Assessing indicators of currency crisis in Ethiopia : signals approach
Institute of Development Policy and Management
Antwerp :UA, Institute of Development Policy and Management, 2013
IOB working paper ; 2013:07
University of Antwerp
Currency crises, generally defined as rapid depreciations of a local currency or loss of foreign exchange reserves, are common incidents in modern monetary sys - tems. Due to their repeated occurrence and severity, they have earned wide coverage by both theoretical and empirical literature. However, unlike advanced and emerg - ing economies, currency crises in low-income countries have not received due atten - tion. This paper uses the signals approach developed by Kaminsky et al. (1998) and as - sesses currency crisis in Ethiopia over the time frame January 1970 to December 2008. Using the Exchange Market Pressure Index (EMPI), we identify three currency crisis episodes that coincide with the liberalisation following the fall of Ethiopian socialism, the Ethio-Eritrean border conflict, and the zenith of the global financial crisis. The tim - ing shows the importance of both local and international dynamics. More macro-eco - nomic indicators picked up the first crisis in a 24 month signalling window, compared to the latter two. Three categories of indicators were used: current account, capital account and domestic financial sector. None of the capital account indicators were significant based on the noise-to-signal ratio rule. One possible explanation for this might be the weak integration of the Ethiopian economy with global capital markets.