be further cut down, if we admit a confluence of the postcrisis period with the cumulative consequences of incomplete structural and institutional reforms. Thus, a useful lesson may be drawn from the Czech experience as to how to handle difficult situations once they arise. The more detached the view we take when investigating the currency crisis of 1997 the more common and the less original may seem the reasons that caused this event. It can be stated that the Czech economy underwent a standard shake-up caused by a gradualist accumulation and a shock-type solution to external imbalance.l There exists sufficiently conclusive evidence that the current account deficit gradually exceeded a sustainable limit. Simultaneously, the resistance of the economy was weakened partly by the reluctant implementation of a number of important reforms. In this hotbed, the market forced a fast and vigorous solution of external imbalance , with all negative consequences brought about inevitably by any sharp swing. 1. THE DEBATE ABOUT A SUSTAINABLE EXTERNAL IMBALANCE A close look at the data describing economic development in the years 1993-96 (see table 8.1) reveals an evident tendency toward deepening external imbalance manifested by the widening deficits of the balance of payments ' current account. The values of this variable ultimately brought-in the negative sense of the word-the Czech Republic the "leading position" in the group of emerging economies. However, quite a number of examples from other parts of the world warn that this growth of the current account deficit may end up causing serious problems. An unbiased observer may therefore ask why the Czech economy followed this dangerous path. Why did economic policy not pay greater attention to the growing...