To our knowledge, the only paper that has pursued a similar line of analysis is Atoyan (2010). This paper expands his analysis, however. First, vulnerability is defined more broadly. Atoyan uses two indicators of external vulnerability: namely the current account deficit and the accumulation of external debt. By contrast, we consider vulnerability to be multifaceted, covering both external and domestic dimensions. For instance, external vulnerabilities may be a source of risk, but they might occur with or without banking sector vulnerabilities. Thus, monitoring banking sector developments is also critical. Second, our focus is primarily on the policy angle. To this end, controls are introduced not only for a country’s initial conditions and economic structure, but also for global push factors that might impact the growth-vulnerability dimensions. This allows a more detailed examination of the role of economic policies; namely, the role of fiscal, monetary, and exchange rate policies, as well as of de jure measures on capital account liberalization. Finally, the interpretation of the estimated coefficients from multinomial logits is always cumbersome. This paper puts forward two graphical representations based on underlying probabilities that, in our view, facilitate the interpretation of the estimation results.

**Table 1: External Positions of Western Banks vis-à-vis Transition Countries and Turkey** (adjusted for exchange rate changes)

||Levels|(in billions o|f US$)|Levels|(in % of 2008|GDP)|Flows (in % of|2008 GDP)|
|---|---|---|---|---|---|---|---|---|
||2007Q3|2008Q3|2010Q2|2007Q3|2008Q3|2010Q2|2007-2008|2008-2010|
|Latvia|18.6|23.4|18.0|55.0|69.0|53.1|14.0|-15.9|
|Estonia|17.2|19.1|16.0|72.6|80.7|67.5|8.1|-13.2|
|Lithuania|16.0|22.3|17.8|33.9|47.3|37.8|13.3|-9.4|
|Ukraine|24.0|38.1|22.7|13.3|21.2|12.6|7.8|-8.5|
|Romania|49.5|70.2|59.4|24.2|34.4|29.1|10.1|-5.3|
|Russia|178.0|210.3|126.9|10.7|12.6|7.6|1.9|-5.0|
|Kazakhstan|18.0|21.2|15.0|13.3|15.6|11.1|2.3|-4.5|
|Bulgaria|13.2|24.6|22.4|26.5|49.2|44.9|22.7|-4.3|
|Turkey|125.2|156.1|138.5|17.1|21.4|19.0|4.2|-2.4|
|Bosnia & Herzegovina|3.9|4.6|4.2|20.8|25.0|22.7|4.2|-2.3|
|Hungary|72.2|94.3|90.7|46.4|60.6|58.3|14.2|-2.3|
|Moldova|0.4|0.6|0.5|6.2|10.6|8.7|4.4|-2.0|
|Poland|95.6|128.2|123.1|18.1|24.2|23.3|6.2|-1.0|
|Croatia|39.3|42.2|41.6|56.7|60.9|60.1|4.2|-0.8|
|Belarus|2.5|3.1|2.8|4.1|5.1|4.5|1.0|-0.5|
|Georgia|0.5|0.5|0.5|3.7|4.3|3.8|0.6|-0.5|
|Azerbaijan|1.5|3.6|3.5|3.2|7.8|7.6|4.6|-0.2|
|Armenia|0.2|0.2|0.3|1.3|1.9|2.6|0.6|0.7|
|FYR Macedonia|0.3|0.5|0.6|3.1|5.4|6.5|2.2|1.1|
|Albania|0.6|0.7|1.2|4.3|5.5|9.4|1.2|3.9|

Source: BIS Locational Statistics and IMF WEO Database October 2010; authors’ calculations.

A caveat is in order. On the one hand, the strength of the results may be specific to the region, which indeed experienced some of the largest external imbalances (and, eventually, external adjustments) that emerging markets have ever had to tackle. Moreover, it must be acknowledged that some of the global events that characterized the increased process of integration might not repeat themselves in the near future; for example, the excessive global liquidity of 2003-07. On the other hand, however, some regularities are evident from the data and, thus, provide policy prescriptions going forward: a better understanding of the determinants of different growth-vulnerability combinations seems warranted and this paper attempts to provide some preliminary answers.

# **1. Methodology and Stylized Facts**

The goal of this paper is to empirically investigate the relative importance of economic policies and other factors in defining the balance between vulnerability (risk) and growth (reward). As mentioned earlier, a multifaceted approach to vulnerability is taken. Specifically, several indicators are 2