No. 55, Julius Horváth (1998): Currency crisis in the Czech Republic in May 1997

The inherited macroeconomic stability combined with the decisive pro-western and pro-market oriented economic policy and rhetoric has made the Czech transition the darling of international investors and commentator in the first half of the 1990s. Favourable assessments of the Czech experience abounded. Part of this success – at least as it was perceived at that time – was also the Czech monetary and exchange rate policy. A fixed exchange rate regime was introduced on January 1st 1991, and persisted for more than six years. It was seen by some policy makers and by part of the public as a symbol of the Czech success. However, a worsening of the macroeconomic situation in the second half of the 1990s, combined with political instability at the beginning of 1997 and with contagious effect from the Asian crisis led to currency crisis in May 1997 and consequently to the abandonment of the peg. Together with other factors this has changed the perception of the Czech transition performance and consequently a more negative view of the Czech transition emerged. It seems to be important to understand how this change in performance and perception occurred, and what was the role of the currency crisis in it. Indeed, this is exactly what this paper intends to do. We deal with a relatively new issue: currency crisis in the transition economy. To our knowledge the Czech currency crisis in May 1997 was the first typical currency crisis in the advanced part of the Second World. The Czech currency crisis was definitely far less spectacular than the Russian crisis in summer 1998, or the crisis in the South-East Asia in 1997, however, it still exhibited most of the basic characteristics of the currency crisis. These include worsening of some macroeconomic fundamentals and political instability before the crisis followed by a speculative attack and an attempt to defend the currency, and finally after approximately ten days depreciation and the change of the exchange rate regime. There was a variety of factors which played a role in inducing the crisis. It seems to be very difficult to estimate to which extent which factor contributed to the crisis, however it can safely be said that the high current account deficit combined with slow growth, political instability and contagious effects created a situation in which one-way bet against the koruna seemed to be winning strategy.

Project leader:
Julius Horváth