Capital inflows, exchange market pressure, and credit growth in four transition economies with fixed exchange rates

With the transition from planned economic systems to membership in the European Union, capital inflows and domestic credit have expanded tremendously in Central and Eastern Europe. Four of these countries-Estonia, Latvia, Lithuania, and Bulgaria-maintain fixed exchange-rate regimes, which may face pressure because of rapid credit growth or during a slowdown. This study uses a Vector Autoregressive (VAR) approach to assess the contribution of capital inflows to exchange market pressure in these four countries, as well as to the growth of domestic credit. Both FDI and non-FDI flows are shown to feed credit growth in Bulgaria, but not the Baltics. Relatively volatile flows, particularly non-FDI inflows, reduce EMP in three of the four countries.