Revisting Capital Account Convertibility in the Aftermath of the Currency Crisis

The paper analyses the causes of the Asian Financial Crisis 1977/79. The increase in cross-border capital mobility and the issues of regulating sequencing of trade liberating and capital account convertiblity are also discussed. A typology of generation-models of currency crises is analyzed. It is argued that the Asian Financial Crisis was not the result of profiligate fiscal policies inconsistent with the currency peg as postulated in the First-Generation Models. Nor was the Asian Financial Crisis due to self-fulfilling expectations converting a (no bank-run) equilibrium to a sudden bank-run disequilibrium causing the collapse of the currency peg as subsumed in the Second -Generation Models. But it was due moral hazard behavior of lenders operating under implicit government guarantees that resulted in lending to risky projects. Sudden exogenous shocks resulted in herd and panic behavior causing foreign lenders to recall of short-term capital, thereby converting a liquidity crisis into insolvency crisis as postulated by the Third-Generation Models. The case for revamping the domestic banking and financial structure and the International Financial Architecture to mitigate the recurrence of global finacial crises is also debated in the paper