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TB0088
October 21, 2007

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F. John Mathis
Paul Keat
John J. O’Connell

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Country Risk Analysis and Managing
Crises: Tower Associates
Teaching Note

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Objective
This case teaches program participants the skills to analyze relevant economic country data and use
country risk assessment tools in order to arrive at and make an informed investment decision.

Synopsis
Susan Brédé, an investment manager for a private equity firm, Tower Associates (the case uses a financial
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service private equity company, but the analytical process applies to almost any company) has identified
four countries that meet a preliminary set of investment criteria. She must now undertake a country risk
analysis in order to reach an investment decision that she can recommend to Tower’s senior manage-
ment team. Her main concern is to avoid recommending countries that might be vulnerable to eco-
nomic crises during the next three to five years.

Program participants, presented with specific economic data from four unidentified countries
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Susan selected, must look for evidence of any of the following investment risks: currency crisis, financial
crisis, foreign debt crisis, and/or banking crisis. The exercise teaches participants how to use analytical
tools to evaluate risks and, more importantly, understand how this type of evaluation process can lead
managers to make or recommend actual business decisions. The case may be taught by assigning a single
country to be analyzed or by assigning two or more countries to be analyzed and compared in terms of
the different risks they present for Tower Associates.
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Case Questions and Use

The case teaching plan is structured for a 90-minute class/module session, but can be used for a 120-
minute session by adding a 30-minute pre-case team discussion period.

10 minutes—discussion of the case topic, the background information and why risk assessment is
important
20 minutes—discussion of assumptions and exchange rate forecast using the six forecasting tech-
niques discussed
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Copyright © 2007 Thunderbird School of Global Management. All rights reserved. This teaching note was prepared by
Professors F. John Mathis, Paul Keat, and John J. O’Connell for the sole purpose of aiding instructors in the classroom use
of the case “Country Risk Analysis and Managing Crises: Tower Associates.” It should not be used in any way that would
prejudice future use of this case.

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 30 minutes—examination, evaluation, and comparison of the four countries to determine which of

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them is/are following appropriate policies given the economic situation presented in the data

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tables, followed by a discussion and justification of which country is least likely to encounter
country risk problems and/or one of the four types of crisis, and is, therefore, the likeliest
candidate for investment
30 minutes—class discussion focusing on management decision tools and what hedging alterna-
tives may be appropriate to reduce risks

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Case questions may include the following:

1. Are there any hidden assumptions or price rigidities in the country or countries that might inhibit
market force indicators from revealing the true economic health of the country, thereby either
preventing government policy actions from correcting the problems or otherwise making them
ineffective and counterproductive?

2. What is the current domestic and international economic situation of each country relative to

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benchmark performance measures for that country?

3. Is the country currently following appropriate economic policies from a domestic as well as an
international perspective? Provide supporting justification for your answer.

4. When the basic tools of country risk analysis are applied to the different countries being analyzed,
which country is more likely to have what kind of crisis, and why?
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5. If you recommend that Tower Associates proceed with a transaction in one of the selected coun-
tries, which strategy would you suggest they follow: a foreign exchange hedging strategy or a coun-
try risk crisis management strategy? Explain and justify your recommendation

Historical Review
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The “Historical Review of Country Crises” documents that crises occur often throughout the world,
and can occur repeatedly within a single country. For the most current data on crises, refer to The World
Bank, Global Development Finance, 2007 (or latest year) Annex 1 (commercial debt restructuring) and
Annex 2 (official debt restructuring). The report lists commercial debt restructurings, buybacks, and
swaps for these 11 countries: Nigeria, Belize, Brazil, Colombia, Mexico, Panama, Peru, The Philip-
pines, Turkey, Uruguay, and Venezuela. Six countries underwent debt restructurings, with official credi-
tors, arranged under the aegis of the Paris Club. The countries were: Moldova, Grenada, Cameroon,
Afghanistan, Malawi, and Haiti.
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Birth and Life Cycle of Crises—Resources

The information on “Understanding the Birth and Life Cycle of Crises” was drawn from the bench-
mark study of crises by the International Monetary Fund (IMF) published in World Economic Outlook,
May 1998. The report summarized the research and findings from a large number of empirical studies
of various types of crises throughout the world during the post-World War II period. The following
year, the IMF published another summary report on “International Financial Contagion” in World
Economic Outlook, May 1999. This report studied factors that cause a crisis in one country to spread to
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others. A summary of these two reports is attached. The summary identifies key indicators for specific
types of crises, and what type of pattern to look for in the indicators. Understanding how these indica-
tors work is critical since their predictive accuracy is somewhat less than perfect. Also, in some cases, a
government can successfully correct a crisis indicator, thus avoiding the crisis by acting quickly and
taking appropriate policy actions.

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 In 2006 and 2007, the IMF produced a compilation of articles, Finance and Development in

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Financial Globalization, Washington, D.C. This publication focused on the impact of financial global-

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ization on trade, policy, labor, and capital flows. It also reported on the linkage between the huge
growth in cross-border capital flows and economic crises.

Country Analysis
By concealing the identity of the four countries studied in the case, greater emphasis can be placed on

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the actual analytical process, and personal bias can be minimized or eliminated. However, to make the
learning experience more vivid, the instructor may wish to reveal the names of the countries: Country A
is Brazil, Country B is Russia, Country C is India, and Country D is China.

Analytical Framework
There are six steps in the country risk analysis process:

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1. Identify price controls or restrictions, if any, on production factors such as labor, capital, land, and
entrepreneurship.
2. Forecast the exchange rate using PPP, IRP, IFE, and BoP methods.
3. Determine the current economic situation (pattern over the last three years) relative to benchmark
measures of a healthy economy.
4. Determine appropriate policy actions if the economy is not healthy, and compare them with cur-
rent government policy.
5. Examine and analyze short-term and medium-term indicators of country crises.
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6. Justify management’s decision regarding trade and/or investment and, if appropriate, how to hedge
against an identified risk.

Step 1: Assumptions
The first step in the analytical process is to identify any government controls that might limit the ability
of the economy to adjust to market forces—especially a controlled price variable. Determine if govern-
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ment regulations and restrictions are hindering the free movement of market forces in the economy.
Controls, if enforced strictly, tend to be a precursor of a crisis, and the challenge then is to determine the
timing. If such a variable shows no change year to year, this can be an indication that controls are in
place.

Step 2: Exchange Rate Determination

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Program participants should continue the risk analysis by forecasting the exchange rate in order to
determine the possibility of a currency crisis. This can be done by calculating the relative PPP (purchas-
ing power parity) against the country’s major trading partners—or against all countries—to determine
trends pointing to the longer-term competitiveness of the country. Similarly, the IRP (interest rate
parity) and IFE (international Fisher effect) may be used to calculate a required adjustment in the
exchange rate that would establish parity in financial markets, which move much more quickly that
trade flows. Finally, examining the overall balance of payments—surplus or deficit—serves as an indica-
tor of currency appreciation/depreciation by a large or small amount, depending of the size of the
balance of payments.
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For each of the four countries in the case, the exchange rate appears in its particular data table in
two formats: as an index relative to the base year, and as a real effective exchange rate. If the index
number remains close to 100, the exchange rate could be in equilibrium, but it could also be fixed or
managed. If the index number rises over time, the currency is appreciating by a percentage equal to the
difference between the index numbers over that time span. If the number drops below 100, the currency
is depreciating relative to the base year.

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 The real effective exchange rate adjusts the exchange rate for inflation differentials among that

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country’s major trading partners. If the index rises, it reflects a real appreciation in the currency and a

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loss of competitiveness. However, if the index number falls, this reflects a gain in competitiveness be-
cause the currency is depreciating at a rate greater than the rate of inflation. These exchange rate mea-
sures, therefore, can also serve as a guideline for deciding how much of a price/currency adjustment—
and the direction of the adjustment—are required to keep the country’s products competitive.

Step 3: Current Economic Situation

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For the following discussion, refer to Charts 1, 2, and 3 below. Step 3 of a country risk analysis is to
establish the correct benchmarks for both the domestic and the international sides of the economy.
Benchmarking a country’s economy is comparable to benchmarking an individual company’s perfor-
mance against an industry standard adjusted to the size of the company. The domestic indicators of a
healthy performance are low inflation and real GDP growth relative to increased employments levels. A
country with near-full employment and no inflation maximizes the individual’s income or standard of
living. Most major industrialized nations accept the following as healthy economic performance bench-

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marks: 3% inflation and 3% real GDP growth, with a 1% plus or minus target range. Rapidly growing
emerging markets have a higher benchmark target of 8% real GDP growth and 8% or higher inflation
rate. Actual benchmarks for a country may be established by using the average inflation and real GDP
growth rate over the previous 10 years. This assumes that the economy has been operating optimally, on
average, during those10 years and has not experienced any crises during that period. By plotting the
past three years’ actual economic performance against the benchmark target, it is possible to determine
whether or not the economy falls outside of the target zone. If it does, then appropriate policy actions
(monetary, fiscal, or exchange rate policy) can be determined in order to move the economy into the
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target zone.
Domestic Benchmark for a Healthy Economy
Appropriate Policy Target Zone

Inflation
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Developing
Country
8%
+/- 3%

3%
+/- 1%
Industrial
Country
No

0
3% 8% Real GDP growth

In general, when an economy is benchmarked to the left of the target zone (in recession or grow-
ing below a full-employment rate of growth), expansionary policy is required to move the country into
the target zone. When an economy lies to the right of the target zone (experiencing inflation or growing
too rapidly relative to labor and other resource availability), the government should slow the pace of
growth by pursuing either an expansionary or a restrictive economic policy. Which of the two types of
policy to pursue is determined by examining the international economic benchmarks.
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If expansionary policy is required in order to achieve domestic economic health, and the country’s
currency is depreciating (above the international target zone), then pursuing an expansionary fiscal policy
is appropriate as it will cause the currency to appreciate and move toward the target zone.

However, if the domestic economic situation requires expansionary policy and the international
side of the economy shows the currency is appreciating, then the appropriate policy is expansionary

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 monetary policy as this will cause the currency to depreciate and move into the target zone. If the

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exchange rate is in the target zone, then both expansionary monetary and fiscal policy should be fol-

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lowed.

Analyzing the basic structure of the economy as reflected in the composition of the national
income accounts is also helpful for a clear understanding of the current economic situation. The basic
structure of an economy is presented as a percent of GDP in the charts in order to make comparison
across countries easier. The national income accounts indicate which sectors of the economy contribute

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to GDP. If investment as a percent of GDP is between 25-35%, this suggests that the private sector is
the main driver of economic growth. In addition, it suggests that the economic infrastructure for pri-
vate sector growth is supportive or that domestic financial markets are channeling savings effectively to
support a healthy business investment. For some countries, the main driver of economic growth is the
government as reflected in a percentage of GDP at 20% or higher. The relative importance of consump-
tion in the U.S. makes it an important driver of economic activity, but in developing countries it is less
significant. The size of total GDP measured in U.S. dollars allows the ability to rank countries by stage
of economic development or industrialization, although it tells us little about the distribution of in-

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comes received to generate GDP.

The healthy performance benchmarks for the international side of an economy are shown in
Chart 2. The vertical scale indicates the degree of volatility in the exchange rate as measured on an
average daily, weekly or monthly basis. The horizontal axis measures the size of the balance of payments
surplus or deficit as a percent of GDP. In the case of an industrial country, the target zone is +/- 3%
around the origin, or zero, meaning that there is no foreign exchange volatility; and, because the balance
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of payments is in equilibrium, the exchange rate is stable. If the country is a developing country, the
target zone is +/- 6% around the origin.
International Benchmark for a Healthy Economy
Appropriate Target Policy Zone

+% ∆FX
Depreciating Home Currency
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Developing Country
+/- 6%

- B/P % GDP + B/P % GDP

Industrial Country
No

+/- 3%

Appreciating Home Currency

- % ∆FX

Step 4: Appropriate Policy

Using both domestic and international benchmarks for each country can determine the appropriate
policy actions each government should be pursuing. The decision process focuses on the domestic
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situation first. If the economy falls outside of the target zone, the correct policy action will be either
expansionary or contractionary, depending on additional analysis on the international side.

The domestic side of the economy is normally analyzed first because its performance plays a key
role in a government’s ability to remain in power and to be effective with its constituency. Once the
correct domestic policy action is determined (expansionary or contractionary), the next step is to decide
if it should be monetary or fiscal by examining the international side of the economy.

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 By showing the impact on the exchange rate and balance of payments, the international side of the

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economy establishes the choice of the appropriate policy tool: monetary policy, fiscal policy, both mon-

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etary and fiscal policy together, or exchange rate policy.

To determine the policy currently being followed by a government, program participants should
examine and evaluate the rate of growth of money supply, domestic credit expansion, and the direc-
tional change in interest rates, from information found at the bottom of the country data tables, by:

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• analyzing the movement in the fiscal balance
• assessing whether there is a budget surplus or a budget deficit
• assessing its direction of change, measured as a percent of GDP

Trade policy is not considered a policy option here because trade policy actions are generally not
used to manage economic activity. Trade restrictions have been reduced to very low levels in most
countries, and the WTO works to keep the situation this way. Also, most governments realize that an
increase in trade restrictions generally triggers retaliation.

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Chart 3 provides a policy trade-off matrix showing unhealthy or out-of-equilibrium economic
situations, including inflation and unemployment. Because of the importance given to staying in power,
it is imperative to note that governments give priority to maintaining or improving the domestic stan-
dard of living of their populations. This often creates a policy conflict between the domestic and inter-
national sides of the economy that results in a change in the exchange rate.
The Internal Conflict of Goals:
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Internal vs. External Balance

BALANCE OF PAYMENTS or Deficit Balance

Surplus
CURRENT ACCOUNT

DOMESTIC POLICY None

Contraction Expansion
ECONOMY REQUIREMENT
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Inflation Contraction No conflict Conflict Conflict

Recession Expansion Conflict No conflict Conflict

No

Balance None Conflict Conflict No conflict

Step 5: Indicators of Country Risk

Steps 1 through 4 of the analytical framework have:
• examined the exchange rate risk
• determined the likelihood of an exchange rate change
• assessed how large a change might occur
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• determined the appropriate policy actions that would result in healthy economic performance
• compared the appropriate corrective policy actions to the current policy actions

These steps have established whether or not there is a policy conflict signaling the possibility of an
economic crisis. The next step in the analytical process is to determine the likelihood of a crisis and
establish what type of crisis is most likely to occur in order to make appropriate management decisions
to protect any investment made be recommended to Tower Associates.

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 Relying on the crisis indicators summarized in the appendix to this teaching note, participants

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should check activity during the past year in the stock market index, real interest rates, real exchange

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rate, and real estate prices. Only two indicators appear in the data provided: real exchange rates and real
interest rates. (There are two other indicators, but no information is provided on them.) If these indica-
tors have risen by about 50% during the past 12 months and then suddenly declined sharply by at least
20%, there is a likelihood of a foreign exchange or financial crisis within the next 6–9 months, dating
from the turning point in the price of the asset(s).

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If there is no evidence of problems immediately ahead, the next step is to examine the amount of
liquidity being injected into the economy by looking at money supply growth trends, domestic credit
expansion trends and real interest rate trends. If liquidity in the economy is expanding rapidly and
upward pressure on prices is beginning to occur, this may signal problems in the next 18–36 months
unless policy is changed.

Finally, there are at least two important indicators of a foreign debt crisis that can be examined.
Foreign debt service ratio has traditionally been a critically important indicator of a debt crisis. This is

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a ratio of foreign debt service payments (both principal and interest) to export earnings. Net factor
payments may be used as a proxy for foreign debt service payments.

The number of months of imports covered by reserves is also an indicator of the ability of a
country to support itself in a foreign debt servicing or currency crisis. The calculation is done by deter-
mining how many months of imports may be purchased with the amount of convertible currency
holding in international reserves. If the amount of reserves exceeds three months of imports, it is con-
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sidered to be at an adequate level; if it is below three months, this represents a dangerous situation.

Step 6: Management Recommendations

The final step in applying the country risk analysis framework is to determine management decisions
based on the foregoing analysis. A significant amount of class time should be devoted to fully pursuing
this discussion. There may be several scenarios that need to be discussed.
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If careful analysis of a particular country shows that the country is likely to experience some form
of crisis in the near future, the recommendation to Tower’s senior management team may be to delay
investing in that country and instead consider a country which is unlikely to experience a crisis within
the investment timeframe proposed in the case.

If it is determined that the country’s currency is likely to depreciate or that there might be a
foreign exchange crisis or a financial crisis (these often occur together because the first policy action by
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governments is usually to raise interest rates and tighten credit), then the recommendation may be to
explore using a foreign exchange hedging tool: forward, future, swap, or option.

If Tower Associates is considering a foreign direct investment option, it may want to consider
either borrowing within the country in which it is investing, or creating a foreign currency liability to
offset its foreign currency earning from local sales.

The possibility of a foreign debt servicing problem in a target country may result in the govern-
ment imposition of foreign exchange and financial controls that would limit any conversion of local
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currency by Tower into a convertible currency until the debt issue is resolved or renegotiated, which
may take some time. A crisis of this type could also result in the freezing of convertible currency domes-
tic bank accounts or the imposition of a tiered exchange rate system for converting local currency to a
hard currency, depending on the importance of the transaction to the government. In this situation, it
would be advisable for Tower management to delay any investment until the situation is resolved.

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 Finally, evidence of a banking crisis has a negative impact on local credit availability, and may also

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be associated with a financial crisis. Together, these developments may lead to a depressing impact of the

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overall pace of economic activity. A banking crisis historically has been one of the worst and longest
lasting type of problems for a country to manage. Thus, the pace of economic activity can remain
depressed for long periods of time, and may be accompanied by widespread bankruptcies. It is recom-
mended that management delay any investment in a country with a banking crisis until the crisis is fully
resolved.

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Appendix: Crises Indicators

Country Risk Monitor—Step-by-Step Approach to Evaluating Country Risk Analysis

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Country ______________________________ Date _______________

Use this as a checklist to indicate the present and future conditions of the country of your interest.
Variable
Present One-year Considered
Indicator Type of Crisis Characteristics Trigger Points Situation Outlook Y/N
No
Early Warning—Short Term Low Risk Monitor High Risk Lead Time
Asset Prices
Stock market prices Fx-Financial Rises sharply - plunges 12 to 6 mo. Stable 50% rise 20% fall 9 to 6 mo.
before crisis
Real estate prices Fx-Financial Rises sharply - plunges 12 to 6 mo. Stable 50% rise 20% fall 9 to 6 mo.
before crisis
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Real interest rates Fx-Financial Negative, then jumps 3% Negative High 12 to 6 mo.
Real exchange rates Fx-Financial 36 mo. high rising, peaks at crisis, Floating Adjustable Fixed 24 to 3 mo.
overvalued then falls
Change in nominal exchange rate 36-12 mo. high, 12 mo. falls Normal High Falls 12 mo.

Liquidity
Money supply growth Fx-Bank-Fin. Normal M2 to GDP ratio Normal Rising Falls below normal
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Credit expansion growth Fx-Bank-Fin. Normal domestic assets to GDP ratio Normal Rising Falls below normal
Change in M2 to reserves ratio Fx-Bank-Fin. 24 mo. rising, 3 mo. jumps Normal Rising Jumps 24 to 3 mo.
Nominal M2 growth Fx-Bank-Fin. 24 mo. increase, 18 mo. declines Normal Rising 18 mo. declines 24 to 18 mo.
Real M2 growth Fx-Bank-Fin. 24 mo. increase, 12 mo. declines Normal Rising 12 mo. declines 24 to 12 mo.
Nominal private credit growth Fx-Bank-Fin. 24 mo. high 10-20%, 15 mo. falls Normal Rising 20-30% 15 mo. falls 24 to 15 mo.

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Change in M2 toM1 ratio Fx-Bank-Fin. 24 mo. high-rising, 15 mo. plummets, Normal High & rising Plummets 24 to 9 mo.
9 mo. rises
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Banking crisis Fx-Financial 12 mo. before currency crisis, high & Normal Increase Jumps 12 mo.
rising non-performing loans
Inflation Debt-Fx-Bank-Fin. CPI, 24 mo. increased, 15 mo. moderated Low Rising Surges then falls 24 to 15 mo.

International Reserves
Change in months of imports Debt-Fx-Fin. Less than 3 mo.; rises then declines Greater than 3-8 mo. Plummets 6 to 3 mo.
covered by reserves 20-30% 8 mo.
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Short term capital inflow Debt-Fx-Fin. 36 mo. increases, 12 mo. falls Normal Increases Declines sharply 12 mo.
(% of GDP)
Private capital inflow Debt-Fx-Fin. 36 mo. high 5-12%, 24 mo. declines Normal Increases Declines sharply 24 mo.
(% of GDP)
Capital Inflows—long term Fx-Financial Maturity exceeding 1 year Normal Increases Declines sharply 24 mo.
Errors & omissions Fx-Financial From balance of payments Positive & Fluctuating Large negative 12 mo.
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stable & falling

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Longer-term Indicators
Export growth Debt-Fx-Fin. 12 mo. decline in growth -5 to -10% points Real growth Stable Falls 5 to 10%points 12 mo.
below normal
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Trade balance Debt-Fx-Fin. Net exports as % imports Stable Deteriorating Sharp decline 9 mo.
Industrial/mfg. growth Debt-Fx-Fin. 18 mo. rises 2-5% points above norm Normal High Declines 12 mo.
Annual real GDP growth Bank-Fin. 36 mo. high 1-3% points, 12 mo. declines Normal High Declines 12 mo.
Investment (% of GDP) Bank-Fin. 36 mo high 3-6% points, 24 mo. falls Normal High Falls 24 mo.
Fiscal balance (% of GDP) Bank-Fin. 36 mo. high 1-4% points, 12 mo. falls Normal High Falls 12 mo.
Debt Service Debt-Financial Change relative to real GDP growth Less than Equal to Greater than 24 mo.
Debt Service Ratio Debt-Financial Share of exports used to make debt Less than 20% 20-30% Greater than 30% 24 mo.
service payments
% short-term debt to total Debt-Financial Short term debt as % of total debt Less than 20% 20-30% Greater than 30% 12 mo.
No
% variable Debt-Financial Short term or variable interest rate on Low Moderate High 12 mo.
foreign debt as % of total debt
Current account/GDP Debt-Financial 36 mo. declines, 24 mo. rises Less than 2% 2-5% Greater than 5% 24 mo.

Co-incident Indicators
Debt/GDP Debt-Financial Less than 30% 30-50% Greater than 50% 0
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Debt/Exports Debt-Financial Less than 150% 150-250% Greater than 250% 0

Lagging Indicators
Bond ratings Debt-Financial No change Fall Falling 0
Risk ratings Debt-Financial No change Fall Falling 0

Overall Rating
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Vulnerabilities
Commodity prices Debt-Financial Export concentration by product Low Moderate High 36 mo.
Export concentration Debt-Financial Concentration by country Low Moderate High 36 mo.
Environment Debt-Financial General political & economic environment Favorable Neutral Unfavorable 36 mo.

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Contagion Debt-Financial See vulnerabilities to contagion Low Moderate High 36 mo.
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Macroeconomic Characteristics of a Currency Crisis: Indicators of Vulnerability
Variable Before Crisis After Lead Time

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Real effective exchange rate 24 mo. 5-10% overvalued vs normal Declines 24 to 3 mo.
Change in international reserves (months of imports) 18 mo. Rises, 3-6 mo. Declines 20-30% Rises 18 to 3 mo.
Export growth 12 mo. Decline in growth 5-10%points Declines 12 mo.
Trade balance (net exports as % imports) 9 mo. Sharp decline Improves 9 mo.
Industrial/mfg. growth 18 mo. Rises 2-5%points above norm Falls 12 mo.
Stock price change (US$) 9 to 6 mo. Decline 20% Falls 9 to 6 mo.
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Inflation 24 mo. Increased, 15 mo. Moderated Surged 24 to 15 mo.
Change in M2-to-reserves ratio 24 mo. Rising, 3 mo. Jumps Falls 24 & 3 mo.
Nominal M2 growth 24 mo. Increase, 18 mo. Declines Declines 24 to 18 mo.
Real M2 growth 24 mo. Increase, 12 mo. Declines Declines 24 to 12 mo.
Nominal private credit growth 24 mo. High 10-20%, 15 mo. Falls Rises 24 to 15 mo.
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Change in M2-toM1 ratio 24 mo. High-rising, 15 mo. Plummets, 9 mo. Rises Rises 24 to 9 mo.
Banking crisis 12 mo. Before currency crisis 12 mo.

Macroeconomic Characteristics of a Banking Crisis: Indicators of Vulnerability

Variable Before Crisis After Lead Time
Annual real GDP growth 36 mo. high 1-3%points, 12 mo. declines Falls 12 mo.
Investment (% of GDP) 36 mo. high 3-6%points, 24 mo. falls Falls 24 mo.
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Fiscal balance (% of GDP) 36 mo. high 1-4%points, 12 mo. falls Falls 12 mo.
Annual rate of inflation 36 high 5-20%points, 24 mo. falls Rises 24 mo.
Change in nominal exchange rate 36-12 mo. high, 12 mo. falls Falls 12 mo.
Real effective exchange rate 36 mo. high rising, peaks at crisis Falls 36 mo.

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Domestic credit (% of GDP) 36 mo. rising Rises 36 mo.
Ratio of M2 to M1 (Logs) 36 mo. high & rising, 12 mo. falls Stable 12 mo.
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Change in stock prices (US$) 36-24 mo. high, 12 mo. plummets Rises 12 mo.
Current account (% of GDP) 36 mo. declines, 24 mo. rises Rises 24 mo.
Short term capital inflow (% of GDP) 36 mo. increases, 12 mo. falls Rises 12 mo.
Private capital inflow (% of GDP) 36 mo. high 5-12%, 24 mo. declines Falls 24 mo.
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 12
International Financial Contagion: Indicators of Vulnerability (Experience during the 1990s)
Variable Before Crisis After Lead Time
Real effective exchange rate appreciation 36 mo. 15%points higher than normal 36 mo.
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Ratio of current account deficit to GDP 12 mo. 2%points higher than normal 12 mo.
Ratio of short-term debt to total debt 12 mo. 6%points higher than normal 12 mo.
Ratio of short-term debt to reserves 12 mo. 200%points higher than normal 12 mo.
Ratio of M2 to reserves 12 mo. 30%points higher than normal 12 mo.
Real interest rate 12 mo. 4%points higher than normal 12 mo.
GDP growth 36 mo. 1-2% slower than normal 36 mo.
Unemployment rate 36 mo. 4%points higher than normal 36 mo.
Real domestic credit growth 36 mo. higher than normal 36 mo.
No
Common creditor 12 mo. 10%points higher share of debt

Composite Indicators
External imbalances Real exchange rate appreciation, productivity growth in export 36 to 12 mo.
sector, and current account deficit
tC
Domestic macro imbalances Fiscal deficit % GDP and M2 growth relation to GDP. 36 to 12 mo.
Portfolio management spillovers Common creditors and short-term debt as a % of total debt 36 to 12 mo.
Reserve adequacy Ratios of M2 to reserves and short-term debt to reserves 36 to 12 mo.
Trade spillovers Regional trade linkages, price competition from exchange rate 36 to 12 mo.
changes, and export market growth effects.
Credit expansion, exchange rate appreciation, ratio of M2 to reserves 36 to 12 mo.
op
Source IMF, World Economic Outlook, May 1998, based on 1975-97 (50 countries, deviation from trend in tranquil period).

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