NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Negative Alchemy? Corruption, Composition of Capital Flows, and Currency Crises

Shang-Jin Wei, Yi Wu

NBER Working Paper No. 8187
Issued in March 2001
NBER Program(s):   IFM   ITI

Crony capitalism and self-fulfilling expectations by international creditors are often suggested as two rival explanations for currency crisis. This paper examines a possible linkage between the two that has not been explored much in the literature: corruption may affect a country's composition of capital inflows in a way that makes it more likely to experience a currency crisis that is triggered/aided by a sudden reversal of international capital flows. We find robust evidence that poor public governance is associated with a higher loan-to-FDI ratio. Such a composition of capital flows has been identified as being associated with a higher incidence of a currency crisis. We also find some weaker evidence that poor public governance is associated with a country's inability to borrow internationally in its own currency. The latter is also associated with a higher incidence of a currency crisis. To sum up, even though crony capitalism does not forecast the timing of a crisis, it can nevertheless increase its likelihood. This paper illustrates a particular channel through which this can happen.

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Document Object Identifier (DOI): 10.3386/w8187

Published: Negative Alchemy? Corruption, Composition of Capital Flows, and Currency Crises, Shang-Jin Wei, Yi Wu. in Preventing Currency Crises in Emerging Markets, Edwards and Frankel. 2002

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