Negative Alchemy? Corruption, Composition of Capital Flows, and Currency Crises
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.
- An increase in corruption from the level of Singapore to that of Mexico would have the same negative effect on...foreign investment as...
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