Over the past decade, a series of major crises in emerging market economies has forced analysts to look anew at the tools they use to identify macroeconomic vulnerabilities. One important contribution to our understanding of how capital account crises occur is the “balance sheet approach.” This analytical framework examines the stocks of assets and liabilities in an economy’s main sectors for maturity, currency, and capital structure mismatches. It is intended to complement the IMF’s traditional flow-based analysis, which assesses variables such as external current account and fiscal balances for potential vulnerabilities.
The balance sheet approach helps to highlight how even domestic problems in one sector can spill over into other sectors and eventually trigger an external balance of payments crisis. Such a crisis can result from a plunge in demand for the financial instruments of one or more sectors as creditors lose confidence either in a country’s ability to earn foreign exchange to service external debt, or in the government’s ability to service its own debt, in the banking system’s ability to meet deposit outflows, or in corporations’ ability to repay bank loans and other debt, or in some combination of these.
If one sector finds itself unable to attract new financing or roll over existing short-term liabilities, it must then either find the resources to pay off its debts or seek a restructuring of them. Ultimately, a plunge in demand for a sector’s liabilities leads to a reallocation of demand to foreign assets and/or to assets denominated in foreign currency, touching off problems for other sectors and, sometimes, an entire economy or regional group of national economies. Massive outflows of capital, a sharp depreciation of the exchange rate, a large current account surplus, and a deep recession are often the necessary counterparts to a sudden decline in investors’ willingness to hold a country’s accumulated stock of financial instruments.
Work in progress
At this stage, applications of the balance sheet approach are being focused on member countries where balance sheet weaknesses, particularly currency mismatches, appear largest and where the IMF’s efforts will add the most value in reducing vulnerabilities. These include emerging market countries and those of systemic importance where balance sheet developments can generate negative regional or international externalities. The IMF will also continue to work with industrial countries to refine balance sheet analysis and to integrate their assessments into Article IV consultations, specifically in staff studies of potential risks from equity and housing price bubbles in mature countries.
More work on the balance sheet approach is also envisaged at both the analytical and operational levels. The IMF’s First Deputy Managing Director, Anne Krueger, summing up an October 2004 Executive Board discussion on the balance sheet approach, underscored that it cannot be applied mechanically, and added that there is no intent at present to make it a standardized element of IMF surveillance. Data limitations and other constraints complicate application of the balance sheet approach to many countries. Nevertheless, staff’s work suggests that a great deal of insight can be gleaned from even partial data. Going forward, the IMF will work with member countries to improve the statistical basis for its assessment of balance sheet vulnerabilities. An initial step toward operationalizing the balance sheet approach would be the development of simple ratios that can be easily calculated and compared across countries and time.
The full text of “Debt-Related Vulnerabilities and Financial Crises—An Application of the Balance Sheet Approach to Emerging Market Countries” is available at www.imf.org/external/np/pdr/bal/2004/eng/070104.htm.
The IMF Survey (ISSN 0047-083X) is published in English, French, and Spanish by the IMF 22 times a year, plus IMF in Focus. Opinions and materials in the IMF Survey do not necessarily reflect official views of the IMF. Any maps used are for the convenience of readers, based on National Geographies Atlas of the World, Sixth Edition; the denominations used and the boundaries shown do not imply any judgment by the IMF on the legal status of any territory or any endorsement or acceptance of such boundaries. Text from the IMF Survey may be reprinted, with due credit given, but photographs and illustrations cannot be reproduced in any form. Address editorial correspondence to Current Publications Division, Room IS7-1100, IMF, Washington, DC 20431 U.S.A. Tel.: (202) 623-8585; or e-mail any comments to firstname.lastname@example.org.
To request an IMF Survey subscription ($79.00 annually for private firms and individuals) or IMF publications, please contact IMF Publication Services, Box X2005, IMF, Washington, DC 20431 U.S.A. Tel.: (202) 623-7430; fax: (202) 623- 7201; e-mail: