External vulnerability, balance sheet effects, and the institutional framework — Lessons from the Asian crisis

This study tests the balance sheet approach of “third-generation” explanations of external crises in emerging markets, looking in particular at the 1997–98 Asian crisis. Using unique datasets, we find that corporate sector balance sheets, macroeconomic balance sheets, and the legal environment have a significant impact on the likelihood of external crises, and some of which also on the depth of crises. These indicators supplement, rather than substitute, the traditional macroeconomic variables. Predictions point to potentially large improvements in the predictive power of models that include these indicators. The results highlight the importance of sound financial structures and institutional framework, alongside prudent macro policies, in limiting external vulnerability.