Persistent external deficits and balance of payments crises

Abstract

Persistent external deficits are a recurrent phenomena in low and middle income countries. We define a new empirical measure to study balance of payment crises related to the accumulation of persistent external deficits. Using a non-parametric difference-in-differences estimator we estimate a critical value for the accumulated current account deficits associated with a crisis. Countries that have increased their net external indebtedness by an accumulated amount of at least 26%–31% of the GDP in a time span of 3 to 5 years are more vulnerable to suffer a crisis, which includes a consumption fall of 3.1% and a current account reversal of 4.9 percentage points of GDP. These crises are far more severe than an average sudden stop. Thus, our empirical results suggest that fast accumulation of external debt though current account deficits is related to severe crises.