2016 External Sector Report

After narrowing in the aftermath of the global financial crisis and remaining broadly unchanged in recent years, global imbalances increased moderately in 2015, amid a reconfiguration of current accounts and exchange rates. Shifts in 2015 were driven primarily by the uneven strength of the recovery in advanced economies, the redistributive effects of the sharp fall in commodity prices, and tighter external financing conditions for emerging markets (EMs). A relatively stronger U.S. outlook led to a further appreciation of the USD and a depreciation of the yen and the euro. The sharp decline in commodity prices, reflecting both supply shocks and concerns about rebalancing and growth in China, brought about a significant redistribution of income from commodity exporters to importers, and a weakening of commodity exporters’ currencies. Meanwhile, heightened global risk aversion, contributed to softer capital inflows and depreciation pressures in many EMs. This moderate widening of current account imbalances was largely driven by systemic economies. Surpluses in Japan, the euro area and China grew, supported by improved terms of trade and currency depreciation, while the current account deficit in the U.S. widened amid the steep appreciation of the USD. These widening imbalances were only partially offset by narrowing surpluses in large oil exporters and smaller deficits in vulnerable EMs and some euro area debtor countries. Similarly, excess imbalances expanded in 2015. External positions in the U.S. and Japan moved from being broadly in line with fundamentals to being “moderately weaker” and “moderately stronger”, respectively. This was partly offset by a further narrowing of excess deficits in vulnerable EMs and euro area debtor countries. Meanwhile, excess surpluses persisted among the larger surplus countries, some of which remain “substantially stronger” than fundamentals (Germany, Korea). Currency movements since end-2015 helped to partially reverse the trends observed last year, although market volatility following the result of the U.K. referendum to leave the European Union have led to a strengthening of the USD and yen along with a weakening of the sterling, euro, and EM currencies. The implications for external assessments going forward, especially for the U.K. and the euro area, remains uncertain and will likely depend on how the transition is managed and on what new arrangements are adopted. With output below potential in most countries, and limited policy space in many, balancing internal and external objectives will require careful policy calibration. In general, a more balanced policy mix that avoids excessive reliance on policies with significant demanddiverting effects is necessary, with greater emphasis on demand-supportive measures and structural reforms. Surplus countries with fiscal space have a greater role to play in supporting global demand while reducing external imbalances. Global collective policy action, especially if downside risks materialize, would also help address global demand weakness while mitigating its effects on external imbalances.

Abstract

After narrowing in the aftermath of the global financial crisis and remaining broadly unchanged in recent years, global imbalances increased moderately in 2015, amid a reconfiguration of current accounts and exchange rates. Shifts in 2015 were driven primarily by the uneven strength of the recovery in advanced economies, the redistributive effects of the sharp fall in commodity prices, and tighter external financing conditions for emerging markets (EMs). A relatively stronger U.S. outlook led to a further appreciation of the USD and a depreciation of the yen and the euro. The sharp decline in commodity prices, reflecting both supply shocks and concerns about rebalancing and growth in China, brought about a significant redistribution of income from commodity exporters to importers, and a weakening of commodity exporters’ currencies. Meanwhile, heightened global risk aversion, contributed to softer capital inflows and depreciation pressures in many EMs. This moderate widening of current account imbalances was largely driven by systemic economies. Surpluses in Japan, the euro area and China grew, supported by improved terms of trade and currency depreciation, while the current account deficit in the U.S. widened amid the steep appreciation of the USD. These widening imbalances were only partially offset by narrowing surpluses in large oil exporters and smaller deficits in vulnerable EMs and some euro area debtor countries. Similarly, excess imbalances expanded in 2015. External positions in the U.S. and Japan moved from being broadly in line with fundamentals to being “moderately weaker” and “moderately stronger”, respectively. This was partly offset by a further narrowing of excess deficits in vulnerable EMs and euro area debtor countries. Meanwhile, excess surpluses persisted among the larger surplus countries, some of which remain “substantially stronger” than fundamentals (Germany, Korea). Currency movements since end-2015 helped to partially reverse the trends observed last year, although market volatility following the result of the U.K. referendum to leave the European Union have led to a strengthening of the USD and yen along with a weakening of the sterling, euro, and EM currencies. The implications for external assessments going forward, especially for the U.K. and the euro area, remains uncertain and will likely depend on how the transition is managed and on what new arrangements are adopted. With output below potential in most countries, and limited policy space in many, balancing internal and external objectives will require careful policy calibration. In general, a more balanced policy mix that avoids excessive reliance on policies with significant demanddiverting effects is necessary, with greater emphasis on demand-supportive measures and structural reforms. Surplus countries with fiscal space have a greater role to play in supporting global demand while reducing external imbalances. Global collective policy action, especially if downside risks materialize, would also help address global demand weakness while mitigating its effects on external imbalances.

Overview

1. The 2016 External Sector Report (ESR) documents the evolution of global external imbalances and provides an updated assessment of the external positions of 29 economies for 2015. Like past years, this Overview Paper summarizes the assessments detailed in the Individual Economy Assessments paper, while identifying cross-country patterns and policies that should be considered beyond the country level. A more thematic approach is taken, with a deeper exploration of the drivers of external imbalances and a discussion of the policy trade-offs arising from the persistence of both domestic and external gaps. The paper is organized as follows. Section II documents shifts in global external imbalances and exchange rates, with Section III discussing the role played by the different drivers of imbalances during 2015. Section IV assesses the evolution of stock imbalances, including the role of valuation effects. Section V provides a normative assessment of external positions (Box 1), and Section VI discusses the outlook and policy challenges, including tradeoffs between internal and external objectives and the role of global policy coordination.

Key ESR Concepts

Current account imbalance refers to any current account balance different from zero; i.e., surpluses or deficits, and may be appropriate or inappropriate.

Current account gap, or excess imbalance, the difference between actual imbalance and that assessed by staff to be consistent with fundamentals and desirable policies (or “norm”). It reflects distortions and other factors and strips cyclical effects as well as temporary effects from terms-of-trade variations. A current account balance deemed to be “stronger” (“weaker”) than implied by fundamentals and desired policies implies a positive (negative) gap. Eventual elimination of such gap is desirable, though there may be good reasons for a gradual adjustment. REER gap corresponds to underlying CA gap; adjustment of an excess imbalance would involve a change in expenditure (domestic demand) as well as a change in REER. A positive (negative) REER gap implies an overvalued (undervalued) exchange rate. REER gaps are not necessarily related to expected future exchange rates, and may occur in any economy, including those with floating exchange rates.

Multilateral consistency of the assessments means that too-high current accounts of some economies are matched by the too-low current accounts of others.

External sector position refers to the overall assessment based on multiple indicators used in this Report, namely current account balances (and the counterpart financial account balance), international investment positions and exchange rates. External Balance Assessment (EBA) methodology Quantitative methods developed by IMF staff to inform, but not solely determine, assessments

(http://www.imf.org/external/pubs/ft/wp/2013/wp13272.pdf).

Evolution Of Global External Imbalances And Exchange Rates

2. After narrowing sharply in the aftermath of the global financial crisis (GFC) and remaining broadly unchanged in recent years, global current account imbalances increased moderately in 2015 (Figure 1 and Table 1). The widening of imbalances was led by systemic economies, with growing current account surpluses in Japan, the euro area and China, and increasing deficits in the United States. Surpluses also grew in many commodity-importing advanced economies (Korea, Sweden, Switzerland, Singapore, Hong Kong), and deficits increased in some commodity exporting advanced economies (Australia, Canada). This widening was partly offset by reduced surpluses of large oil exporting countries (most noticeably Saudi Arabia and Norway, with the former shifting into a large deficit) as well as narrowing deficits in key EMs (Brazil, Indonesia, South Africa, Turkey). Current accounts in euro area improved in most countries, and especially in debtor countries which either moved further into positive territory (e.g. Italy, Portugal, Spain) or closed most of their previously large deficits (Box 2). Meanwhile, the current account statistical discrepancy fell sharply, likely reflecting the drop in the value of global trade (see Oct. 2009 WEO).

Figure 1.
Figure 1.

Evolution and Reconfiguration of Global Current Account Balances, 2001-15

Citation: Policy Papers 2016, 005; 10.5089/9781498345545.007.A001

Sources: World Economic Outlook and IMF staff calculations.1/Surplus AEs: Korea, Hong Kong SAR, Singapore, Sweden, Switzerland, Taiwan POC; AE Commodity Exporters: Australia, Canada, New Zealand; Deficit EMs: Brazil, India, Indonesia, Mexico, South Africa, Turkey; Oil Exporters: WEO definition plus Norway.2/ Red (green) bubbles indicate widening (narrowing) of imbalances. Bubble sizes are proportional to the change in current account, in percent of world GDP (i.e., contributions to reconfiguration of global imbalances).
Table 1.

Selected Economies: Current Account Balance, 2012-15 1/

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Source: World Economic Outlook and Fund Staff calculations.

Sorted by size (in USD) of surplus and deficit in 2015.

2/ For India, data are presented on a fiscal year basis.

External Adjustment in the Euro Area

External positions of systemic countries in the euro area have improved markedly since the global financial crisis. This process of external adjustment has been particularly visible in countries with large external deficits, which have witnessed steep improvements in their current accounts—all of which have reached or are near positive territory by now. Most noticeable adjustments have taken place in Greece and Portugal, (10-11 percentage points of GDP since 2010) followed by Italy and Spain (5-6 ppts). The adjustment can be largely explained by the marked contraction in domestic demand, supported by the real depreciation of the euro (10 percent during 2010-15) resulting from relatively weak cyclical position easy monetary policy in the euro area. The weakening of the euro through mid-2015, also allowed the external position of creditor countries to strengthen further. As a result, the euro area’s aggregate current account surplus (3 percent of GDP) is largely explained by the large surpluses in Germany (8 percent of GDP), and the Netherlands (9 percent).

Mirroring the strengthened current accounts, the euro area’ net foreign asset position has improved steadily since 2012, mostly on account of the growing positions

of creditor countries. Stock positions of debtor countries remain largely negative, especially in Greece (124 percent of GDP), Portugal (107) and Spain (89), although they have recently started to narrow as current account balances have turned positive.

uA01fig01

Systemic Euro Area. Evolution of External Position, 2005-15

(percent of Euro Area GDP)

Citation: Policy Papers 2016, 005; 10.5089/9781498345545.007.A001

Sources: World Economic Outlook, Lane and Milesi-Ferretti dataset and IMF staff estimations.1/ Index (2010=100). Weighted average using GDP as weights.2/ 2015 based on current account only (no valuation effects).

3. Sharp real exchanges rate movements accompanied the reconfiguration of current

accounts. In varying degrees, most countries depreciated in nominal terms vis-à-vis the U.S. dollar during 2015, leading to a sharp appreciation of the latter in real effective terms, as well as of currencies closely linked to it (Figure 2). Closely tied to the USD, China’s currency also appreciated sharply in real terms. The euro and the yen depreciated significantly both in nominal and real terms, as well as currencies of many commodity-exporting economies (e.g. Australia, Brazil, Canada, Russia). These sharp currency movements during 2015 occurred on the back of large shifts already in train from previous years, and contributed in different degrees to recent current account dynamics (Box 3).

Figure 2.
Figure 2.

Selected Economies: Real and Nominal Exchange Rates, 2001-16

Citation: Policy Papers 2016, 005; 10.5089/9781498345545.007.A001

Sources: IMF international Financial Statistics; World Economic Outlook Database, Global Statistics Database.1/ GDP-weighted average of ESR countries.

Exchange Rates and Trade: Disconnected?1

Recent exchange rate movements have been unusually large, triggering a debate on their effects on trade and countries’ external positions.2 Some new studies suggest that the increasing role of global value chains (GVCs) has reduced the relevance of exchange rate movements for trade flows.3 This is not the first time conventional wisdom regarding exchange rate elasticities has been questioned.4 A key question is whether this time is different, possibly reflecting the changing structure of world trade (e.g., rise of GVCs, trade liberalization, increased international competition, inflation moderation, etc.) or whether, once lags have played out, the apparent disconnect between exchange rates and trade will once again dissipate.

To answer this question, a recent study (IMF, 2015a) explores the link between exchange rate and trade, estimating four elasticities (exchange rate-to-price and price-to-volume, both for exports and imports) at the individual-economy level using annual data for 60 economies over the period 1980-2014. Results (Table 1) indicate that exchange rate movements typically have substantial effects on relative trade prices, with the estimates of long-term pass-through elasticities in the 0-1 interval. On average, a 10 percent real effective currency depreciation increases import prices by 6.1 percent, reduces export prices in foreign currency by 5.5 percent relative to competitors’ prices, and is associated with a rise in real net exports of about 1.5 percent of GDP. Most of the effects take place in the first year.

Table 1.

Exchange Rate Pass-Through and Price Elasticities1/

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Source: IMF staff estimates.Table reports simple average of individual economy estimates for 60 economies during 1980-2014.

See details in Fall 2015 World Economic Outlook and Leigh and others (forthcoming).

A variant of this approach is undertaken to investigate possible changes in the relationship over time via structural breaks or rolling regressions. The results suggest that, possibly with the exception of Japan, exchange rates have not generally become disconnected from trade (Table 2).

Table 2.

Trade Elasticities over Time

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Source: Authors’ estimates.1 *p < 0.1;

p < 0.05

p < 0.01.

Overall, these findings indicate that, while changes in the structure of trade (especially the rise of global value chains) may have weakened the relationship between exchange rates and trade in some specific countries, there is limited evidence of a general disconnect between exchange rates and trade. The role of flexible exchange rates in facilitating the resolution of trade imbalances remains key.

1Prepared by Daniel Leigh, Weicheng Lian, Marcos Poplawski-Ribeiro and Viktor Tsyrennikov. See further details in Fall 2015 World Economic Outlook and Leigh and others (forthcoming).2Japan’s recent experience of a sharp real depreciation but little near term trade responses had an important bearing in the debate.3See, for example, Ollivaud, Rusticelli, and Schwellnus (2015) or Ahmed, Appendino, and Ruta, (2015).4In the late 1980s, the U.S. dollar depreciated, and the yen appreciated sharply after the 1985 Plaza Accord, but trade volumes were slow to adjust, leading some commentators to suggest a disconnect between exchange rates and trade. By the early 1990s, however, U.S. and Japanese trade balances had adjusted, after some lags, largely in line with the predictions of conventional models. See Krugman (1991).

Drivers Of Global Imbalances In 20151

4. The evolution of external balances and exchange rates during 2015 was driven by a confluence of related factors. Key drivers included the asymmetric recovery and associated monetary policies in systemic advanced economies, the sharp drop in commodity prices (especially oil), and tightening external financial conditions for EMs, in part reflecting concerns related to China’s rebalancing process and prospects of monetary policy normalization in the U.S. The importance of these factors varied during the course of 2015. The U.S. dollar appreciated sharply throughout the year reflecting the relatively strong outlook of the U.S. economy and expectations of monetary policy lift-off, while China-related uncertainties gained prominence during the second half of 2015, accompanied by a further weakening of commodity prices. This section explores the role of each of these factors in the evolution of external current accounts.

Asymmetric Recoveries in Systemic Economies

5. Uneven recoveries and expectations about monetary policies led to marked exchange rate movements across systemic currencies, supporting the widening of their external imbalances.

Stronger recoveries in the U.S. and the U.K.—relative to the euro area and Japan—and divergence over the expected path of monetary policy, led to a significant strengthening of the U.S. dollar and sterling, and a weakening of the euro and yen in 2015. These shifts contributed to a widening of the U.S. current account deficit and an expansion of surpluses in both the euro area (debtor and creditor countries) and Japan, the latter also supported by larger terms of trade gains (see further discussion below). Meanwhile, the real appreciation of the renminbi helped contain China’s surplus. Exchange rate movements among major currencies, although not unprecedented, were sharp from a historical perspective, and built on trends in place since 2010-11 (Figure 3). Since late-2015, a partial reversal of some of these currency trends has taken place, especially for the yen and sterling, largely driven by revised expectations about monetary policies and idiosyncratic factors (¶128). Financial conditions, however, remain fluid, especially following the U.K. referendum, and the real effects of both the direction and volatility of reserve currency movements have yet to play out.

Figure 3.
Figure 3.

Selected Systemic Economies: Long-Term View of the Real Effective Exchange Rate, Jan. 1980-May 2016

(Index, Average 1980-2016=100)

Citation: Policy Papers 2016, 005; 10.5089/9781498345545.007.A001

Source: IMF Information Notice System.

The Commodity Price Decline

6. The sharp fall of commodity prices brought about a sizable redistribution of income across countries, although its direct impact contributed only modestly to a narrowing of global imbalances. A measure of the terms-of-trade income windfall—which reflects the direct effect of changes in trade prices on current accounts (keeping quantities constant)—indicates a significant income transfer, primarily from heavy oil exporters (notably Russia and Saudi Arabia) to net commodity importers such as the U.S., China, Japan, Korea, and Germany (Figure 4). This direct income effect contributed to narrowing imbalances of commodity exporting countries with surpluses (most notably oil exporters), and commodity importing countries with deficits (U.S., U.K.). However, much of such contributions to the narrowing of global imbalances was offset by a widening of deficits in commodity exporters (notably, Australia, Canada, Mexico) and of surpluses in commodity importers (China, euro area, Japan, Korea).

Figure 4.
Figure 4.

Terms-of-trade Income Windfalls, and Global Imbalances, 2015 1/

Citation: Policy Papers 2016, 005; 10.5089/9781498345545.007.A001

Sources: IMF International Financial Statistics,WEO, and IMF staff calculations.1/ Methodological detailsare provided in Appendix I. Countries with small ToT income shocks (lessthan 0.01% of world GDP) are excluded.2/ Classification into commodity exporter/importer based on the direction of the terms-of-trade movement in 2015.

7. Exchange rates generally moved with the terms-of-trade shock, although other factors also played an important role in commodity importing countries (see also April 2016 WEO). For the most part, exchange rates responded as expected to the terms-of-trade shock and helped support external adjustment in both commodity exporters and importers, as countries with depreciating currencies observed a stronger response of net export volumes (Figure 5). With the notable exception of Saudi Arabia and other smaller but heavy oil exporting countries with pegs, most commodity exporters observed an important weakening of their currencies, Meanwhile, commodity importers’ currencies tended to appreciate (or depreciate less), with the notable exceptions of the euro area and Japan. The movement of the latter currencies, however, were dominated by other factors, including the relative strength of demand and the associated outlook for monetary policies.

Figure 5.
Figure 5.

Selected Economies: Terms-of-trade Income Shock, REER Changes and External Adjustment, 2015 1/

Citation: Policy Papers 2016, 005; 10.5089/9781498345545.007.A001

Sources: World Economic Outlook and IMF staff calculations.1/ Bubbles are proportional to the economy’s size (US$ GDP).

Tighter External Financing Conditions for Emerging Markets

8. In the case of EMs, current account balances and exchange rates also reflected a tightening in external financial conditions. Concerns over the rebalancing process in China and prospects of rising interest rates in the U.S. led to increased financial volatility, lower commodity prices, and higher borrowing costs for many EMs, especially for commodity exporters and economies with close trade links with China (see April 2016 WEO). The slowdown in inflows was not uniform, however, with differences reflecting also shifts in the demand for external financing (mainly related to the terms-of-trade shock) and country-specific factors (Figure 6).

Figure 6.
Figure 6.

Selected EMs: Capital Inflows, Current Account and Cost of External Financing, 2014-15

(Excludes China, Russia and Saudi Arabia, in percent of GDP, 4-quarter moving average)

Citation: Policy Papers 2016, 005; 10.5089/9781498345545.007.A001

Sources: Haver Analytics; Bloomberg; IMF, World Economic Outlook; IMF, Balance of Payment Statistics; and IMF staff calculations.1/ Commodity exporters include Argentina, Brazil, Chile, Colombia, Egypt, Malaysia, Mexico, Morocco, Peru, South Africa, Sri Lanka. Commodity importers include Costa Rica, Guatemala, Hungary, India, Indonesia, Pakistan, Philippines, Poland, Thailand, Turkey, Uruguay. GDP weighted averages are reported. Other countries not reported due to data limitations. Russia is excluded as 2014-15 dynamics mostly reflect idiosyncratic geopolitical factors.2/ EMBI sovereign spreads relative to January 2014 level.
  • Many EM commodity exporters observed a sharp increase in external financing costs yet only a minor slowdown in net inflows, reflecting the combination of tighter supply of external funding and greater financing needs to cover the direct impact of the negative terms of trade shock. Reserve use among this group was generally limited, with the key exception of Saudi Arabia (and other peggers) who drew on their foreign asset holdings to finance rising current account deficits and private capital outflows. In Russia, the sharp downward demand adjustment and a slowdown in private outflows prevented further decline in official reserves.

  • Meanwhile, many EM commodity importers saw a steeper reduction in net private inflows and only a moderate increase in spreads, suggesting the reduced demand for financing on account of the positive income shock played a larger role. A key exception was China, where, despite a higher surplus, the intensification of private outflows (both from foreign and domestic sources), led to sizable reduction in official foreign assets and a tighter enforcement of capital flow management measures (Box 4).

    China’s Domestic Rebalancing and External Imbalances

    After peaking at nearly 10 percent of GDP in 2007, China’s current account surpluses narrowed significantly in subsequent years, plateauing in the 1¾/4-¾ percent of GDP range since 2011. This narrowing was driven by a sharp increase in investment in the years following the GFC, a decline in the national savings rate, and weakness in advanced economies.

    Since 2011, investment has gradually come down, as China began rebalancing its economy towards domestic consumption, supported by a sharp (33 percent) real appreciation of its currency. In 2015, however, subdued exports, worries over China’s growth outlook, a shift in expectations about relative returns on RMB assets, and general uncertainties over the direction of policies led to record capital outflows and balance of payments pressure. These net capital outflows (6 percent of GDP in 2015) more than offset the current account surplus, resulting in a sizable decline in reserves (3 percent of GDP), the first in two decades.

    Over the medium term, as the economy rotates further toward private consumption and away from external demand, the trade surplus is expected to narrow and the services deficit to rise with healthy outbound tourism. The volume of capital outflows is expected to be broadly steady with the dominant force being the continued secular trend in residents’ portfolio rebalancing toward foreign assets amid the gradual opening of the capital account. Pressure on FX reserves is projected to remain manageable under the baseline.

    uA01fig02

    Balance of Payments and REER, 2002-15

    (percent of GDP)

    Citation: Policy Papers 2016, 005; 10.5089/9781498345545.007.A001

    Sources: WEO and IMF Staff estimates.1/ Non-Reserve flows include errors and omissions.
    uA01fig03

    Saving and Investment, 2002-15

    (percentof GDP)

    Citation: Policy Papers 2016, 005; 10.5089/9781498345545.007.A001

9. In most cases, the use of foreign exchange intervention to mitigate the effect of tighter financial conditions and the commodity price shock was limited. Although there is some evidence of balance sheet effects still constraining their buffering role (Box 5), exchange rates moved sharply in most EMs, consistent with a commodity price decline perceived as mostly permanent—and against a backdrop of economic slack and lack of inflationary pressures. Aside from Saudi Arabia and China who drew down their reserves, foreign exchange intervention was limited and deployed in a few cases (Malaysia, Mexico, Thailand, and Turkey) where reserves were used to stem very rapid currency depreciation and associated volatile conditions (see further discussion in paragraph 21).2 Reflecting these net FX sales—partially offset by purchases in India, Switzerland, and Hong Kong—official holdings of reserves assets fell moderately in 2015 (by about US$220 billion, or 1.9 percent of the stock of official reserves of EBA/ESR countries). The decline in the USD value of global reserves also reflected valuation effects, mainly due to the appreciation of the USD via-a-vis other reserve currencies (Figure 7).

External Adjustment and FX Exposure*

Although most EMs allowed their exchange rate to play a buffering role in the face of external and domestic shocks during 2015, the extent of exchange rate flexibility differed across countries. This box explores the role balance sheet dollarization may have played in explaining these cross-country differences, following earlier work, most notably by Calvo and Reinhart (2002).

While currency mismatches fell across EMs over the last decade (see April 2016 WEO Chapter 2), large differences across countries remain. Moreover, improvements in the net foreign asset position do not fully capture underlying vulnerabilities, especially since gross liabilities have also grown (and FX exposure has rotated from the public to the private sector, where incomplete hedging is more likely, see Chapter 3 in October 2015 GFSR). A simple look at the data suggests that countries with larger FX debt positions experienced smaller depreciations in 2015, with differences in FX exposure

explaining roughly 20 percent of the variation in currency movements in major EMs.

The role of liability dollarization in constraining exchange rate depreciation is also assessed in a panel regression involving 15 non-pegged EMs during periods of USD appreciation and negative terms of trade shocks.1 The change in the nominal exchange rate ( %AUSDER, ) is regressed against the change in commodity terms of trade (ACToTi ), the change in USD exchange rate vis-à-vis the systemic currencies (%AUSDS3 ) controlling for the country’s gross FX liabilities to GDP.2
%USDERit=αi+β0%CTOTit+β1%USDS3t+β2%USDS3t×FXDEBTi¯+εit

Country fixed effects are used to control for time-invariant factors that can drive both the degree of dollarization and the extent to which shocks affect the currency. The estimation amounts to a difference-in-difference approach where the interaction term captures the differential response (within-country across-years) to movements in the USD, depending on the average degree of each country’s liability dollarization.

Results suggest that FX exposure dampens the degree of exchange rate flexibility (see Table). A USD appreciation against other systemic currencies similar in magnitude to that observed in 2015 is associated with a depreciation of 22 percent for countries in lower dollarization quartile and 14 percent in the upper quartile. This difference of 8ppts is large and amounts to 2 standard deviations of exchange rate movements in the sample. Similar results are obtained when looking at the response to terms of trade shocks (column 2) and the results carry through to the response of the real, rather than the nominal exchange rate (columns 3-4). Similar results hold when using FX intervention as a dependent variable.

FX-denominated debt and exchange rate response to negative shocks

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Robust standard errors in parentheses

p<0.01,

p<0.05,

p<0.1

While limiting exchange rate flexibility may be appropriate where FX exposure is large, this does not resolve the underlying problem. Coherent macro policies coupled with measures targeted to address balance sheet exposures are necessary to avoid a more disorderly adjustment process, including the negative confidence effects associated with a rapid pace of reserve loss.

* Prepared by Mai Da.1 Include are Brazil, Chile, Colombia, India, Indonesia, Korea, Malaysia, Mexico, Peru, Philippines, Russia, South Africa,3 The systematic difference in the propensity to intervene during depreciations is also confirmed when estimating a reserve reaction function at monthly frequency for the 2 groups of countries.
Figure 7.
Figure 7.

Selected Economies: Gross International Reserves, 2005Q1-2016Q1

(In billions of U.S. dollars)

Citation: Policy Papers 2016, 005; 10.5089/9781498345545.007.A001

Source: IMF International Financial Statistics. Last observation corresponds to March 2016.

Global External Adjustment

10. The confluence of these factors shaped current account and exchange rate adjustments, resulting in a moderate widening of global external imbalances. While the commodity price shock and the uneven recovery in advanced economies had first order effects, the tightening of financial conditions in EM appears to have had more localized impact.

  • Among commodity exporters, the dominant factor was the sharp decline in commodity prices, which resulted in weakening current accounts, despite significant (net export volume) adjustments (Figure 8). Consistent with mitigating external imbalances, deficit commodity exporters offset a sizably larger share of the income loss, in comparison to surplus commodity exporters. With a few exceptions, exchange rate flexibility played a key role in cushioning the negative terms-of-trade shock, including by reducing the need for large fiscal adjustment (where currency depreciations contained the loss of commodity revenues measured in local currency). Imports contracted in these economies, reflecting shrinking domestic demand, and especially investment (most notably in the energy sector), which also responded to tighter financing conditions. Generally, countries with larger policy buffers were in a better position to smooth the income loss (Box 6), although sizable cuts in government spending were still necessary in the largest oil exporters (Saudi Arabia and Russia).

    External Adjustments in Oil Exporting Countries

    The collapse in oil price during 2015 had significant effects on the external positions of large oil exporting countries. With only a few exceptions (Norway, UAE, Kuwait, Qatar), the drop in (net) oil exports exceeded the previous year’s current account surplus (especially for Algeria, Kazakhstan, Oman, Saudi Arabia, Turkmenistan, Venezuela).

    Responses to this large terms-of-trade shock varied widely, depending mostly on the extent of external buffers available to finance the arising external deficits. Countries with the strongest net foreign asset (NFA) positions—most of which had pegged exchange rates—relied on the use of these buffers to limit the near-term impact of the shock, offsetting with domestic demand compression only a minor share of the income loss. For many of these economies, the brunt of the adjustment is yet to take place, and sustained fiscal consolidation will need to underpin their exchange rate regime.1 Other countries allowed their exchange rates to play a greater buffering role—either within their floating regimes or by abandoning or recalibrating their pegged exchange rates (e.g. Azerbaijan, Kazakhstan, and more recently Nigeria—and witnessed a greater degree of adjustment to the income shock.

    uA01fig05

    NFA Position and Adjustment to Oil Shock, 2014-15

    Citation: Policy Papers 2016, 005; 10.5089/9781498345545.007.A001

    Sources: IMF International Financial Statistics, WEO, and IMF staff estimates.1/ Circle sizes are proportional to the fall in net oil revenues (in US$).
    uA01fig06

    Nominal and Real Effective Exchange Rate, 2015

    Citation: Policy Papers 2016, 005; 10.5089/9781498345545.007.A001

    1 See further discussion in “Learning to Live with Cheaper Oil: Policy Adjustment in MENA and CCA Oil Exporting Countries,” IMF, 2016 (b).
    Figure 8.
    Figure 8.

    External Adjustment in Commodity Exporters & Importers, 2015

    (percent of GDP, GDP-weighted avg. by group)

    Citation: Policy Papers 2016, 005; 10.5089/9781498345545.007.A001

    Sources: IMF International Financial Statistics, and IMF staff estimates.1/ Deficit and surplus countries are classified based on CA balance in 2014. AE exclude USA, GBR, JPN, EA countries; EMEs exclude CHN, SAU, RUS. See Appendix I for technical details on the current account decomposition.2/ A negative import contribution to the net trade volume implies an expansion of imports.3/ A negative domestic demand contribution to the net trade volume implies an expansion of domestic demand.

  • Among commodity importers, terms-of-trade income gains were accompanied by weakening net trade volumes, with visible disparities between deficit and surplus countries. On aggregate, deficit commodity importers spent a large share of the income gains, while surplus importers saved most of the windfall. This pattern, leading to a widening of global imbalances, reflected the stronger recovery and currencies of large deficit countries (U.S. and U.K.), in comparison to the large surplus economies, especially Japan and the euro area. The latter two registered a widening of their surpluses, supported by weaker currencies. In Japan domestic demand growth was flat, amid a slight pickup in output; while in the euro area a welcomed pickup in demand outpaced output growth although not enough to offset the income gains from improved terms-of-trade. On aggregate, fiscal policy played a more limited role in the evolution of imbalances, as the pace of consolidation was relatively small and more evenly distributed across deficit and surplus countries.3 An important exception was China, where a large fiscal stimulus supported domestic demand and contained the expansion of the current account surplus from terms-of-trade income gains.

Evolution Of Stock Imbalances

11. Despite narrowing flow imbalances since the GFC, external stock imbalances have continued to widen. For most countries, current accounts did not change signs since the GFC. Continued current account deficits further weakened the largest debtors’ positions, while surpluses further strengthened the largest creditors’ positions (Figure 9). The expansion of global stock imbalances since the GFC, however, was largely skewed, with the largest deterioration in the U.S.—whose net debtor position reached about 11 percent of World GDP in 2015—while improvements were more evenly spread across Germany, the Netherlands, Korea and a number of commodity exporters (notably Brazil, South Africa, Russia, Saudi Arabia). Key exceptions to the pattern of widening stock imbalances are the heavily-indebted countries in the euro area, whose current accounts moved to positive territory in recent years, although their net stock positions remain largely negative.

Figure 9.
Figure 9.

Selected Economies: Stock Imbalances and Current Accounts, 2010-15

(percent of GDP)

Citation: Policy Papers 2016, 005; 10.5089/9781498345545.007.A001

1/ Bubble size proportional to countries USS GDP.

12. Valuation effects played varying roles across economies, exacerbating stock imbalances in some systemic economies but mitigating in others, especially EMs.

  • Since the GFC, and in contrast to the crisis’ run-up period, valuation effects worked to widen stock imbalances in some systemic economies. The U.S.’s net foreign asset (NFA) position weakened by close to 25 percentage points of GDP since 2010, with negative valuation effects contributing over two-thirds of the total, and reflecting an increase in the value of liabilities due partly to the post-crisis recovery in equity prices, and the recent appreciation of the USD (Figure 10). For the UK, the marked NFA weakening during 2010-14 (14 percentage points of GDP), reversed entirely in 2015 (19 percentage points) on account of valuation effects. Similarly, in Japan positive valuation effects— resulting in part from gains associated with the weakening of the yen—were largely responsible for the close to 15 percentage points of GDP improvement in its NFA position. Valuation effects were less important in most euro area countries.

    Figure 10.
    Figure 10.

    Selected Economies: Drivers of NFA Changes, 2010-15

    (percent of GDP)

    Citation: Policy Papers 2016, 005; 10.5089/9781498345545.007.A001

    Sources: Haver Analytics; IMF, International Financial Statistics (IFS) database; IMF, Financial Flows Analytics database; IMF, World Economic Outlook database; Bénétrix, Lane and Shambaugh 2015; and IMF staff calculations.See Technical Appendix for more details.

  • In contrast, valuation effects and relatively strong output growth worked to reduce stock imbalances (relative to income) in China and some key EMs. Despite persistent, albeit smaller, current account surpluses, China’s NFA position fell somewhat since the GFC mainly on account of the renminbi’s strengthening and continued high output growth rates. Valuation effects played a key role in helping to contain (and in some cases reduce) stock imbalances in many EMs, especially those with large USD asset positions and a sizable share of their liabilities in equity and local currency (Brazil, South Africa, Russia).

13. Unlike earlier episodes of tightening in external conditions, valuation effects have played a supporting role in many EMs (Figure 11). Efforts to build official and private foreign assets, and to improve the composition of liabilities (by increasing the share of equity and local currency liabilities) have changed the (valuation) impact of exchange rate movements on EM’s external positions. Unlike past episodes of balance of payment pressures, the widespread depreciations during 2015 have been accompanied by improvements in the NFA positions in many EMs, highlighting their increased resilience to external shocks.

Figure 11.
Figure 11.

Selected Economies: NFA Changes around Large Exchange Rate Depreciations

Citation: Policy Papers 2016, 005; 10.5089/9781498345545.007.A001

Sources: External Wealth of Nations Mark II data set (Lane and Milesi-Ferretti 2007); Haver Analytics; IMF, International Financial Statistics; IMF, World Economic Outlook database; Lane and Milesi-Ferretti 2012; and IMF staff calculations.

Normative Assessment Of External Positions

14. This section summarizes the staff assessments of countries’ external positions, included in the companion paper. Current accounts and real exchange rate assessments for 2015 are compared to previous ones as well as the results from the EBA regressions, which are the main methodological tools for a multilaterally consistent evaluation of external positions and are based on data and IMF staff projections prior to the U.K. referendum (Box 1). The section also discusses the key drivers behind the assessments, including the role of domestic policies.

15. Differences in current accounts and real exchange rates across countries are generally explained by staff-assessed norms (i.e., fundamentals). Countries with persistently large current account surpluses (deficits) continue having correspondingly large (small) current account norms (Figure 12). Differences in staff-assessed norms largely reflect relative differences in income and institutional development levels, growth prospects, demographics, and NFA position, as well as other idiosyncratic variables related to a country’s non-renewable resource wealth, and reserve currency and financial center status.4 To control for temporary and cyclical factors, adjustments to the current account are made to abstract from the economy’s cyclical position and temporary changes in its terms of trade (Box 7). Given difficulties and uncertainties in their assessment, staff-assessed norms are presented in ranges.

Figure 12.
Figure 12.

ESR Economies: Cyclically-adjusted Current Accounts. Actual vs. Staff-Assessed Norm, 2015

Citation: Policy Papers 2016, 005; 10.5089/9781498345545.007.A001

Source: IMF Staff estimates.1/ Adjusted for both the relative output gap and terms of trade gap. Sorted by mid-point of the CA norm.

Treatment of Commodity Shocks in the EBA1

The treatment of commodity terms of trade (TOT) differs for the current account (CA) and real effective exchange rate (REER) regressions depending on the duration of the shock. A permanent TOT gain that boosts real income and wealth is expected to appreciate the REER, but to have limited impact on the CA level, as permanent real income and spending would move in tandem. On the other hand, a temporary change in the TOT would affect the CA via the consumption-smoothing channel and the inter-temporal substitution channel, although the overall impact is ambiguous as these work in opposite directions (Ostry, 1988). Given these conceptual priors, the country-specific commodity TOT index enters the EBA CA and REER regressions as follows:2

  • CA regression: The commodity TOT index is measured as a cyclical deviation from its trend, in order to capture only the temporary component of the shocks. This is estimated first by extending the time series into the medium term (using WEO-projected commodity prices) and then by using an HP filter for each country to obtain a country-specific series of the cyclical component. This measure is then interacted with trade openness (the ratio of exports plus imports of goods and services to GDP). The coefficient suggests that a temporary 1-ppt fall in the TOT is associated with a 0.25 percent of GDP fall in the CA in a country with an average level of trade openness. Recent TOT changes are estimated to explain about 1.2 and 0.6 percent of GDP of the CA deterioration for oil and nonoil exporters, respectively. Given that the actual CA balance deteriorated by much less the underlying CA improved.

  • REER regression: The commodity TOT index enters the regression without any adjustments in this case, to capture the effect of both temporary and permanent shocks. The estimated coefficient suggests that a 10 percent decline in commodity TOT leads to a 1 percent depreciation of the REER. This is somewhat lower that the coefficients in the literature based on data through mid-2000s. While REERs for oil and non-oil exporters depreciated by an average of 12and 3 percent, respectively, in 2015, the TOT coefficient contributed only a minor portion of this movement (1.3 and 0.3 percent for oil and non-oil, respectively).

For net oil and gas exporters, the CA regression also includes a measure of resource exhaustibility. This is necessary to capture energy exporters’ need to save a large portion of its income in recognition of inter-generational considerations related to the non-renewable nature of their commodity resources. CAs are positively related to the size of the energy trade balance, adjusted to the degree of “temporariness”, which is measured as the ratio of production to the stock of proven reserves (relative to Norway 2010 for multilateral consistency purposes). The estimated coefficient indicates that a 1-ppt of GDP increase in “temporariness” increase the CA norm by 0.6 ppts. The recent declines in oil prices led to a 0.4 percent of GDP decline in temporariness, raising the CA norm by 0.2-0.3 percent.

TOT shocks can also enter indirectly through its impact on medium-term growth estimates. A one percent decline in the 5-year ahead growth forecast is associated with (i) a 0.5 ppt of GDP increase in the CA balance; and (ii) a 2.5 percent weakening of the REER. Recent downward revisions in the medium-term growth forecast for commodity exporters (0.1 and 0.4 percent for oil and nonoil, respectively) are responsible for a slightly higher CA norm.

EBA CA Regression: Commodity Exporters

article image
Source: Staff Estimated CA regression.1/ Simple average across groups. Oil exporters include: Canada, Colombia, Malaysia, Mexico, and Russia. Non-oil exporters include: Australia, Brazil, Chile, Indonesia, New Zealand, Peru, and South Africa. Figures correspond to coefficient* contribution.
1 See: The External Balance Assessment (EBA) Methodology, 2013, IMF Working Paper 13-272; and Ostry, J. 1988, “The Balance of Trade, the Terms of Trade, and the Real Exchange Rate: An Intertemporal Optimizing Framework,” IMF Staff Papers, Vol. 35, No. 4.2 Commodity price indices are measured against manufacturing goods prices of advanced economies.

16. The reconfiguration of external imbalances during 2015, however, led to some shifts in staff-assessed excess imbalances (Figure 13 and Table 2). Changes in excess current account imbalances were concentrated in a few countries and driven in part by the confluence of factors discussed earlier.

Figure 13.
Figure 13.

ESR Economies: Staff-Assessed Current Account Gaps, 2014-15

(percent of GDP)

Citation: Policy Papers 2016, 005; 10.5089/9781498345545.007.A001

Source: IMF Staff assessments.1/ Mid-points of staff assessments. For some countries, changes in the gap could reflect new adjustments to the norm or actual current account (e.g. Korea’s income balance).
Table 2.

Summary of Staff-Assessed Current Account and REER Gaps, 2015

article image
Sources: IMF Staff Assessments and IMF International Financial Statistics (IFS).
  • External gaps widened among key systemic countries. The deterioration in the underlying U.S. current account deficit (after controlling for cyclical factors), supported by the sharp USD appreciation, led staff to shift its external assessment from “broadly consistent” with fundamentals and desired policies in 2014 to “moderately weaker” in 2015. In contrast, the improvement in Japan’s underlying current account moved its external assessment to “moderately stronger”. The euro area’s current account gap turned more positive, yet not enough to change the qualitative “broadly consistent” assessment. Staff-assessed external positions were broadly unchanged for China (“moderately stronger”) and the U.K. (“weaker”), even though both currencies strengthened in real terms between 2014 and 2015.

  • Within the euro area, external balances improved in most countries, although individual assessments continued to vary widely. Amid slightly larger excess surpluses, Germany and the Netherland’s external position remained “substantially stronger” and “stronger”, respectively. In France and Spain, excess deficits narrowed, although Spain’s external position remained “substantially weaker” given its still large negative NIIP. Belgium’s underlying current account deteriorated (shifting to become “moderately weaker”) although partly reflecting data revisions.

  • External gaps remained large and positive in many of the other surplus economies. Current accounts remained “substantially stronger” in Korea and Singapore, and “stronger” in Malaysia and Sweden, as their underlying current accounts were broadly unchanged.

  • The external position deteriorated in some of the large oil exporters, as buffers or external financing were used to mitigate the near-term demand impact of the commodity price shock. Canada and Saudi Arabia moved from “broadly in line” in both cases to “moderately weaker” and “substantially weaker”, respectively. The marked change in Saudi Arabia’s assessment highlights the additional adjustment (fiscal and structural) necessary over the medium term to achieve external balance.

  • Excess deficits continued to narrow in key EMs (Brazil, Indonesia, Russia, South Africa, Turkey), reflecting significant domestic demand adjustments since 2013 in the context of tighter external financing conditions, currency depreciation, and domestic uncertainties.

17. This reconfiguration implied a widening in excess imbalances of ESR economies as a group.

A simple indicator of aggregate current account gaps—given by the weighted average of the absolute value of staff-assessed current account gaps for ESR economies—reached 1.6 percent of world GDP in 2015, well above the levels estimated for 2013-14 (0.5-0.6 percent of GDP). Contributions to the excess surpluses were concentrated in China (mainly reflecting the size of its economy and despite no change in the assessed gap) and Germany, followed at a distance by Japan and Korea. Meanwhile, contributions to the excess deficits were dominated by the U.S., followed by the U.K., Saudi Arabia, Brazil, Canada and a few euro area countries (Belgium, France, and Spain). The increase in excess imbalances in the U.S., the euro area and Japan were largely responsible for the widening of gaps at the global scale, which more than offset the narrowing of gaps in vulnerable EMs and some euro area countries.

18. Current account and currency assessments point in the same direction, with differences in implied magnitudes in a few cases mainly reflecting lagged exchange rate effects (Figure 14). Consistent with 2015 current account gap assessments, the USD and pound sterling were considered overvalued; the yen undervalued; and the euro broadly in line (although slightly weaker than last year). China’s renminbi moved to become broadly in line with fundamentals (from moderately undervalued), despite its current account being stronger than fundamentals and desired policies, although its current account gap is projected to narrow with the delayed effects of the real appreciation and further progress in rebalancing. Meanwhile, currencies of most commodity exporters moved to become less overvalued than in 2014. The notable exception was Saudi Arabia, whose currency appreciated sharply in real terms, despite sharply lower oil prices, because of being pegged to the USD.

Figure 14.
Figure 14.

ESR Economies: Staff-Assessed REER and Current Account Gaps, 2015

Citation: Policy Papers 2016, 005; 10.5089/9781498345545.007.A001

Source: IMF Staff assessments.1/ Midpoints of REER and CA Gaps. Shaded area represents range for “broadly in line” assessment.

19. The staff-assessed external norms were broadly consistent with EBA regression results

(Figure 15). All three EBA models5 were used to assess countries’ external positions, although the current account model tended to carry a heavier weight in most assessments. Departures of staff assessments from the current account EBA results mainly centered on countries with large offshore financial centers and/or large income and service balances (Sweden, Switzerland, and to a lesser extent Korea) for which REER and CA EBA-models sometimes pointed in different directions. As in past years, staff carried out minor country-specific adjustments not captured by the EBA model. These adjustments are detailed and discussed in the companion paper. Meanwhile, REER regressions had a poorer fit for commodity exporters, partly reflecting the low estimated elasticities to terms-of-trade changes (Box 7). For countries with large negative NIIP (e.g. Spain, Turkey), the external sustainability approach carried a heavier weight in the final assessment of the external gap.

Figure 15.
Figure 15.

ESR Economies: Staff-Assessed vs. EBA Estimated Current Account and REER Gaps, 2015

Citation: Policy Papers 2016, 005; 10.5089/9781498345545.007.A001

Source: IMF Staff assessments.1/ Soreted by the mid-point of the Staff Assessed gap. Saudi Arabia, Hong Kong and Singapore and not included in EBA. For Saudi Arabia, the current account gap is a reflection of a fiscal policy gap related to the desirability of saving of oil export income.2/ REER gap is defined as the average of index and level based regressions. For Saudi Arabia the REER gap is not identified.

20. The factors explaining staff-assessed gaps vary significantly across countries (Figure 16). Contributions to the gap are derived from the EBA estimated policy gaps (fiscal, credit, reserves, health spending, capital controls), as well as other policies and distortions that are not captured by the model, the details of which are discussed in the country pages (Table 3). These “identified” policy gaps are estimated relative to the future desired level (when the economy is at full employment and not relative to the current conjuncture), and their overall contribution depends on how large the gap is relative to other countries.6

Figure 16.
Figure 16.

ESR Economies: Contributions of Policy Gaps to the 2015 Staff-Assessed Current Account Gap

(percent of GDP)

Citation: Policy Papers 2016, 005; 10.5089/9781498345545.007.A001

Source: IMF staff estimates and assessments.1/ Policy gaps after multilateral consistency adjustment.
Table 3.

Selected ESR Countries: Current Account Regression Policy Gap Contributions, 2015

(in percent of GDP)

article image
Source: IMF staff estimates.

Total contribution after adjusting for multilateral consistency.

Total domestic contribution is equivalent to coefficient*(P-P*)

  • External gaps and policies. Fiscal policy gaps are generally the largest contributors to overall “identified” policy gaps in most countries. Positive fiscal gaps (stronger-than-desirable fiscal stance) can explain a significant part of the excess surplus of some countries (e.g. Germany, Korea and Thailand), while negative fiscal gaps (weaker-than-desirable) are key contributors to the excess deficits in others (Belgium, Brazil, France, Spain, U.K.). While not part of EBA, Saudi Arabia’s large external gaps is assessed to be largely explained by the fiscal gap. In some cases (e.g. China, Japan, U.S.), estimated policy gaps cannot explain the staff-assessed external gap, suggesting that other policies or structural factors not captured by the model are playing a role. This does not imply, however, that the identified policy gaps are not individually important, since the contribution of different policy gaps could offset each other.

  • Role of changes in policy gaps. Key systemic economies (China, Japan, U.S. and U.K) registered improvements in their overall policy gaps during 2015, with fiscal consolidation playing a role in Japan, the U.S. and the U.K. However, these reduced policy gaps did not translate into a narrowing of external imbalances in all cases, highlighting the role of other underlying impediments (not identified by the model) to external adjustment. In a few cases (France, Spain), however, reduced policy gaps (mainly fiscal) contributed to the narrowing of external imbalances.

21. In the context of limited foreign exchange intervention, reserve coverage remained adequate for most EMs (Figure 17). Despite FX sales, reserves for China and Thailand remained well above the Adequacy of Reserves Metric (ARA), while reserve coverage for Mexico (with a Flexible Credit Line) remained within the desirable range. Reserve coverage improved in some cases (Brazil, Korea, Poland, Russia, South Africa), although these partly reflected improved short-term debt profiles, as well as lower export receipts, and a fall in monetary aggregates. Key exceptions include Malaysia and Turkey, whose reserve coverage became slightly less adequate. Foreign exchange intervention was not a visible contributing factor to the widening of external gaps during 2015. Reserve purchases were limited to a few financial and safe haven centers (notably Switzerland, Hong Kong), India and, to a lesser extent, Poland; while reserve sales took place mainly in countries with external positions deemed stronger (Malaysia, Mexico and Thailand) or in line with fundamentals (China).

Figure 17.
Figure 17.

Selected Economies: Foreign Exchange Intervention and Reserve Adequacy, 2014-15

Citation: Policy Papers 2016, 005; 10.5089/9781498345545.007.A001

Sources: IMF International Financial Statistics, International Reserves and Foreign Currency Liquidity Template, and IMF staff calculations.1/ Unadjusted metric, except for China, India and Thailand which metrics are adjusted for capital flow measures.2/ Estimated FXI encompasses changes in international reserves from BOP statistics (net of estimated income flows) and estimated non-spot interventions. Non-spot interventions include aggregate positions in forwards and futures in foreign currencies vis-à-vis the domestic currency (including the forward leg of currency swaps), and financial instruments denominated in foreign currency but settled by other means.

22. Progress in reducing excess external imbalances has stalled in the last years, and recent shifts raise some concerns (Figure 18). In particular, there has been little progress in reducing imbalances at the top end of the distribution. Most countries with external positions deemed “substantially stronger” (Germany, Korea, Singapore) or “stronger” (Malaysia, Netherlands) than implied by fundamentals and desired policies have remained in that category since 2012-13. At the bottom of the distribution progress there has been slightly more progress, although external positions have remained “substantially weaker” (Spain) and “weaker” (Turkey), given still very large negative NIIP positions and despite improvements on flows. Meanwhile, there has been some narrowing of negative external gaps in key EMs (Brazil, Indonesia, Russia, South Africa) and some debtor euro area countries (Italy, France). The re-emergence of excess imbalances in Japan and the U.S., although a symptom of the asymmetry in their recoveries, point to the need to better balance policies and global demand going forward.

Figure 18.
Figure 18.

ESR Economies: Evolution of External Assessments, 2012-15

Citation: Policy Papers 2016, 005; 10.5089/9781498345545.007.A001

Outlook And Policies

23. Since 2015, currencies have been subject to large fluctuations—including following the U.K. referendum.7

  • Particularly noteworthy has been the appreciation of yen, which after weakening since late 2011 (35 percent in real terms), strengthened sharply (about 15 percent through June 2016) relative to the 2015 average, reflecting revised market perceptions about monetary policy in Japan vis-a-vis other reserve currencies as well as safe have flows. This suggests the yen has moved towards a level consistent with medium-term fundamentals, although this rapid appreciation may undermine efforts to lower deflation risks. 8 The USD, after some weakening earlier this year, strengthened recently in response to increased global risk aversion, and remains broadly unchanged relative to 2015 (suggesting a similar degree of overvaluation).

  • The sterling weakened moderately in the months preceding the referendum (about 5 percent in real terms relative to the 2015 average) and steeply afterwards. Meanwhile, the euro, after strengthening earlier in the year, weakened more recently and remains broadly unchanged in real terms relative to 2015. The overall implicatio