Evan Lau

On the sustainability of current account deficits: evidence from four ASEAN countries

This paper examines the sustainability of the current account imbalance for four ASEAN countries (Indonesia, Malaysia, the Philippines and Thailand) over the 1961-1999 period. To this end, we utilize the intertemporal budget constraint (IBC) model to explain the behavior of the current account in these countries. The analysis is based on various unit root and cointegration procedures including those allowing for a structural break to deal with the major shortcomings of previous studies. The empirical results indicate clearly that for all countries, except Malaysia, current account deficits were not on the long-run steady state in the pre-crisis (1961-1997) era. This leads us to conclude that the current accounts of these countries were unsustainable and did not move towards external account equilibrium. Moreover, the persistent current account deficits might serve as a leading indicator of financial crises. In contrast, we find strong comovement between inflows and outflows in Indonesia, the Philippines and Thailand in the period including the post-crisis years, while Malaysia was on an unsustainable path. This is because macroeconomic performance of most of the ASEAN countries has changed dramatically since the onset of the Asian crisis in mid-1997. The evidence suggests that action to prevent large appreciations should have been taken prior to the 1997 crisis.

Testing Twin Deficits Hypothesis using VARs and Variance Decomposition

ABSTRACT This paper examines the twin deficits hypothesis in the ASEAN countries. The major findings of this paper are the following. (1) Long run relationships are detected between budget and current account deficits. (2) The Keynesian view fits well for Thailand since the causality runs from budget deficit to current account deficit. For Indonesia, the causality runs in an opposite direction while the empirical results indicate that a bidirectional pattern of causality exists for Malaysia and the Philippines. (3) We also found support for an indirect causal relationship that runs from budget deficit to higher interest rates, and higher interest rates leading to the appreciation of the exchange rate, which in turn leads with the widening of the current account deficit. The results of the variance decompositions and impulse response functions suggest that the consequences of large budget and current account deficits become noticeable only over the long run.

Financial Integration of East Asian Economies: Evidence from Real Interest Parity

In this article, we investigate the financial linkages between the East Asian economies with Japan and the United States. We test for long-run Real Interest-rate Parity (RIP) using an array of panel-data techniques, including recent techniques developed by Breuer et al. (2002) and Carrion-i-Silvestre et al. (2005). This study offers two important results: first, the failure to account for structural breaks in the industrialized countries and Asian emerging economies is likely to provide evidence of nonstationary series that are stationary. Second, we found strong evidence that the parity condition holds in all the Asian countries. The failure of earlier studies to confirm mean reversion of Real Interest-rate Differential (RID) may reflect the choice of estimation/testing procedure rather than any inherent deficiency in the RIP.

Dynamics of fiscal and current account deficits in Thailand: an empirical investigation

Purpose - The purpose of this paper is to contribute further on the twin deficits debate in a developing economy. Design/methodology/approach - The data for Thailand over three decades are used as a case study. Findings - The major findings are: first, a stable, long-run equilibrium relationship between fiscal deficit, interest rate, exchange rate, and current account was found. Second, the causal relationship between the two deficits runs from fiscal deficit to current account deficit. This evidence is supportive of the twin deficits hypothesis. Further econometric analysis reveals that the two financial variables (interest rate and exchange rate) act as intermediating variables – that is an increased fiscal deficit causes interest rate to rise, and this in turn puts pressure on the exchange rate. The appreciation of the domestic currency causes a current account deficit. Originality/value - The paper is of value by showing both direct and indirect channels to uncover the twin deficits phenomena. Based on a persistent profile response, it was found that the adjustment process may take as long as a year to complete.

Sustainability of External Imbalances: The Case of Malaysia

The understanding of the sustainable external imbalances over the 1961-2001 for Malaysia is presented in this paper. The empirical results clearly show that inflows and outflows share a common stochastic trend prior to the 1997 Asian crisis while in the post-crisis period the current account surpluses are on an unsustainable path. Our findings highlight the important role of imports (mainly intermediate inputs) in exports. For an economy that depends on export promotion for its growth process, imports are important in restoring external imbalances to its sustainable steady state path. As illustrated by the recent crisis, the large depreciation of the ringgit contributed to a decline in imports and for an economy that is highly dependent on imported capital, this means an economic slowdown.

An empirical investigation on sustainability of balancing item in Asian countries

This study explores the sustainability of the balancing item in Asian economies. The conventional unit root tests (includes panel tests) illustrate that the results are rather inconclusive. However, the results from the series-specific panel unit root test consistently illustrate that five of the countries (Singapore, Bangladesh, Indonesia, Korea and Malaysia) balancing item is on the sustainable path. For other remaining eight countries (Maldives, Mongolia, Myanmar, Nepal, Pakistan, the Philippines, Sri Lanka and Thailand), there is evidence that her balancing item of balance of payments accounts is unsustainable.

Assessing the mean reversion behaviour of fiscal policy: the perspective of Asian countries

This article investigates fiscal policy sustainability in 10 Asian countries by adopting a battery of unit root tests. Univariate unit root tests reveal that the fiscal stance in these countries follows a nonstationary process while the opposite conclusion was drawn for the same dataset using the commonly employed panel unit root techniques. By utilizing the series-specific panel unit-root test recently developed by Breuer et al. [2002, SURADF (Seemingly Unrelated Regression Augmented Dickey-Fuller)] that allows testing for the presence of nonstationarity within individual cross sections of the panel, we found that only cross sections four out of 10 countries in the panel are stationary. This means that fiscal deficits in most Asian countries are in violation of their intertemporal budget constraint and that the deficits are too large.

Interdependence of Income between China and ASEAN-5 Countries

Purpose - The purpose of the paper is to empirically examine the interdependence of income between China and ASEAN-5 countries by using the real gross domestic product (GDP). Besides answering this important policy question, the paper is also concerned with ascertaining the causal direction between China and the ASEAN-5 income. Design/methodology/approach - The paper resorts to the standard time series econometrics analysis. These includes the unit root, cointegration and the Granger causality tests in order to test the causal interplay and interdependence of income between ASEAN-5 and China for the estimation period from 1960 to 2003 obtained from the Penn World Table (PWT) 6.2. Findings - Empirical results are found to support the strong interdependence of income between China and ASEAN-5 countries. Further, the causality experiment suggests that China is the key factor in connecting (equilibrium point) the ASEAN-5 region, where China in one-way or another marks the resemblance of the income amongst these economies. Originality/value - The paper is of value in that it highlights the issue of interdependence of income especially in developing countries. With the increasing interest of economic integration around the globe especially the China-ASEAN Free Trade Area (CAFTA), the interdependence and synchronization movements of income between member countries is an important characteristic for suitability towards the regional common currency goal.

Testing the Effectiveness of Monetary Policy in Malaysia Using Alternative Monetary Aggregation

The capability of monetary aggregates to generate stable links with fundamental economic indicators verifies the effectiveness of monetary targeting. However, traditional monetary aggregates become flawed when financial reforms take place. As official monetary aggregates fail to maintain stable links with crucial economic indicators in Malaysia, monetary targeting has been substituted by interest rate targeting. Therefore, Divisia monetary aggregates, which are considered superior to their simple-sum counterparts are used in the investigation for Malaysia. The findings imply that Divisia M2 money demand is stable and capable of generating appropriate coefficients with correct signs for the variables included. Thus, Divisia money has shed new light on the usefulness of monetary targeting in formulating monetary policy in Malaysia.

Mean Reversion of the Fiscal Conduct in 24 Developing Countries

In this paper, we examine the mean reverting behaviour of fiscal deficit by analysing the fiscal position of 24 developing countries. Using annual data over the period 1970-2003 and the series-specific panel unit root test developed by Breuer et al. (Oxford Bulletin of Economics and Statistics, Vol. 64 (2002), pp. 527-546), we found the budget process for most developing countries fails to satisfy the strong-form sustainability condition. Further investigation shows the budget process for a majority of the countries is on a sustainable path (weak form) when a one-time, structural break is allowed in the model. Therefore, our empirical results suggest that the budget process in most of the sample countries is in accordance with the intertemporal budget constraint. Copyright