Contagious financial crises and emerging countries: Lessons for China
Financial contagion is currently receiving an increasing amount of attention in the literature on international macroeconomics. The present study explored the mechanism of financial contagion, reviewed the experiences of contagious crises in a sample of transition economies and drawn out a number of policy lessons to deal with this process. In light of the experiences in these transition economies, the policy stance of China was examined, and some recommended policies were proposed so this country may prevent the occurrence of such crises in the future. Findings from the study revealed that financial contagion could be warranted and unwarranted. The warranted contagion described crisis in a domestic economy spreading to a foreign country with similar macroeconomic structure and fundamentals via trade and financial channels. The unwarranted contagion reflected a situation where economies exhibiting different fundamentals experienced crises driven by investors’ herd behavior. Transition economies were more vulnerable to warranted contagion due to their deteriorated financial fundamentals in the process of transition. Premature financial liberalization exacerbated crises that were partially attributed to unwarranted contagion. Applying the theoretical study to three transition economies, the following results emerged. First, in addition to enhancing the traditional fundamentals- inflation rate, economic growth, external debt, current account balance, and exchange rate regime-police makers in transition countries had to improve some new fundamentals: domestic banking system, financial institution supervision, and state-owned enterprises reform. Second, improving transparency in financial system and sequencing capital account liberalization should be implemented in transition countries as well. Experiences of three transition countries demonstrated that the development and reform of the banking system should have a high priority on the agenda for policy makers in China. It is crucial that Chinese government establishes clear legal and institutional guideline, implements adequate prudential supervision, clearly defines accounting and auditing practices, and restructures state-owned enterprises. Liberalization of capital account transactions should be sequenced carefully to ensure that they will function efficiently and that they can be properly regulated.