Stress test for reforms - Transition and East Asian 'contagion'

Contagion from East Asia imposed a severe 'stress test' on the market-orien ted reforms of transition economies. We find that the portfolio reallocatio ns of investors differentiated sharply among these economies at the height of the East Asian turmoil, appearing clearly in the relative movements in i nterest rates and share prices. Those countries that appeared more vulnerab le to contagion had large public or private sector imbalances and low reser ve cover of short-term debt. The analysis, however, goes beyond macroeconom ic and financial imbalances to link these weak fundamentals to inadequate s tructural and institutional reforms. We find that flaws in public finances together with weak enterprises and financial institutions were key underlyi ng factors in the vulnerability to East Asian contagion. They were also key causes of the Russian crisis, which initiated a new round of contagion dri ven primarily by high exposures to Russian trade.