Persistent External Deficits and Balance of Payments Crises1

Persistent external deficits are a recurrent phenomena in low and middle income countries. We define a new empirical measure to identify balance of payment crises related to the accumulation of persistent external deficits. Using a non-parametric difference-in-differences estimator we identify and estimate a critical value for the accumulated current account deficits just before the crisis sets off. Countries that have increased their external indebtedness by an accumulated amount of at least 26%-31% of the GDP in a time span of 3 to 5 years suffer a crisis, which includes a consumption fall of 3.1% and a current account reversal of 4.9 percentage points of GDP. These crises are far more severe than an average sudden stop. Thus, our results suggest that fast accumulation of external debt though current account deficits may generate severe crises, even when compare with sudden stops