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APPENDIX I: Net Foreign Assets and the Saving-Investment Model: Steady-State Relationship
This appendix describes the steady-state relationship between the intertemporal saving-investment model of Section 2.a and the foreign asset considerations discussed in Section 2.c. The connection between the net foreign asset equilibrium and the intertemporal saving-investment model can be seen from the following relationship between the current account (CA), net exports excluding net interest payments (NE), and net interest payments (the product of the interest rate, if, and the beginning-of-period net foreign asset position): 1/
To obtain a stationary 2/ net foreign asset position (i.e., NFA-NFA(t)-NFA(t-l)), it is necessary that net foreign assets are proportional to the long-run net export balance, with the factor of proportionality depending on the interest rate on foreign assets:
The result is intuitive. Suppose a country were to maintain a positive net foreign asset position over the long-run. By itself, the net foreign assets would accumulate interest income thereby further increasing the net foreign asset position. To offset this effect, the country would have to run a deficit on its net exports. Hungary at present is clearly in the opposite situation: with its large negative net foreign asset position, even stabilizing net foreign assets at the present level would require a sizable surplus on net exports (excluding net interest payments, but including net transfers).
Prepared by Thomas Krueger.
For a more detailed discussion of earlier developments see IMF (1995). The most recent developments are discussed in the main Staff Report.
Other factors were also important, see SM/95/51 (3/15/95).
The Hungarian concept of net debt is defined as gross debt minus foreign exchange and other foreign assets; it excludes the stock of foreign direct investment (FDI).
The discussion below is necessarily selective and focusses on only one important theoretical model. Inter alia, some other approaches focus more directly on the exchange rate, including some purchasing power parity models; recent expositions and reviews in this area include Isard (1995) and Rogoff (1996).
Net exports consists of net exports of goods and services, including interest payments and other factor incomes, but excludes transfer payments.
However, to the extent that temporary shocks affect a country’s net foreign asset position—for example, a temporary deterioration in the current account raises the external debt level and increases the future financing need—temporary shocks may also have longer run implications for saving and investment and thereby the current account.
To some extent, these factors have an analogue on the capital account side. In particular, FDI-based financing may be able to sustain larger current account deficits or deficits for longer time periods. This has played an important role in recent years in Hungary.
The steady-state mapping between the two concepts is described in Appendix 1.
The relevant data series in Hungary are often too short to allow meaningful econometric analysis, especially for the period after the breakup of the CMEA trading regime in 1991. In addition, external balance of payments data, including on external trade, continue to be subject to substantial statistical weaknesses (see main Staff Report, Appendix V).
The following sections draw extensively on ongoing, and still preliminary, work at the Fund, and in particular a recent study by Debelle and Faruqee (1996).
For international comparability, the dependency ratio is defined here as the sum of the number of people under 19 and above 65, divided by the rest of the population. This understates the ratio in cases where the mandatory retirement age is below 65 or a portion of the working age population is not employed. These factors are likely to be more important in Hungary than in many other countries (for example, the mandatory retirement age is presently 55 for women and 62 for men and there is a large number of early retirees; see also the discussion in Chapter III). Still, with the planned reforms in the pension system and the demographic developments, Hungary’s dependency ratio should temporarily decline in the near to medium-term.
See Debelle and Faruqee (1996). On the other hand, they can not find statistically significant support in their cross-section analysis. It is possible, however, that some of the indirect effects of fiscal policy on the current account (including through the real exchange and interest rate) are difficult to disentangle in empirical studies, and that this accounts for the sometimes weak statistical results.
It may be more informative to choose a more distant rather than the current year as a reference point, thereby eliminating the effects of most temporary factors (like the cyclical position). Accordingly, the simulations use the year 2001, the final year of the present IMF’s World Economic Outlook projections, as a reference point.
In line with the model described in equation (6), one can solve for the value of the real exchange rate that would be consistent with the simulated values based on the estimated parameters. As an example, staff estimates indicate that a 1 percent improvement in the current account in 2001 (i.e., to a deficit of 1 percent of GDP) would be consistent with a 2/3 of 1 percent per annum depreciation of the forint in real terms relative to the staff’s baseline projections, resulting in a cumulative relative depreciation of the real value of the forint by about 3½ percent after five years (other exchange rate simulations are indicated in Tables 6-8). The simulations assume import and export price elasticities that sum to close to 2; this is somewhat larger than the averages reported in Goldstein and Khan (1985), reflecting the particular experience in Hungary.
In some respect, Hungary may also be closer to the experience of many developing rather than industrial countries. Here, even the point estimates based on developing countries’ comparisons indicate that the projected current account path for Hungary is appropriate (Table 8).
In the absence of more adequate data, the authorities’ net foreign debt figure is used as a proxy for Hungary’s net foreign asset position.
Staff projects a moderate improvement in competitiveness over the medium-term, reflecting relatively strong projected productivity growth in Hungary (see EBS/96/18, 2/5/96, and main Staff Report).
For international comparability, this concept is used in Table 9. It differs from the net debt data for Hungary reported in the main Staff Report, which are net of foreign exchange reserves but also net of other foreign assets. As shown in the text table above, net debt at end-1996 is estimated at 35 percent of GDP versus about 44 percent of GDP for external debt net only of foreign exchange reserves.
For simplicity, it is assumed that there are no valuation or other capital gains or losses on net foreign assets, other than those recorded in the current account.