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External Balance in Low Income Countries

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  • Lone Engbo Christiansen
  • Alessandro Prati
  • Luca Antonio Ricci
  • Thierry Tressel

Abstract

This paper offers a coherent empirical analysis of the determinants of the real exchange rate, the current account, and the net foreign assets position in low income countries. The paper focuses on indicators specific to low income countries, such as the quality of policies and institutions, the special access to official external financing, and the role of shocks. In addition to more standard factors, we find that domestic financial liberalization is associated with higher current account balances and net foreign asset positions, while capital account liberalization is associated with lower current account balances and net foreign asset positions and with more appreciated real exchange rates. Negative exogenous shocks tend to raise (reduce) the current account in countries with closed (opened) capital accounts. Finally, foreign aid is progressively absorbed over time through net imports, and is associated with a more depreciated real exchange rate in the long-run.

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Paper provided by International Monetary Fund in its series IMF Working Papers with number 09/221.

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Length: 52
Date of creation: 01 Oct 2009
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Handle: RePEc:imf:imfwpa:09/221

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Keywords: Developing countries; Capital flows; External financing; External shocks; Financial assets; Foreign investment; Low-income developing countries; Real effective exchange rates; Terms of trade; current account; exchange rate; capital account; real exchange rate; capital account liberalization; exchange rates; real effective exchange rate; effective exchange rate; real exchange rates; current account balance; current accounts; current account balances; capital account openness; open capital account; real exchange rate appreciation; exchange rate appreciation; exchange rate misalignment; capital accounts; balance of payments; exchange rate depreciation; foreign exchange; real exchange rate depreciation; current account adjustment; foreign exchange reserves; effective exchange rates; nominal exchange rate; balance of payment; exchange reserves; current account surpluses; official exchange rate; exchange rate fluctuations; real exchange rate misalignment; open capital accounts; closed capital accounts; history of exchange rate; current account imbalances; flexible exchange rate; balance of trade; exchange rate policies; dual exchange rate; exchange rate behavior; current account surplus; exchange rate regimes; exchange rate regime; capital account transactions; depreciating exchange rates; real exchange rate behavior; exchange rate systems; restrictions on capital account transactions; exchange rate arrangements; average exchange rate; balance of payments crises; current account responses; current account deficit; flexible exchange rate regime;

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