## 2019 External Sector Report — Preface and Executive Summary (selected excerpts) ## Source details **Canonical URL:** [2019 External Sector Report — Preface and Executive Summary (selected excerpts)](https://www.imf.org/-/media/files/publications/esr/2019/english/text.pdf) ## Other formats - [Markdown version](/-/media/files/publications/esr/2019/english/text.pdf.md) - [Structured JSON version](/-/media/files/publications/esr/2019/english/text.pdf.json) --- ### Purpose, scope, and methodology - Produced since 2012, the IMF’s annual External Sector Report analyzes global external developments and provides multilaterally consistent assessments of external positions for the world’s largest economies (representing over 90 percent of global GDP). - Chapter focus: - Chapter 1: multilateral issues and how individual economies fit into the global picture; policies needed to reduce global imbalances. - Chapter 2: role of exchange rates in external adjustment, emphasizing dominant currency invoicing and integration into global value chains. - Chapter 3: “Individual Economy Assessments” with policy recommendations for 30 economies. - This year’s report and associated external assessments are based on the latest vintage of the External Balance Assessment (EBA) methodology and on data and IMF staff projections as of June 20, 2019. - Normative assessment framework: - Current account gaps = actual current account (stripped of cyclical and temporary factors) minus level consistent with fundamentals and desirable medium-term policies. - Positive (negative) current account gap = excess surplus (deficit). - REER gaps assessed consistent with CA gaps; REER gaps do not predict future exchange rates. - Overall assessments consider current account balances, REERs, financial account balances, international investment positions, reserve adequacy, and competitiveness measures. ### Key global findings and diagnostics - Global imbalances and stock positions: - Overall global current account balances (absolute sum of surpluses and deficits) about 3 percent of global GDP in 2018. - IMF multilateral approach suggests about 35–45 percent of overall current account surpluses and deficits were deemed excessive in 2018. - At the global level, excess current account imbalances narrowed from about 1.4 percent of global GDP in 2017 to about 1.2 percent in 2018. - Net creditor positions are about 20 percent of global GDP and at a historical peak—four times the level prevailing in the early 1990s. - Geographic concentration: - Higher-than-warranted balances centered in the euro area as a whole (driven by Germany and the Netherlands) and in other advanced economies (Korea, Singapore, Sweden). - Lower-than-warranted balances concentrated in the United Kingdom, the United States, and some emerging market economies (Argentina, Indonesia). - China’s external position assessed to be in line with fundamentals and desirable policies as its CA surplus narrowed. - Risks and vulnerabilities: - Short-term financing risks generally contained because debtor positions concentrated in reserve-currency-issuing advanced economies. - Intensification of trade tensions or a disorderly Brexit could affect economies highly dependent on foreign demand and external financing. - Over the medium term, absent corrective policies, entrenched trade tensions and further divergence of external stock positions could trigger costly disruptive adjustments with global spillovers. ### Recent external developments (2018–19) - Trade, prices, and currency movements: - China’s CA surplus narrowed from 1.4 percent to 0.4 percent of GDP in 2018. - United States CA deficit broadly unchanged at 2.3 percent of GDP in 2018 despite a sizable fiscal impulse. - The euro and renminbi appreciated slightly against the US dollar in 2018, translating into average annual real effective appreciations ranging between 1½ percent and 3 percent; the yen remained generally unchanged. - Emerging market REER movements (average 2018): Argentina about –20 percent; Turkey about –15 percent; Brazil, India, Indonesia, and Russia changes between 3 percent and 10 percent. - Estimates through end-May 2019: real appreciation of the US dollar and yen (about 3 percent relative to the average for 2018 in both cases) and a weakening of the euro (2½ percent). - Trade tensions and growth: - US tariffs on subsets of Chinese imports totaling $250 billion in 2018 and further tariff actions in 2019 contributed to a sharp slowdown in global trade and industrial production. - IMF staff simulations estimate: - 2018 tariffs projected to lower global GDP by 0.2 percent in 2020. - Recently announced and envisaged tariffs could reduce global GDP by an additional 0.3 percent in 2020 (simulations assume retaliatory actions by China). - Announced tariff increase: from 10 percent to 25 percent on $200 billion of US imports from China as of May 8, 2019. - Envisaged potential tariffs: 25 percent on the remaining $267 billion of US imports from China. - Examples of US import categories called out with values: Solar panel and washing machines ($10 Billion); Steel and aluminum ($18 Billion). ### Policy recommendations and priorities (global and country-agnostic) - Trade and multilateral framework: - Avoid policies that distort trade (including trade barriers and subsidies); both surplus and deficit countries should revive liberalization efforts and strengthen the rules-based multilateral trading system. - Excess deficit economies: - Give priority to growth-friendly fiscal consolidation. - Use macroprudential policies where credit growth or foreign-currency borrowing may be excessive. - Excess surplus economies: - Deploy available fiscal space to boost potential growth, including public infrastructure investment. - Avoid overreliance on monetary policy. - Implement reforms to encourage investment (support innovation, deregulation) and discourage excessive saving by households and corporations. - Exchange rate and structural policies: - Exchange rate flexibility remains key to facilitate external adjustment. - Sluggish near-term export responses—partly reflecting dominant currency invoicing and GVC integration—mean exchange rate flexibility may need complementary policies (improve access to credit, transport infrastructure, export finance). - Monitoring and methodology: - Monitor rising external debt liabilities closely for maturity and currency mismatches. - Continue improving EBA methodologies and data collection; exercise caution given large unexplained residuals. ### Scenarios and outlook for external stock imbalances - Three scenarios considered for creditor/debtor stock positions through 2030: - Baseline policies (WEO forecast): projected fiscal easing in the United States leads to larger US CA deficit over the medium term; stock imbalances projected to remain generally unchanged. - Unchanged current account scenario: current account balances remain constant at 2018 levels; creditor and debtor positions expand by an additional 5 percentage points of world GDP by 2030. - Current account at the norm scenario: countries’ CA gaps close; creditor and debtor positions narrow. - Projection stylized outcome: - Over time, global creditor and debtor stock positions would likely widen further by about 2 percentage points of world GDP by 2030 if corrective policies are absent. - Key risks: - Short term: intensified trade and geopolitical tensions, or a disorderly Brexit. - Medium term: disruptive adjustments in large debtor economies if creditor/debtor divergence persists; risk from sudden reassessment of the “r-g” relationship. ### Role of exchange rates, dominant-currency invoicing, and global value chains (GVCs) - Mechanisms and empirical evidence: - Dominant-currency invoicing (notably US dollar) and GVC integration alter short-term mechanisms of external adjustment; conventional exchange rate effects operate in the medium term. - Empirical trade-price pass-through (average effects): - A 1 percent change in the bilateral exchange rate → 0.2 percent change in trade prices in the exporter’s currency (short term, average). - A 1 percent change in the exchange rate vis-à-vis the US dollar → 0.45 percent change in trade prices in the exporter’s currency (short term, average). - Medium-term (three years) averages: - US dollar pass-through to export prices falls from 0.45 to 0.25; bilateral pass-through rises slightly to 0.25. - Heterogeneity by US dollar invoicing: - High US dollar invoicing countries (short term): bilateral pass-through to exporter-currency prices ≈ 0.1; US dollar pass-through ≈ 0.7. - Low US dollar invoicing countries (short term): bilateral ≈ 0.3; US dollar ≈ 0.2. - GVCs: - Greater GVC integration reduces exchange rate elasticity of gross trade volumes in short and medium term, but associated increase in gross trade flows largely offsets elasticity reduction in most cases. - Example medium-term elasticity of export volumes: low GVC integration ≈ 0.45; high GVC integration ≈ 0.3. - Quantitative illustrative effects of a 10 percent depreciation vis-à-vis all other currencies: - Short-term indirect estimation (Average effect): - Prices: Exports 6.31***; Imports 7.95*** - Volumes: Exports 0.516; Imports –2.88*** - Trade Balance (Percent of GDP): 0.322*** - Medium-term indirect estimation (Average effect): - Prices: Exports 5.07***; Imports 7.50*** - Volumes: Exports 4.32***; Imports –4.50*** - Trade Balance (Percent of GDP): 1.177*** - Direct estimation highlights different outcomes for low vs high US dollar invoicing. - Policy implication: - Exchange rate flexibility remains beneficial, especially in the medium term. - Because short-term effects can be muted by invoicing and GVCs, complementary macroeconomic and structural policies (e.g., improved access to credit, transport infrastructure, export finance) may be required to support adjustment. ### GVC-related exchange rate shocks and supply-chain flexibility (empirical box highlights) - Empirical specification uses FVA (foreign value added) and DVA (domestic value added) shares in exports and REERs of own and importing partners. - Short-term evidence rejects fully flexible task-based trade—supply chains are generally quite inflexible in the short term. - Estimated half-life for transition from short- to long-term relationships ≈ three to five years; closing three-quarters of short-term deviations requires six to nine years. - Policy conclusion: production complementarities imply trade barriers and exchange-rate shocks generate larger disruptions than under flexible trade-in-tasks assumptions. ### Selected country-level diagnostics and policy guidance (high-level highlights) - Aggregate concentration of excess imbalances: - Excess imbalances increasingly concentrated in advanced economies; excess current account imbalances estimated at about 1.2 percent of global GDP in 2018. - Representative country findings and exact numeric metrics (select examples preserved verbatim): - Germany (2018): - Actual CA: 7.3; Cycl. Adj. CA: 7.6; EBA CA Norm: 2.5; EBA CA Gap: 5.1; Staff CA Gap: 4.6 - NIIP: 60.6 (% GDP) - Staff assesses 2018 REER undervaluation in range of 8 to 18 percent. - Policy: use substantial fiscal space to invest; implement reforms to foster entrepreneurship and address aging costs. - United States (2018): - Actual CA: –2.3; Cycl. Adj. CA: –2.1; EBA CA Norm: –0.9; EBA CA Gap: –1.2; Staff CA Gap: –1.4 - NIIP: –47.4 (% GDP) - Staff assesses 2018 average REER overvaluation in the 6 to 12 percent range. - Policy: medium-term fiscal consolidation; roll back recently imposed tariffs. - China (2018): - Actual CA: 0.4; Cycl. Adj. CA: 0.3; EBA CA Norm: –0.4; EBA CA Gap: 0.8; Staff CA Gap: 0.8 - NIIP: 15.9 (% GDP); Reserves: US$3.1 trillion end-2018 (about 24 percent of GDP) - Policy: gradually consolidate fiscal and credit gaps while pursuing SOE reform, social safety net improvements, and exchange rate flexibility. - Indonesia (2018): - NIIP: –30.5; Gross Assets: 33.3; Reserve Assets: 11.6; Gross Liab.: 63.8; Debt Liab.: 36.2 (% GDP) - Actual CA: –3.0; Cycl. Adj. CA: –3.3; EBA CA Norm: –0.9; EBA CA Gap: –2.4; Staff CA Gap: –1.5 - Reserves end-2018: US$120.6 billion (12 percent of GDP) - Policy: exchange rate flexibility, reforms to improve labor markets and competitiveness, deepen financial markets. - Argentina (2018): - NIIP: 12.1; Gross Assets: 70.3; Res. Assets: 12.3; Gross Liab.: 58.2; Debt Liab.: 46.7 (% GDP) - Actual CA: –5.2; Cycl. Adj. CA: –6.8; EBA CA Norm: –2.5; EBA CA Gap: –4.3; Staff CA Gap: –3.0 - REER depreciation in 2018: about 18 percent; reserves end-May 2019: US$65 billion - Policy: fiscal consolidation under IMF-supported program; strengthen monetary and exchange policy frameworks; supply-side reforms. - Thailand (2018): - Actual CA: 7.0; Cycl. Adj. CA: 7.0; EBA CA Norm: 0.1; EBA CA Gap: 6.9; Staff CA Gap: 5.4 - NIIP: –0.5; Gross Assets: 96.4; Res. Assets: 43.2; Gross Liab.: 96.9; Debt Liab.: 29.5 (% GDP) - Reserves: 47.4 percent of GDP in 2018 - Policy: fiscal expansion using available space and structural reforms to reduce precautionary saving and boost domestic demand. - Individual country tables and detailed policy recommendations available in Chapter 3 (examples in text include Argentina, Australia, Belgium, Brazil, Canada, China, Euro Area, France, Germany, Hong Kong SAR, India, Indonesia, Malaysia, Mexico, Netherlands, Poland, Russia, Spain, Sweden, Switzerland, Turkey, United Kingdom, United States). ### Conclusions and policy implications (summary) - Exchange rate flexibility remains a central tool for external adjustment, with medium-term efficacy preserved despite short-term muting from dominant-currency invoicing and GVC integration. - When near-term exchange rate pass-through is weak, complementary policies (fiscal, macroprudential, structural reforms, capacity-enhancing measures) are needed to achieve timely rebalancing. - Avoid trade-distorting measures; focus on reviving multilateral liberalization and modernizing the rules-based trading system to address issues including e-commerce, services, subsidies, and technology transfer. - Strengthen monitoring of external stock positions, gross external financing needs, currency and maturity mismatches, and nonbank financial sector vulnerabilities. - Further empirical work recommended on invoicing choice, services trade, balance-sheet channels, and integration of trade and financial features into policy design. *Italic: Source: Preface, Executive Summary, Chapter 1–3 excerpts, Boxes and Annexes — 2019 External Sector Report (International Monetary Fund | July 2019).* ### Preface ### Preface ### Purpose and scope - Produced since 2012, the IMF’s annual External Sector Report analyzes global external developments and provides multilaterally consistent assessments of external positions, including current accounts, real exchange rates, external balance sheets, capital flows, and international reserves, of the world’s largest economies, representing over 90 percent of global GDP. - Chapter focus: - Chapter 1: multilateral issues and how individual economies fit into the global picture; policies needed to reduce global imbalances. - Chapter 2: role of exchange rates in external adjustment, emphasizing dominant currency invoicing and integration into global value chains. - Chapter 3: “Individual Economy Assessments” with policy recommendations for 30 economies. - This year’s report and associated external assessments are based on the latest vintage of the External Balance Assessment (EBA) methodology and on data and IMF staff projections as of June 20, 2019. - The report is part of a continuous effort, together with the World Economic Outlook and Article IV consultations, to assess and address spillovers from members’ policies on global stability. ### Key findings and diagnostics - After narrowing sharply in the aftermath of the global financial crisis, overall current account surpluses and deficits reached 3 percent of world GDP in 2018, declining marginally while rotating toward advanced economies in recent years. - The IMF’s multilateral approach suggests that about 35–45 percent of overall current account surpluses and deficits were deemed excessive in 2018. - Geographic and country concentrations of imbalances: - Higher-than-warranted balances remained centered in the euro area as a whole (driven by Germany and the Netherlands) and in other advanced economies (Korea, Singapore). - Lower-than-warranted balances remained concentrated in the United Kingdom, the United States, and some emerging market economies (Argentina, Indonesia). - China’s external position was assessed to be in line with fundamentals and desirable policies, as its current account surplus narrowed further. - Net creditor and debtor positions: - Net creditor positions have continued to increase and, at about 20 percent of global GDP, are at a historical peak—four times the level prevailing in the early 1990s, with net debtor positions reaching a similar magnitude. - Risks and vulnerabilities: - Short-term financing risks from the current configuration of external imbalances are generally contained, as debtor positions are concentrated in reserve-currency-issuing advanced economies. - An intensification of trade tensions or a disorderly Brexit outcome could affect economies highly dependent on foreign demand and external financing. - Over the medium term, absent corrective policies, trade tensions could become entrenched, and further divergence of external stock positions could trigger costly disruptive adjustments in key debtor economies with global spillovers. ### Policy recommendations and priorities - Macroeconomic policy mix: - With output near potential in most systemic economies, a well-calibrated macroeconomic and structural policy mix is necessary to support rebalancing. - Excess deficit countries (United Kingdom, United States) need to adopt or continue with growth-friendly fiscal consolidation. - Excess surplus economies should deploy available fiscal space to boost potential growth and achieve rebalancing (Germany, Korea, Netherlands), including by boosting public infrastructure investment, and avoid overreliance on monetary policy where applicable. - Structural reforms: - Excess surplus countries should adopt reforms that encourage investment and discourage excessive saving, including by supporting innovation and deregulating certain sectors (Germany, Korea), widening the coverage of social safety nets (Korea, Malaysia, Thailand), and addressing rising and high corporate saving. - Excess deficit countries should increase labor market flexibility and improve competitiveness, including by strengthening the skill base of workers (Canada, Indonesia, South Africa, Spain, United Kingdom, United States). - In the euro area, higher wage growth in key creditor economies is necessary for rebalancing while accommodative monetary conditions remain necessary to support the return of area-wide inflation to its objective. - Even in economies broadly in line with fundamentals, targeted structural reforms are necessary to tackle domestic imbalances and prevent a resurgence of external imbalances (China, Japan). - Use of exchange rates: - Exchange rate flexibility remains key to facilitate external adjustment. - Sluggish near-term export responses in some cases—partly reflecting dominant currency invoicing and global value chain integration—suggest that exchange rate flexibility may need to be supported with other policies. ### Role of exchange rates, trade invoicing, and global value chains - Chapter 2 highlights that dominant currency invoicing and global value chain integration can alter short-term mechanisms of external adjustment. - Conventional exchange rate effects on trade flows remain operative in the medium term. - Policy implication: exchange rate flexibility is important but may need complementary policies when trade features weaken near-term pass-through to exports. ### Preparation, contributors, and process - The report was prepared under the overall guidance of Gita Gopinath, IMF Economic Counsellor and Director of Research, and under the direction of the External Sector Coordinating Group. - Lead preparers: Gustavo Adler and Pau Rabanal. - Contributors include staff from IMF area departments, the Fiscal Affairs Department, the Statistics Department, the Strategy, Policy, and Review Department, the Monetary and Capital Markets Department, and the Research Department, and numerous named individual contributors and editorial and production staff. - The analysis benefited from comments and suggestions by staff members from other IMF departments, and by Executive Directors following their discussion of the report on July 10, 2019; projections and policy considerations are those of IMF staff. *Source: Preface, 2019 External Sector Report (text - Preface).* ### EXECUTIVE SUMMARY ### EXECUTIVE SUMMARY ### Overview and key findings - Global imbalances have declined considerably since the global financial crisis, but progress has been more limited in recent years, with increased concentration in advanced economies. - Persistence of current account surpluses and deficits has led to a continued widening of stock imbalances, reaching record levels. - Recent trade measures are weighing on global trade, investment and growth, with no discernible impact on external imbalances thus far. - Near-term financial risks from the current configuration of global imbalances are generally contained; however, an intensification of trade tensions and a disorderly Brexit could adversely affect economies highly dependent on foreign demand and external financing. - Over the medium term, absent corrective policies, trade tensions could become entrenched, and further divergence of external stock positions could trigger costly disruptive adjustments in key debtor economies with global spillovers. ### Recent external developments, 2018–19 - Global current account surpluses and deficits narrowed marginally in 2018; overall global current account balances (the absolute sum of surpluses and deficits) inched down to about 3 percent of global GDP in 2018. - Higher energy prices contributed to larger current account surpluses in oil-exporting economies in 2018, largely matched by a sharp narrowing in China’s current account surplus (from 1.4 percent to 0.4 percent of GDP). - In the United States, the current account deficit was broadly unchanged at 2.3 percent of GDP in 2018 despite a sizable fiscal impulse. - In more vulnerable emerging market and developing economies, current account deficits narrowed as financial conditions tightened, portfolio capital inflows slowed sharply, and currencies weakened. - Currency movements in 2018 were generally supportive of minor narrowing of imbalances: the euro and renminbi appreciated slightly against the US dollar, translating into average annual real effective appreciations ranging between 1½ percent and 3 percent; the yen remained generally unchanged. - Emerging market and developing economy currencies experienced larger movements: Argentina and Turkey REERs weakened on average by about 20 percent and 15 percent, respectively; Brazil, India, Indonesia, and Russia saw changes ranging between 3 percent and 10 percent on average. - Estimates through the end of May 2019 suggest a real appreciation of the US dollar and yen (about 3 percent relative to the average for 2018 in both cases) and a weakening of the euro (2½ percent), with continued volatility in emerging markets and developing economies. - Intensified trade tensions in 2018–19 (including US tariffs on subsets of Chinese imports totaling $250 billion in 2018 and further tariff actions in 2019) have contributed to a sharp slowdown in global trade and industrial production and are weighing on investment and business sentiment. - Evidence from the first round of bilateral US-China tariff increases suggests only a small impact on the overall US trade balance and imports for 2018 because of trade diversion effects through third countries. ### Normative assessment framework and methodology notes - Current account gaps are defined as the difference between the actual current account (stripped of cyclical and temporary factors) and the level assessed by IMF staff to be consistent with fundamentals and desirable medium-term policies. - A positive (negative) current account gap corresponds to an excess surplus (deficit). - Real effective exchange rate (REER) gaps are assessed normally consistent with the current account gap; a positive (negative) REER gap implies an overvalued (undervalued) exchange rate. REER gaps do not predict future exchange rates. - Overall external position assessments consider current account balances, REERs, financial account balances, international investment positions, reserve adequacy, and competitiveness measures (including unit-labor-cost-based REER). Assessments aim to be multilaterally consistent. ### Policy recommendations and priorities - Avoid policies that distort trade (including trade barriers and subsidies); both surplus and deficit countries should work to revive liberalization efforts and strengthen the rules-based multilateral trading system. - Excess deficit economies: - Give priority to adopting or continuing growth-friendly fiscal consolidation. - Deploy macroprudential policies where credit growth or foreign-currency borrowing may be excessive. - Excess surplus economies: - Deploy available fiscal space to boost potential growth, including through public infrastructure investment. - Avoid overreliance on monetary policy where applicable. - Implement reforms to encourage investment—through innovation support and deregulation—and discourage excessive savings by households and corporations. - Exchange rate flexibility remains key to facilitate external adjustment; policies that ease capacity constraints (improved access to credit and transportation infrastructure) can strengthen exchange rate mechanisms. - Carefully-sequenced structural reforms are essential: enhance competitiveness and productivity of tradable sectors in deficit economies; encourage investment and reduce excessive saving in surplus economies. - Monitor rising external debt liabilities closely, especially maturity and currency mismatches. - Continue improving External Balance Assessment (EBA) methodologies and data collection to better understand risks posed by external stock positions and multinational corporations’ cross-border activities; use all EBA models and complementary tools and exercise caution given large unexplained residuals. ### Outlook and risks - In the near term, financial risks from global imbalances are generally contained, but intensified trade tensions or a disorderly Brexit could increase risk aversion, slow global growth, and adversely affect externally dependent economies. - Over the medium term, unchecked divergence in external stock positions and entrenched trade tensions could prompt disruptive adjustments in key debtor economies with global spillovers. - Further analysis is planned on mechanisms of external adjustment, including balance sheet channels and trade in services, to inform integrated policy lessons. *International Monetary Fund | July 2019 — 2019 EXTERNAL SECTOR REPORT, EXECUTIVE SUMMARY* ### 1. Change in US Imports, Sept.–Nov. 2018 compared to 2017, ### 1. Change in US Imports, Sept.–Nov. 2018 compared to 2017 ### The impact of recent trade actions and tensions - IMF staff simulations estimate that: - "The recently announced and envisaged tariffs could reduce global GDP by an additional 0.3 percent in 2020 (on top of the impact of the 2018 tariffs, which have been projected to lower global GDP by 0.2 percent in 2020; see the 2019 G-20 Surveillance Note and Scenario Box 1 of the October 2018 World Economic Outlook)." - The simulations "assume retaliatory actions by China." - Specifics on US–China tariff measures reported in the text: - Announced tariffs relate to the increase in tariffs from 10 percent to 25 percent on $200 billion of US imports from China as of May 8, 2019. - Envisaged tariffs are the possible 25 percent tariffs on the remaining $267 billion of US imports from China. - Broader distributional effects noted: - The impact of the dispute would be felt not only in directly involved countries but also through cross-border investment and global supply chains. - Expected shifts in manufacturing capacity "away from China and the United States, and toward Mexico, Canada, and east Asia." - Sizable job losses anticipated in certain sectors, particularly in China and the United States. ### Trade measures highlighted in the US imports context - Key tariff date examples and affected goods (as presented): - Solar panels and washing machines: ($10 Billion) - Steel and aluminum: ($18 Billion) - Country code listing and chart context show large monthly swings in imports/production across country groups (labels include CHN VNM THA PHL KOR DEU USA CAN JPN MEX etc.), with an accompanying US average tariff rate series for Jan. 2014–Dec. 2018. ### Short-run and confidence/policy caveats - The overall impact on growth "will depend on the associated confidence effects and offsetting policy responses." - Reference to additional detail: simulations and sectoral employment effects are linked to Box 4.4 in the April 2019 World Economic Outlook (as cited in the text). ### Key statistics and explicit numeric findings (preserved verbatim) - Additional reduction in global GDP in 2020 from recently announced and envisaged tariffs: 0.3 percent - Projected reduction in global GDP in 2020 from the 2018 tariffs: 0.2 percent - Announced tariff increase: from 10 percent to 25 percent on $200 billion of US imports from China as of May 8, 2019 - Envisaged potential tariffs: 25 percent on the remaining $267 billion of US imports from China - Examples of US import categories called out with values: Solar panel and washing machines ($10 Billion); Steel and aluminum ($18 Billion) *Source: IMF staff analysis and simulations cited in the chapter "External Positions and Policies," 2019 EXTERNAL SECTOR REPORT (text excerpt).* ### 1. Net International Investment Position (NIIP), 1990–2018 ### 1. Net International Investment Position (NIIP), 1990–2018 ### Key findings on external positions and imbalances - Excess current account imbalances narrowed somewhat in 2018, with China’s external assessment moving from “moderately stronger” to “broadly in line.” - Overall excess current account imbalances narrowed in 2018 to about 35–45 percent of global current account surpluses and deficits. - At the global level, excess current account imbalances narrowed from about 1.4 percent of global GDP in 2017 to about 1.2 percent in 2018. - Excess current account imbalances became more concentrated in a few large advanced economies, with lower-than-desirable current account balances centered in the United Kingdom and the United States and higher-than-desirable balances increasingly centered in the euro area and other advanced economies (Korea, Singapore, Sweden). - Excess surpluses remain large and persistent in northern Europe (Germany, Netherlands, Sweden) and some advanced Asian economies (Korea, Singapore); deficits are less persistent except in the United Kingdom and the United States. ### IMF staff assessments of external positions (2018) - “Substantially stronger” (current account gaps of more than 4 percentage points of GDP): Germany, the Netherlands, Singapore, and Thailand. - “Stronger” (2–4 percentage points of GDP): Malaysia. - “Moderately stronger” (1–2 percentage points of GDP): Korea, Russia, and Sweden. - “Weaker” (negative current account gaps in the range of 2–4 percent of GDP): Argentina, Belgium, Canada, and the United Kingdom. - “Moderately weaker” (1–2 percent of GDP): Indonesia, Saudi Arabia, South Africa, Spain, and the United States. - “Broadly in line” with medium-term fundamentals and desirable policies: Australia, Brazil, China, France, Hong Kong SAR, India, Italy, Japan, Mexico, Poland, Switzerland, and Turkey. ### Methodology and staff judgment - External Balance Assessment (EBA) model underpins staff-assessed current account norms; Hong Kong SAR, Saudi Arabia, and Singapore are excluded from the EBA model and use indirect approaches. - IMF staff applies analytically grounded judgment and adjustments for country-specific factors (institutional strength, reserve-currency status, nonrenewable commodity exports, demographics, structural features, measurement biases, and temporary factors). - Staff-assessed gaps are presented in ranges and are multilaterally consistent so that excess current account surpluses generally match excess current account deficits. - REER assessments use multiple inputs: mapping of current account gap using trade elasticities; EBA REER index and level models; and alternative sources including unit-labor-cost–based exchange rates. ### Drivers and decomposition of current account gaps - Staff-assessed gaps are decomposed into “identified policy gaps” (differences between actual and desired medium-term policies) and “other gaps” (residuals reflecting structural distortions and factors not explicitly modeled). - Identified policy gaps captured in the EBA model include structural fiscal balance, public health spending, foreign exchange intervention, capital controls, and the credit cycle. - Identified policy gaps explain only part of external imbalances; in many countries structural distortions play an important role. - Examples of identified policy contributions: - Higher-than-warranted current account balances: tighter-than-desirable fiscal stance in Germany, Korea, Netherlands, Thailand; insufficient health care spending in Korea, Malaysia, Russia, Thailand. - Lower-than-warranted current account balances: looser-than-desirable fiscal policy in Argentina, South Africa, Spain, United Kingdom, United States; credit excesses in Canada. - Broadly in line cases with offsetting distortions: China—undesirably easy fiscal and credit policies offset by weak social safety net coverage and state-owned-enterprise subsidies; Japan—looser-than-warranted fiscal policy masking structural constraints on investment; Brazil and Italy—undesirable credit weakness masking competitiveness problems. ### Foreign exchange intervention and capital flow pressures - Foreign exchange intervention appears to have been limited in 2018, though some emerging market and developing economies sold reserves in the face of market pressures. - Mid-2018 capital outflow pressures led to foreign exchange sales in Brazil, India, Indonesia, Malaysia, and Turkey. - Foreign exchange intervention reflected standard operations in regimes with exchange-rate-based monetary policy (Hong Kong SAR, Saudi Arabia, Singapore). - The impact of foreign exchange intervention on staff-assessed current account gaps was generally limited. ### Distribution and persistence of excess imbalances - Excess imbalances are increasingly concentrated in advanced economies; distributional shifts include smaller positive gaps in China matched by smaller negative gaps in Canada, United Kingdom, Saudi Arabia, Brazil, and Turkey. - The global measure of excess current account imbalances was estimated at about 1.2 percent of global GDP in 2018 (down from about 1.4 percent in 2017). - The 2018 External Sector Report previously estimated about 1.5 percent of world GDP in 2017; data revisions account for changes in these estimates. ### Outlook and scenarios for stock imbalances - Future evolution of external flow and stock imbalances depends on policy responses, current account trajectories, and the growth–interest-rate differential; valuation effects are not included in the simulations described. - Three scenarios considered: - Baseline policies (consistent with the latest IMF staff World Economic Outlook forecast): projected fiscal easing in the United States leads to a larger US current account deficit over the medium term and a projected increase in current account balances elsewhere; under this scenario stock imbalances are projected to remain generally unchanged over the medium term despite a modest rise in the US current account deficit. - Unchanged current account scenario: current account balances remain constant as a share of GDP at 2018 levels over the projection period; creditor and debtor positions expand by an additional 5 percentage points of world GDP by 2030. - Current account at the norm scenario: countries’ current account gaps close; under this scenario creditor and debtor positions narrow. *Source: IMF staff assessments and External Balance Assessment (EBA) estimates, chapter material on external positions and policies (2019 External Sector Report).* ### 2030. Under the baseline policies and unchanged current account ### 2030. Under the baseline policies and unchanged current account ### Projections and evolving external positions - Creditor positions of Germany, Japan, Netherlands, and Singapore keep expanding through 2030 under the baseline policies and unchanged current account scenarios. - China’s current account position stabilizes under these scenarios. - Net international investment positions and projected current account dynamics are shown through 2030 (Figure 1.15), with bubble sizes proportional to US dollar GDP. - Over time, global creditor and debtor stock positions would likely widen further by about 2 percentage points of world GDP by 2030 if corrective policies are absent. ### Short- and medium-term risks - Short-term: Intensification of trade and geopolitical tensions, or a disorderly Brexit, could adversely impact economies highly reliant on foreign demand and external financing. - Medium-term: In the absence of corrective policies, widening creditor and debtor positions raise the likelihood of a disruptive adjustment in large debtor economies with global spillovers, including large valuation losses in creditor economies. - A sudden reassessment of long-term real interest rates and growth prospects (the “r-g” relationship) in large debtor economies could precipitate disruptive adjustments. - Gradual tackling of high sovereign and corporate foreign currency leverage is required in some advanced and emerging market economies to stem vulnerabilities from rapid shifts in global financial conditions or faster-than-expected monetary policy normalization. - Special concern for China: a sudden deleveraging would have large knock-on effects on global growth and productivity through global value chain interlinkages and would lead to rapidly widening global imbalances. ### Policy challenges and recommended macroeconomic responses - Greater urgency is needed to tackle persistent excess imbalances amid escalating trade tensions. - Countries should avoid policies that distort trade: - Refrain from using tariffs to target bilateral trade balances; tariffs are costly for global trade, investment, and growth and are generally not effective in reducing external imbalances. - Avoid managed trade agreements as they introduce distortions and do not necessarily address aggregate saving and investment imbalances. - Concentrate on reviving liberalization efforts and modernizing the multilateral rules-based trading system to capture e-commerce and trade in services, strengthen rules on subsidies and technology transfer, and assure enforceability of WTO commitments through a well-functioning WTO dispute settlement system. - Macroeconomic policy guidance: - Excess surplus economies should use available fiscal space to boost potential growth and reduce overreliance on accommodative monetary policies. - In the euro area, fiscal policy in key creditor economies could boost potential growth through infrastructure investments and greater support for innovation (Germany, Netherlands). - In Germany, consider further tax relief for low-income households, and property and inheritance tax reform to reduce excess saving and wealth concentration. - Excess deficit economies should adopt gradual growth-friendly fiscal consolidation while allowing monetary policy to be guided by inflation developments and expectations (United Kingdom, United States). - Tighten macroprudential policies where necessary to slow excessive credit growth, especially in the real estate sector (Canada). ### Structural reforms to support rebalancing and potential growth - Structural reforms are essential to incentivize higher private investment and boost potential growth; careful sequencing is required since payoffs are often gradual and materialize in the medium term. - Recommendations for excess surplus economies: - Encourage investment by incentivizing research and development spending, ensuring financing for innovative activities (for example, by increasing access to venture capital), and deregulating the service sector (Germany, Korea). - Discourage excessive saving by expanding the social safety net (Korea, Malaysia, Thailand) and prolonging working lives (Germany). - Support internal revaluation in euro area surplus countries by incentivizing stronger wage growth. - Strengthen banking, fiscal, and capital market integration at the euro area level to support investment and resilience. - Recommendations for excess deficit economies: - Boost saving and competitiveness by strengthening the skill base of workers (Canada, Indonesia, South Africa, Spain, United Kingdom, United States). - Safeguard sustainability of public pension systems where needed (Spain) and deepen and increase inclusion in financial systems (Indonesia, South Africa). - Resource-rich economies should diversify export markets and strengthen productivity in non-oil sectors (Canada, Saudi Arabia). ### Addressing corporate saving, exchange rate policy, and external liability vulnerabilities - Rising net corporate saving in several advanced surplus economies (Germany, Korea, Japan, Netherlands) requires deeper understanding; possible drivers include: - Increased concentration of wealth and firm ownership. - Reduced wage compensation and top income inequality. - Lower domestic investment. - Policy implications may include tax and structural measures that encourage domestic demand and support higher labor compensation and disposable income for lower-income households. - Exchange rate flexibility remains key for external adjustment: - Conventional exchange rate channels regarding trade flows remain relevant in the medium term despite dominant currency invoicing and global value chain integration affecting short-term mechanisms. - Support exchange rate flexibility with complementary macroeconomic policies and structural measures (improve export infrastructure, expand access to export credit, lower regulatory barriers and red tape). - Vulnerabilities from rising external liability positions: - Net foreign currency-denominated external debt has fallen since the early 2000s for emerging market and developing economies as a whole, but gross external debt and gross external financing needs have increased, reaching record highs as shares of their own GDP and global GDP (Figure 1.16). - Monitor currency and maturity mismatches and the less regulated nonbank financial sector. - Policy measures to address vulnerabilities: - Reduce foreign-currency-denominated debt through targeted macroprudential policies. - Encourage more inward direct investment by ensuring equal treatment of domestic and foreign investors (Argentina, India, Indonesia). - Deepen financial markets and aid development of foreign exchange hedging instruments (Indonesia). - Consider foreign exchange intervention if disorderly exchange rate movements threaten stability. ### China: drivers of the current account surplus decline and policy implications - Composition changes (2008–18): - Services trade balance swung from a small surplus of 0.1 percent of GDP in 2007 to a deficit of 2.2 percent in 2018, mainly due to a fourfold increase in outbound tourism. - The income balance turned negative despite China’s net creditor position, reflecting falling global interest rates and rising returns on equity liabilities. - The goods surplus has fallen and been more volatile. - Saving, investment, and market saturation: - China’s saving rate, driven by household saving, has declined from its peak while rebalancing led to a slow shift from investment to consumption. - Growth differentials between China and trading partners suggest import growth will outpace export growth, given market saturation. - Domestic policy contributions to surplus decline and associated vulnerabilities (changes 2008–16): - Structural fiscal balance (share of GDP) deteriorated by 4.5 percentage points. - Private credit (share of GDP) expanded by 85 percentage points, contributing to a decline in net corporate saving. - Reserves (share of GDP) declined by 10.3 percentage points. - Currency appreciation also supported lowering the surplus. - Policy implication: - Gradual reining in of expansionary macroeconomic policies should be accompanied by structural reforms (improving the social safety net, state-owned-enterprise reforms, opening markets) to place China on a sustainable path with higher consumption and lower overall saving. *Source: IMF, World Economic Outlook; and IMF staff calculations. International Monetary Fund | July 2019* ### Box 1.2 (continued) ### Box 1.2 (continued) ### Adjustment and intra-euro-area asymmetries - The rise in the euro area current account surplus since the global financial crisis reflects a combination of strong deleveraging in most debtor countries and persistent large surpluses in creditor countries. - In the decade leading up to the crisis, the aggregate euro area current account fluctuated around a balanced position but masked large intra-area asymmetries, with intra-euro-area imbalances reaching about 4½ percent of euro area GDP in 2007–08. - Since the crisis, large external adjustments by debtor countries (close to 3 percent of euro area GDP) reduced overall asymmetries by half, even though these were associated with mildly larger surpluses in creditor countries. - Creditor countries redirected goods exports to countries outside the euro area while goods imports from debtor countries stagnated (relative to GDP); debtor countries increased exports outside the euro area, notably through tourism expansion (especially in Greece, Portugal, and Spain). - Adjustment was supported by a large internal devaluation in most debtor countries from their precrisis peaks; unit-labor-cost-based real effective exchange rate also fell slightly in most creditor economies, leaving CPI-based REER below levels warranted by fundamentals and desired policies, according to the External Balance Assessment model. - Creditor countries (defined here as Austria, Belgium, Finland, Germany, and the Netherlands) and debtor countries (defined here as Greece, France, Ireland, Italy, Portugal, and Spain) are used in the analysis. ### Sectoral decomposition and policies (euro area) - The rise in the euro area current account balance since the crisis has been driven mainly by an across-the-board increase in net corporate saving, with public saving also contributing, especially in debtor economies. - Debtor countries: - Credit boom and bust underpinned buildup and reversal of external imbalances, reflected in leveraging and deleveraging of households and firms before and after the crisis. - Corporate deleveraging was supported by a sharp contraction in investment. - Reduction in interest payments helped by accommodative monetary conditions. - Fiscal consolidation since 2010 supported increased net public saving, although these efforts have waned somewhat in recent years. - Creditor countries: - Net saving by firms increased further postcrisis, supported by declines in investment and lower interest and dividend payments, which more than offset somewhat higher wage compensation. - Public saving continued to rise, driven by continued fiscal consolidation. - Households offset only a small portion of improved corporate and public balance sheets. - Private credit contracted in the precrisis period and has recovered only mildly since the crisis, doing little to support household and corporate investment and aggregate demand. ### Emerging Market and Developing Economies’ (EMDEs) balance-sheet and currency exposures - Over the past two decades, EMDEs have become more financially integrated with the rest of the world. - New estimates of international investment position currency composition for a group of 18 large EMDEs show a significant shift in aggregate foreign-currency exposure (net position in foreign currency as a share of total assets and liabilities) since 2004. - Most EMDEs moved from being short on foreign currency to being long, with much of this shift occurring between 2004 and 2007. - Drivers of this shift: - Change in currency composition of foreign liabilities away from foreign currency and toward local currency instruments (greater reliance on equity financing and shift in debt instruments toward domestic currency). - Sustained accumulation of foreign currency assets. - Aggregate foreign-currency exposure is defined to range from –1 (zero percent of foreign assets and 100 percent of foreign liabilities in foreign currency) to +1 (100 percent of foreign assets and 0 percent of foreign liabilities in foreign currency). ### Valuation effects of currency exposures - Stronger net foreign currency positions have helped mitigate risks associated with domestic currency depreciations on average, providing aggregate insurance through national balance sheets. - Example: in 2004 a 10 percent depreciation led, all else equal, to a median valuation loss of 0.3 percent of GDP; in 2017 this median effect was positive and equivalent to 1.8 percent of GDP. - The proportion of analyzed EMDEs with buffering valuation effects increased from 44 percent in 2004 to 72 percent in 2017. ### Risks from gross positions and external financing vulnerabilities - Strengthened net foreign currency positions may mask vulnerabilities where foreign currency liabilities as a share of GDP have grown, or where foreign currency assets and liabilities pertain to different sectors or agents. - Some economies now have substantial gross foreign currency liabilities, making them vulnerable to external financing risks. - Findings from a probit model (70 advanced and emerging market economies, 1991–2016) linking external balance sheets to sudden stops and external crises suggest: 1. International investment position size and currency composition matter—higher gross external debt increases likelihood of external crises; higher foreign exchange external debt increases chances of sudden stops. 2. Higher levels of foreign reserve assets lower the likelihood of external crises, although with diminishing returns. 3. Larger current account deficits increase likelihood of external crises, while overvalued currencies increase likelihood of sudden stops. 4. Financial deepening reduces the likelihood of both sudden stops and external crises, all else equal. - Example from model-predicted probabilities: - For a country with median foreign exchange debt (42 percent of GDP), probability of an external crisis increases by about 3½ percentage points when current account moves from a surplus to a deficit of 3 percent of GDP. - When foreign exchange debt is in the top 90 percentile (111 percent of GDP), the probability increases by 4½ percentage points for the same current account shift. ### Financial integration, capital flow sensitivity, and monitoring - External balance sheets (sum of assets and liabilities) have increased by an average of 85 percentage points of GDP since 1996, with heterogeneity across countries and strongest increases in emerging European and Latin American economies. - Net private capital inflows are more sensitive to spikes in global risk aversion (∆VIX) in countries with: - Greater current account deficits, - Higher levels of foreign exchange debt exposure, - Higher levels of net external debt (not shown). - The sensitivity of capital flows to the Chicago Board Options Exchange Volatility Index appears to have grown with financial integration. - Guarding against sudden stops or external crises requires careful monitoring of flow and stock imbalances across sectors and instruments. ### Exhaustible resource exporters: nonregression approaches and consumption allocation rules - Exhaustible resources generate large and temporary income streams; countries may benefit from smoothing domestic absorption. - The External Balance Assessment (EBA) and EBA-Lite models include, for oil and gas exporters, a measure of oil and gas exports’ temporariness proportional to stock of proven reserves; countries with large resource wealth are expected to save a higher portion of current income when resources are more temporary. - Nonregression approaches complement regression models, allowing linkages between resource temporariness and fiscal policy and modeling interactions between below-ground wealth and financial asset positions; they do not substitute for regression models because they omit other policy and nonpolicy determinants. - Consumption allocation rules framework: - Countries consume an annuity out of resource wealth (below-ground wealth as present value of exports of exhaustible commodities plus above-ground wealth as net foreign assets). - The annuity yields a norm for consumption from which a saving norm is derived. - An extension derives fiscal saving norms by defining an annuity for fiscal expenditures drawing from government resource wealth (present value of resource-related revenues plus net government assets). - Models that account for investment needs can lead to lower current account norms in resource-rich developing economies, since part of resource wealth may finance investment where capital is scarce. - Araujo and others (2016) propose a small open economy model incorporating investment; incorporating investment, capital scarcity, and credit constraints leads to lower current account norms. - Current account gaps from this approach depend on calibration of inefficiencies in investment; larger inefficiencies in investment lead to lower optimal investment and therefore to higher current account norms. ### Net corporate saving and persistent surpluses in some advanced economies - Net corporate saving has risen across most advanced economies since the mid-1990s, with especially pronounced increases in a subset of surplus advanced economies (examples: Austria, Denmark, Germany, Japan, Korea, Netherlands). - In these surplus advanced economies: - Public net saving levels have also been higher. - Households’ offsetting role has been smaller, suggesting potential impediments for households to offset corporate behavior ("pierce the corporate veil"). - Drivers of differences in net corporate saving: - Labor compensation: labor shares have fallen across most advanced economies, with largest declines in economies with faster-rising corporate saving. - Investment: declines in corporate investment have been strongest in economies with fast-rising net corporate saving. - Dividends: shifts away from dividend payouts toward retained earnings and share buybacks contributed to rises in net corporate saving. - Interest payments and taxation have played a more limited direct role. - Distributional and structural factors may link corporate saving to aggregate saving: - If rising corporate profits and saving accrue mainly to wealthy households with low propensities to consume, aggregate private saving may comove with corporate saving. - Surplus advanced economies (those that ran surpluses in 2008) include Austria, Denmark, Finland, Germany, Japan, Korea, Luxembourg, Netherlands, Norway, and Sweden. - Deficit advanced economies include Belgium, Cyprus, Czech Republic, Estonia, France, Greece, Ireland, Italy, Latvia, Lithuania, Portugal, Slovakia, Slovenia, Spain, the United Kingdom, and the United States. *Italic: International Monetary Fund | July 2019 — Box 1.2 (continued) and subsequent boxes as presented in the source content.* ### Box 1.7. What is Driving the Rise in Corporate Saving in Advanced Economies? ### Box 1.7. What is Driving the Rise in Corporate Saving in Advanced Economies? ### Key empirical patterns - The rise in corporate saving across Group of Seven countries has coincided with an increase in the average concentration ratio of firms across broadly defined industries (Figure 1.7.4). - Figure 1.7.3 relationship (Wealth Inequality vs. Net Corporate Saving, 2012–16): - Regression: y = 1.48x + 15.19 - R^2 = 0.272 - Figure 1.7.4 relationship (Net Corporate Saving vs. Market Concentration, 1998–2014): - Regression: y = 0.003x + 0.002 - R^2 = 0.063 - Definitions used in the analysis: - Surplus advanced economies are those that ran surpluses in 2008 and include: Austria, Denmark, Finland, Germany, Japan, Korea, Luxembourg, Netherlands, Norway, and Sweden. - Deficit advanced economies include: Belgium, Cyprus, Czech Republic, Estonia, France, Greece, Ireland, Italy, Latvia, Lithuania, Portugal, Slovakia, Slovenia, Spain, the United Kingdom, and the United States. ### Proposed mechanisms discussed in the box - Distributional effects of corporate payouts: - Transfers from firms to shareholders (who are characterized as having a low marginal propensity to consume) can depress aggregate consumption and imports when compared with payouts to households with a high marginal propensity to consume. - Corporate market power and concentration: - The increase in corporate saving has coincided with rising firm concentration across industries. - Rising corporate market power appears, so far, more reflective of a “winner-takes-most” pattern by more productive and innovative firms (see Chapter 2 of the April 2019 World Economic Outlook as cited). - Dao and others (2019) argue that trends that make borrowing constraints less binding benefit large firms disproportionately, leading to both rising corporate saving and concentration. - Tax and accounting drivers (as discussed): - Differences in tax treatment and incentives (for example, between dividends and retained earnings) can influence profit retention decisions and thus corporate saving. - Changes in corporate taxation can affect the composition of the current account and the relative importance of net exports and income, though they tend not to impact (all else equal) the overall current account level (Guvenen and others 2018, as cited). ### Potential policy responses highlighted - Need for country-level, tailored analysis: - Understanding the extent to which the rise in corporate saving reflects policy distortions requires further work and tailored country-level analysis, including of distributional issues. - Product market measures: - Countries could foster domestic business investment by relaxing certain product market regulations, including for example by reducing burdens in the license and permit system and/or procedures to start a business (see 2018 External Sector Report as cited). - Taxation measures: - Consideration could be given to strengthening property and inheritance taxation, especially where increased wealth concentration is leading to excess aggregate saving (see IMF 2019c as cited). - A more equal tax treatment of dividends and retained earnings could in certain circumstances discourage the retention of profits and foster consumption, although this depends on the extent to which households consume more out of actual than latent income. *Source: Box 1.7, 2019 External Sector Report, International Monetary Fund | July 2019.* ### CHAPTER 1 EXTERNAL POSITIONS AND POLICIES ### CHAPTER 1 EXTERNAL POSITIONS AND POLICIES ### EBA Current Account Regression: Policy Gap Contributions, 2018 (Table 1.6) — key observations - The table decomposes 2018 EBA gaps into identified domestic policy gaps (Fiscal Gap, Public Health Expenditures Gap, Private Credit Gap, Foreign Exchange Intervention Gap), "Other (K-Controls)" and totals (EBA Gap), with domestic, identified domestic, residual, coefficients, P, and P* shown for components. - Representative country entries (values are percent of GDP or coefficients as shown): - Argentina: EBA Gap Total = –4.3; Fiscal Gap Domestic Identified = –0.8; Public Health Domestic Identified = –1.1; Private Credit Domestic Identified = –3.5; Foreign Exchange Intervention Total contribution reported = 0.3; Other (K-Controls) Total = 6.5. - Australia: EBA Gap Total = –2.0; Fiscal Gap Domestic Identified = 1.4; Private Credit Domestic Identified = –3.4; Other (K-Controls) Total = 6.3. - Germany: EBA Gap Total = 5.1; Fiscal Gap Domestic Identified = 1.1; Private Credit Domestic Identified = 4.0; Other (K-Controls) Total = 9.6. - United States: EBA Gap Total = –1.2; Fiscal Gap Domestic Identified = –0.7; Private Credit Domestic Identified = –0.5; Other (K-Controls) Total = 8.5. - Notes and methodological points extracted from table footnotes: - EBA = external balance assessment; K-Controls = capital control; Dom = domestic; Coeff = coefficient. - 1 Total contribution after adjusting for multilateral consistency. - 2 Includes contribution of domestic policy gaps to the identified gap. The total foreign policy gap contribution is constant and equal to 0.3 percent for all countries. - 3 Total domestic contribution is equivalent to coefficient*(P-P*). - 4 The euro area EBA CA gap and policy gap contributions are calculated as the GDP-weighted averages of EBA CA gaps and policy gap contributions for the 11 largest euro area economies. - 5 Foreign contributions are estimated as follows: overall = 0.3 percent of GDP; fiscal = 0.7 percent of GDP; public health = –0.1 percent of GDP; private credit = –0.1 percent of GDP; foreign exchange intervention = 0.03 percent of GDP. ### REER and EBA Model Gaps, 2018 (Table 1.7) — summary of staff-assessed gaps and elasticities - Table reports: Staff-Assessed REER Gap (mid-point), REER Gap Implied from Staff-Assessed CA Gap, EBA REER-Level Gap, EBA REER-Index Gap, CA/REER Elasticity, and REER percent change (Avg-18/Avg-17 and May-19/Avg-18). - Selected country values (preserve exact numbers): - Argentina: Staff-Assessed REER Gap = –12.5; REER Gap Implied from Staff-Assessed CA Gap = 21.2; EBA REER-Level Gap = 2. . .–5.9; CA/REER Elasticity = 0.14; REER (Percent change) Avg-18/Avg-17 = –18.2; May-19/Avg-18 = –5.3. - Australia: Staff-Assessed REER Gap = 6.0; REER Gap Implied = 4.4; EBA REER-Level Gap = 11.3; EBA REER-Index Gap = 1.7; CA/REER Elasticity = 0.20; REER changes = –4.0 and –4.5. - China: Staff-Assessed REER Gap = –1.5; REER Gap Implied = –3.5; EBA REER-Level Gap = 12.6; CA/REER Elasticity = 0.00; REER changes = 31.4 and –0.2. - Euro Area (trade-weighted 11 largest members): Staff-Assessed REER Gap = –3.0; REER Gap Implied = –3.3; EBA REER-Level Gap = 0.8; EBA REER-Index Gap = 6.0; CA/REER Elasticity = 0.40; REER changes = 3.0 and –3.1. - Japan: Staff-Assessed REER Gap = –1.5; REER Gap Implied = –1.5; EBA REER-Level Gap = –17.1; EBA REER-Index Gap = –21.8; CA/REER Elasticity = 0.13; REER changes = –0.8 and 2.9. - Turkey: Staff-Assessed REER Gap = –15.0; REER Gap Implied = 0.9; EBA REER-Level Gap = –20.5; EBA REER-Index Gap = –22.5; CA/REER Elasticity = 0.22; REER changes = –14.4 and –10.3. - United States: Staff-Assessed REER Gap = 9.0; REER Gap Implied = 11.7; EBA REER-Level Gap = 11.9; EBA REER-Index Gap = 8.0; CA/REER Elasticity = 0.12; REER changes = –0.9 and 3.4. - Additional notes: - Implied REER gap = -(staff-assessed CA gap/CA-to-REER elasticity). - CA-to-REER semi-elasticity used by IMF country teams is reported in the table. - 5 Discrepancy: GDP-weighted average sum of staff-assessed REER gaps = 1.4. ### 2018 Individual Country Assessments: Summary of Policy Recommendations (Table 1.8) — principal policy guidance by country - Table classifies each economy’s overall 2018 assessment and lists policy recommendations across Fiscal; Monetary | Exchange Rate | Financial; Structural pillars. Selected entries (text preserved verbatim): - Argentina — Overall 2018 Assessment: Weaker - Fiscal: Implement consolidation plan - Monetary | Exchange Rate | Financial: Strengthen monetary and exchange policy frameworks - Structural: Eliminate trade restrictions and barriers to entry to increase productivity and competitiveness and attract FDI - Australia — Broadly in line - Fiscal: Provide near-term support for internal rebalancing and transition to gradual medium-term consolidation - Monetary | Exchange Rate | Financial: Continue monetary accommodation to close output gap and accompany rebalancing - Structural: Structural reforms to boost non-mining productivity - Brazil — Broadly in line - Fiscal: Consolidation, including from federal spending cap and social security reform - Monetary | Exchange Rate | Financial: Remain accommodative to support fiscal consolidation; FX interventions can be appropriate to alleviate disorderly market conditions - Structural: Reduce cost of doing business to improve overall competitiveness and trade openness - China — Broadly in line - Fiscal: Support rebalancing by gradually consolidating to reach debt-stabilizing fiscal balances in the medium term - Monetary | Exchange Rate | Financial: Gradually move toward more transparent, market-based MP framework and ER flexibility while strengthening domestic financial stability - Structural: Improve social safety nets; increase competition through SOE reform and opening up markets; ensure equal treatment between foreign and domestic investors to attract more FDI - Euro Area — Moderately stronger - Fiscal: Strengthen centralized investment schemes and fiscal capacity for macroeconomic stabilization at regional level; address imbalances at national level by using fiscal space where available and consolidation where necessary - Monetary | Exchange Rate | Financial: Remain accommodative until inflation converges to ECB’s medium-term price stability objective; facilitate relative price adjustments at the national level by enabling greater inflation differentials across euro area members - Structural: Make currency union more resilient and finalize banking and capital markets union; address imbalances at the national level by raising potential growth and competitiveness - Germany — Substantially stronger - Fiscal: Growth-oriented fiscal policy using substantial fiscal space to invest in human and physical capital - Structural: Implement reforms to foster entrepreneurship and address aging costs by prolonging working life - India — Broadly in line - Fiscal: Medium-term consolidation to lower public debt levels by increasing compliance and reforming income tax and fuel and food subsidies - Monetary | Exchange Rate | Financial: ER should remain the main shock absorber, with FX intervention limited to addressing disorderly market concerns - Structural: Ease domestic supply bottlenecks and revamp business climate, improve competitiveness and investment prospects, to attract FDI and boost exports; gradual liberalization of portfolio flows - Indonesia — Moderately weaker - Fiscal: Strengthen fiscal position by mobilizing revenues while allowing for higher infrastructure and social spending - Monetary | Exchange Rate | Financial: Continue ER flexibility with limited FX interventions in response to disorderly market conditions - Structural: Bolster global value chain participation; ease non-tariff trade barriers and FDI restrictions; strengthen labor markets and skills; deepen financial markets - Japan — Broadly in line - Fiscal: Gradual, medium-term fiscal consolidation anchored by a credible fiscal framework - Monetary | Exchange Rate | Financial: Continue accommodative stance to achieve inflation objectives - Structural: Adopt measures to boost wages and labor supply, reduce labor market duality, reduce barriers to entry in some industries, and accelerate agriculture and services sector deregulation - Korea — Moderately stronger - Fiscal: More expansionary fiscal policy to boost domestic demand using substantial fiscal space - Monetary | Exchange Rate | Financial: Continue ER flexibility with limited intervention to address disorderly market conditions - Structural: Strengthen the social safety net to lessen incentives for precautionary savings. Address bottlenecks to investment - Malaysia — Stronger - Fiscal: Gradual medium-term consolidation through tax revenue mobilization, while continuing to protect social and growth-enhancing spending - Monetary | Exchange Rate | Financial: Continue ER flexibility with limited intervention to respond to disorderly conditions - Structural: Strengthen social protection, public healthcare spending; address structural bottlenecks (labor market skills mismatch; low female participation; weak education quality; physical infrastructure) - Mexico — Broadly in line - Fiscal: Increase tax revenues to make space for infrastructure investment while adhering to fiscal targets - Monetary | Exchange Rate | Financial: Floating ER should continue to serve as main shock absorber with FX interventions to prevent disorderly market conditions - Structural: Structural reforms to improve competitiveness and investment climate - Netherlands — Substantially stronger - Fiscal: Implement envisaged expansionary fiscal policy and use additional fiscal space in the medium term - Structural: Structural reforms to raise the productivity of small domestic firms, encourage household and SME rebalancing, and support digitalization and lifelong learning, including through public investment - Russia — Moderately stronger - Fiscal: Maintain discipline under the fiscal rule; rebalance expenditures towards health, education, and infrastructure in the medium term - Monetary | Exchange Rate | Financial: Monitor risks from fast-growing household credit - Structural: Structural reforms to invigorate private investment and improve competitiveness, expecially in the nonoil sector - Saudi Arabia — Moderately weaker - Fiscal: Further consolidation to ensure savings for future generations - Structural: Structural reforms to diversify the economy and boost the non-oil tradeable sector over the medium term - Singapore — Substantially stronger - Fiscal: Use substantial fiscal space for higher public investment in physical infrastructure and human capital - Monetary | Exchange Rate | Financial: FX intervention should remain targeted toward achieving inflation and output objectives - Structural: Structural reforms to improve productivity and domestic investment incentives - South Africa — Moderately weaker - Fiscal: Gradual consolidation while providing space for infrastructure investment and education spending - Monetary | Exchange Rate | Financial: Seize opportunities to build up reserves to deal with FX liquidity shocks - Structural: Strengthen education/skills; increase financial inclusion; foster entry into key product markets; accelerate labor and product market reforms - Spain — Moderately weaker - Fiscal: Reduce the still-sizable structural fiscal deficit - Structural: Additional reforms to address labor market duality; accelerate implementation of product and service market reforms; enhance education outcomes, training for workers and firms’ innovation capacity - Sweden — Moderately stronger - Fiscal: Adopt a mildly expansionary fiscal stance consistent with the medium-term surplus target - Monetary | Exchange Rate | Financial: Defer further monetary tightening pending an inflation outlook consistent with durably meeting the inflation target - Structural: Facilitate migrant integration into the labor market to raise potential output - Switzerland — Broadly in line - Fiscal: Moderately loosen to reach a structurally neutral fiscal stance to address longer-term challenges - Monetary | Exchange Rate | Financial: FX intervention should be reserved for addressing large exchange market pressures - Structural: Reform corporate income tax to encourage SME investment, thereby reducing net saving - Thailand — Substantially stronger - Fiscal: Boost public infrastructure within available fiscal space; reform and expand social safety nets - Monetary | Exchange Rate | Financial: ER should move flexibly as key shock absorber, with limited intervention to avoid disorderly market conditions - Structural: Strengthen social safety nets, and reduce barriers to investment, especially in the services sector - Turkey — Broadly in line - Fiscal: Allow automatic stabilizers to operate while aiming at comprehensive policy package to strengthen external resilience and support rebalancing - Monetary | Exchange Rate | Financial: Tighter monetary policy should aim at reanchoring inflation expectations; increase net international reserves - Structural: Structural reforms to enhance productivity and ensure more stable domestic funding, including reducing labor market rigidities and improving business climate - United Kingdom — Weaker - Fiscal: Fiscal consolidation with investment in public infrastructure - Monetary | Exchange Rate | Financial: Maintain financial stability through macroprudential policies - Structural: Broaden skill base; improve public infrastructure - United States — Moderately weaker - Fiscal: Consolidate over the medium term while upgrading public infrastructure - Monetary | Exchange Rate | Financial: Continue data-dependent monetary policy normalization - Structural: Enhance schooling, training and mobility of workers; promote labor force participation and roll back recently imposed tariffs - Note: Table’s note states this is a nonexhaustive list focusing on key recommendations for closing external imbalances in the medium term. Abbreviations preserved: FDI, FX, MP, ER, SOE, ECB, R&D, SME. *Source: IMF staff estimates and 2019 Individual External Assessments (tables and notes as provided in the chapter).* ### 9. https:// voxeu .org/ article/ revisiting -paradox -capital. ### 9. https:// voxeu .org/ article/ revisiting -paradox -capital. ### Introduction and scope - There is an ongoing debate about the role of exchange rates in facilitating external adjustment in the presence of modern trade and finance complexities. - The chapter explores how: - dominant currency pricing (especially the US dollar), and - international integration through global value chains (GVCs) shape the working of exchange rates to induce external adjustment. - The main authors of this chapter are Gustavo Adler, Sergii Meleshchuk, and Carolina Osorio-Buitron, with support from Jair Rodriguez, Kyun Suk Chang, and Zijiao Wang, and contributions from Tam Bayoumi, Diego Cerdeiro, and Jelle Barkema. - The analysis focuses on bilateral manufacturing trade among 37 advanced and emerging market economies during 1990–14 and uses newly constructed data on bilateral prices and quantities and novel measures of value-chain-related exchange rate shocks. - The sample used is representative of the global economy, accounting for about 85 percent of world GDP. - The analysis emphasizes differences in short-term versus medium-term effects; contemporaneous and lagged effects (up to three years) are considered. ### Currency of trade invoicing: mechanisms and implications - Key mechanism: - Stickiness in nominal prices and the currency in which trade is invoiced determine exchange rate pass-through and the response of trade volumes. - Two pricing regimes and their short-term implications: - Producer-currency pricing (as in Mundell-Fleming): - Exchange rate depreciation raises import prices in domestic currency, reducing import demand. - Depreciation lowers prices faced by trading partners in their domestic currencies, increasing demand for exports. - Result: a balanced response involving both import and export volumes. - Dominant-currency (third-country) pricing: - Depreciation raises domestic import prices and reduces import demand. - Local-currency prices faced by trading partners remain unchanged if their exchange rates vis-à-vis the dominant currency do not change. - Result: export volumes do not respond to the depreciation, yielding an unbalanced response concentrated on import compression. - Empirical facts on invoicing: - Major currencies, and the US dollar in particular, play a dominant role in pricing of international trade. - For most countries, the share of exports and imports invoiced in US dollars is significantly greater than the corresponding share of exports to and imports from the United States. - This dominance is particularly marked in emerging market and developing economies, but is also visible in key advanced economies (for example, Australia, Japan, Korea). - The euro is used significantly but much less broadly than the US dollar. - Invoicing in other major currencies (for example, British pounds, yen, swiss francs, and renminbi) is significant mainly in transactions involving the issuing economies. ### Global value chains: mechanisms and implications - Integration into global value chains affects exchange rate elasticities: - Greater foreign-value-added content can lower sensitivity of gross trade flows to exchange rate movements because trade prices and marginal costs move in tandem. - Upstream and downstream third-party exchange rate movements can affect a country’s gross trade flows. - Low substitutability between domestic and foreign intermediate goods can further reduce overall gross trade elasticities. - Empirical finding summarized: - Greater integration into global value chains reduces the exchange rate elasticity of gross trade volumes in both the short and medium term. - However, the associated increase in gross trade flows largely offsets this elasticity reduction in most cases. ### Empirical approach and data highlights - The econometric specification models prices and quantities of bilateral manufacturing trade among 37 advanced and emerging market economies during 1990–14. - The framework disentangles price and quantity responses to bilateral and US dollar exchange rates, from both the exporter’s and importer’s perspectives, allowing computation of the trade balance response. - Distinctions in depreciation experiments: - Depreciation vis-à-vis the US dollar implies currencies of both the country of interest and its trading partners depreciate vis-à-vis the US dollar (the exchange rate between the country of interest and non-US trading partners remains unchanged). - Bilateral depreciation implies movement vis-à-vis a trading partner only (exchange rates between the country of interest and other trading partners remain unchanged). - A country’s depreciation vis-à-vis all currencies (US dollar and other) is analyzed separately. ### Key empirical findings - Dominant-currency invoicing (US dollar): - The widespread use of the US dollar in trade pricing alters the short-term response of trade flows to exchange rate movements. - Export volumes respond timidly to an exchange rate depreciation in the short term, while most of the adjustment takes place through import volumes. - A more balanced adjustment through both export and import volumes reemerges over the medium term. - Global value chains: - Greater integration into global value chains reduces the exchange rate elasticity of gross trade volumes in both the short and medium term. - The increase in gross trade flows associated with GVC integration largely offsets the elasticity reduction in most cases. - Overall implication: - While these features of international trade affect the composition and timing of the external adjustment process, for most countries there remain benefits of exchange rate flexibility, especially in the medium term. - With more muted effects of exchange rates on trade flows in the short term, complementary policies may be needed in some cases to support exchange rate flexibility and facilitate external rebalancing. ### Policy implications and conclusions - Exchange rate flexibility retains benefits for external adjustment, particularly over the medium term. - Because short-term exchange rate effects on trade volumes can be muted by dominant-currency pricing and GVC integration, complementary policies may be necessary in some circumstances to support adjustment. - The chapter highlights limitations and caveats: - The analysis focuses on manufacturing trade and does not consider services trade or balance sheet vulnerabilities. - The work takes invoicing regimes and GVC integration as given and recognizes these are interdependent and determined by other country-specific factors. - Further details on empirical analysis are available in Online Annex 2.1. *2019 EXTERNAL SECTOR REPORT, International Monetary Fund | July 2019.* ### 2. Imports from US and Imports Invoiced in US Dollars ### 2. Imports from US and Imports Invoiced in US Dollars ### Dominance of the US dollar and exchange rate pass-through - Short-term (same year) evidence: - The exchange rate vis-à-vis the US dollar is a statistically and economically important driver of trade prices in domestic currency even after controlling for the bilateral exchange rate. - The US dollar is used for trade pricing in many bilateral transactions that do not involve the United States and plays a dominant role relative to individual partner currencies. - Average effects reported: - A 1 percent change in the bilateral exchange rate → 0.2 percent change in trade prices in the exporter’s currency (on average). - A 1 percent change in the exchange rate vis-à-vis the US dollar → 0.45 percent change in trade prices in the exporter’s currency (on average). - Pass-through from a depreciation vis-à-vis the US dollar is broadly the same for prices in the exporter’s and the importer’s currency. - Unweighted regressions show starker dominance of the US dollar (US dollar invoicing is more pervasive among smaller economies). - Medium-term (three years) evidence: - US dollar pass-through to export prices falls from 0.45 in the short term to 0.25 in the medium term. - Pass-through from the bilateral exchange rate rises slightly from 0.2 to 0.25. - The relative importance of the exchange rate vis-à-vis the US dollar diminishes as US dollar prices become more flexible. - Heterogeneity by degree of US dollar invoicing (direct evidence): - In countries with high US dollar invoicing: - Pass-through from bilateral exchange rates to export-currency prices averages 0.1. - Pass-through from the US dollar exchange rate averages 0.7. - In countries with low US dollar invoicing: - Pass-through magnitudes change to 0.3 (bilateral) and 0.2 (US dollar). - Over the medium term, the effects of US dollar invoicing are visible but less pronounced. ### Effects on export and import volumes and composition of external adjustment - Short-term (non-US countries): - Bilateral export volumes respond positively to a bilateral exchange rate depreciation (an appreciation of the trading partner’s currency alone). - Bilateral exports respond negatively to a depreciation only vis-à-vis the US dollar (when trading partners also depreciate vis-à-vis the US dollar) because trading partners face higher trade prices in domestic currency and lower demand for imports. - Import volumes: - Respond limitedly to a bilateral depreciation (import prices largely unchanged). - Respond more pronouncedly to a depreciation vis-à-vis the US dollar (import prices in the importer’s currency increase). - Medium-term: - As invoicing currency prices adjust, both export and import volumes display greater sensitivity to bilateral exchange rate movements. - The effect of the US dollar exchange rate becomes economically and statistically insignificant. - US dollar invoicing alters the price/quantity composition of external adjustment in the short term: - Unbalanced volume responses: - Import volumes fall following a depreciation irrespective of US dollar invoicing. - Export volumes react less with greater US dollar invoicing. - Greater (and more symmetric) price responses under high US dollar invoicing: - Prices in the exporter’s and importer’s currency react similarly under high US dollar invoicing compared with more asymmetric responses under low US dollar invoicing. - Net effect: Higher US dollar invoicing leads to less adjustment through export quantities and more adjustment through prices (and markups) in the short term. ### Quantitative estimates: Short-term and medium-term effects of a 10 percent depreciation vis-à-vis all other currencies - Table 2.2. Short-Term Effects (response to a 10 percent depreciation vis-à-vis all other currencies) - Indirect Estimation (Average effect): - Prices (Percent): Exports 6.31***; Imports 7.95*** - Volumes (Percent): Exports 0.516; Imports –2.88*** - Trade Balance (Percent of GDP): 0.322*** - Direct Estimation: - Low US Dollar Invoicing: - Prices (Percent): Exports 4.81***; Imports 6.84*** - Volumes (Percent): Exports 1.26***; Imports –2.16*** - Trade Balance (Percent of GDP): 0.256 - High US Dollar Invoicing: - Prices (Percent): Exports 8.28***; Imports 8.96*** - Volumes (Percent): Exports –0.59; Imports –2.77*** - Trade Balance (Percent of GDP): 0.276* - Notes: *** p < 0.01, ** p < 0.05, * p < 0.1. - Table 2.3. Medium-Term Effects (response to a 10 percent depreciation vis-à-vis all other currencies) - Indirect Estimation (Average effect): - Prices (Percent): Exports 5.07***; Imports 7.50*** - Volumes (Percent): Exports 4.32***; Imports –4.50*** - Trade Balance (Percent of GDP): 1.177*** - Direct Estimation: - Low US Dollar Invoicing: - Prices (Percent): Exports 3.81***; Imports 8.09*** - Volumes (Percent): Exports 4.56***; Imports –4.97*** - Trade Balance (Percent of GDP): 0.963*** - High US Dollar Invoicing: - Prices (Percent): Exports 6.95***; Imports 8.62*** - Volumes (Percent): Exports 3.38***; Imports –4.96*** - Trade Balance (Percent of GDP): 1.228*** - Notes: *** p < 0.01, ** p < 0.05, * p < 0.1. ### Global Value Chains (GVCs) — integration, transmission, and implications - Mechanisms: - Greater integration into global value chains implies larger trade in intermediate goods that are reexported (backward integration) and greater exposure to third-country exchange rates (upstream suppliers and downstream buyers). - A currency depreciation may raise export prices in local currency and also production costs when exports contain imported intermediates, muting export-volume responses. - Demand for intermediate goods from foreign downstream buyers may be less responsive to exchange rate changes if input demand is inelastic due to production adjustment costs. - Trends and heterogeneity: - Most economies have become increasingly integrated into global value chains, with large cross-country differences. - In small, highly integrated economies the import content of exports (backward integration) can reach one-third to one-half. - Large systemic economies (for example, China, Japan, United States) remain dominated by traditional trade patterns. - Empirical results on GVC integration: - Greater GVC integration dampens gross trade volume elasticities in both the short term and the medium term. - Example estimates: - Medium-term exchange rate elasticity of export volumes: - Low GVC integration (25th percentile): about 0.45. - High GVC integration (75th percentile): about 0.3. - Import volume elasticities: - Low GVC integration: –0.5. - High GVC integration: –0.25. - GVC integration leads to somewhat higher exchange rate pass-through to both export and import prices (greater sensitivity of marginal costs and input demand), although effects are generally small. - The dominant role of the US dollar is partly related to exporters’ use of imported intermediate goods but remains significant even after including GVC measures. - Implications for trade balance responsiveness: - The sensitivity of the trade balance to exchange rates falls with greater GVC integration (short and medium term). - For a given GVC integration level, greater trade openness increases the trade balance responsiveness (in percentage points of GDP). - For the average country (in terms of GVC integration and trade openness), a 10 percent depreciation is estimated to lead to an increase in the trade balance of about 1 percentage point of GDP. - Interaction between GVCs and trade openness: - Greater GVC integration is associated with higher trade openness; increasing GVC participation has been largely offset by rising trade openness over time, leaving median trade balance elasticities broadly stable since early 2001. *International Monetary Fund | July 2019 — Chapter 2 (Exchange Rates and External Adjustment).* ### Conclusions and Policy Implications ### Conclusions and Policy Implications ### Granular linkages, invoicing, and effective exchange rates - International trade complexity requires granular analysis of cross-country linkages and exchange rates to understand dynamics of external adjustment. - Where dominant currency invoicing is pervasive: - Traditional metrics of effective exchange rates—which focus on currencies of trading partners rather than invoicing currencies—may be less informative to understand short-term adjustment dynamics, although they remain relevant to shed light on medium-term dynamics. - Competitiveness metrics that take invoicing currencies into account would complement traditional metrics. - With high integration into global value chains (GVCs): - Exchange rates vis-à-vis immediate trading partners become less relevant; upstream and downstream exchange rates become more relevant. - The traditional view that a country competes with trading partners may not fully reflect value chain complementarities, especially if supply chains are rigid as suggested by the data. - Taking into account input linkages would be a valuable refinement to existing effective exchange rate measures, particularly for some small economies highly integrated into global value chains. - Data limitations remain an obstacle; improved data collection efforts are essential. ### Short-term muted trade responses and policy implications - Findings suggest exchange rate changes have muted effects on the trade balance in the short term, including because of the limited response of export volumes. - Policy implications when external deficits are excessive: - Achieving meaningful near-term external adjustment may require larger exchange rate movements—which may have adverse balance sheet effects and feed into inflation—and/or tighter macroeconomic policies. - Even with no evident external imbalances: - Weak near-term buffering effects of exchange rates suggest other policy tools may be needed to achieve full employment in the event of a negative shock. ### Strengthening exchange rate mechanisms with structural policies - Price stickiness in dominant currencies partly reflects frictions that limit exporters’ responses to exchange rate movements, including capacity constraints. - Example: firms may price trade and maintain those prices in US dollars despite exchange rate movements when capacity constraints prevent reaping benefits from expanding sales by lowering US dollar prices. - Benefits of exchange rate flexibility could be bolstered by macroeconomic and structural policies that alleviate capacity constraints, including: - Improved access to credit. - Improved transportation infrastructure. - Overall: - Exchange rate flexibility remains key to facilitating external adjustment. - While the chapter’s features of international trade may affect short-term composition and strength of exchange rate effects, conventional exchange rate mechanisms are present in the medium term. - Temporary policies may be needed to support exchange rate flexibility in the near term, but they should not be substitutes for exchange rate flexibility. ### Future considerations and areas for further analysis - Understanding choice of invoicing currencies, associated price stickiness, and intrinsic rigidities of global value chains is key to policy design. - Pricing strategies likely depend on extent of integration into global value chains; these decisions are shaped by numerous country features, including expectations about exchange rate policies. - A deeper analysis of factors shaping invoicing and pricing decisions is necessary for fuller optimal policy design. - Other country characteristics and fundamentals can affect how exchange rates work in adjustment: - Need to understand whether findings on manufacturing trade apply to services trade (such as tourism), which relies more on nontradable inputs. - External balance sheet vulnerabilities can shape exchange rate workings in the adjustment process. - Further efforts are necessary to integrate empirically additional trade and financial features. ### Short-term global implications of US dollar movements (Box summary) - The widespread use of the US dollar in trade invoicing implies global movements in the value of the US dollar (vis-à-vis all other currencies) may have short-term implications for global trade. - Short-term effects of a strengthening of the US dollar implied by the chapter’s empirical results: - United States: - Because a large share of exports and imports are priced in US dollars, an appreciation of the US dollar vis-à-vis other currencies can affect export and import volumes asymmetrically in the short term. - Import demand in the United States is largely unchanged because the price of imports US consumers face is largely unchanged; export volumes tend to contract as the rest of world faces higher domestic prices of tradable goods. - Other countries: - A depreciation of other currencies vis-à-vis the US dollar increases local currency prices of goods traded between country pairs excluding the United States. - As a result, import demand contracts and trade volumes among countries in the rest of the world contract. - Over time: - Adjustment in the United States becomes more balanced (both export and import volumes reacting). - Effects on the rest of the world fade away, consistent with greater flexibility in trade prices. - This exercise sheds light on, among other things, the spill-overs of US monetary policy through trade. *From: Conclusions and Policy Implications (text - Conclusions and Policy Implications).* ### Box 2.3. Measuring Global-Value-Chain-Related Exchange Rate Shocks at the Bilateral Level ### Box 2.3. Measuring Global-Value-Chain-Related Exchange Rate Shocks at the Bilateral Level ### Motivation and conceptual illustration - Global value chains (GVCs) complicate macroeconomic analysis because the degree to which supply chains can reconfigure in response to price changes determines how competitiveness shifts translate into demand for domestic goods and output. - Two polar cases for an intermediate input (Korean flat screens used in Chinese computers exported to the United States): - Inflexible supply chains (trade in goods): production is Leontief-like; demand for the final good (Chinese computer) in the US determines demand for the intermediate; depreciation of the won matters only in proportion to the flat screen’s contribution to the final good’s value. - Flexible supply chains (trade in tasks): Chinese production adjusts to input prices and the flat screens effectively behave as direct exports from Korea to the United States; the won’s value fully matters for flat-screen demand and the renminbi is inconsequential. - The existence of GVCs mutes impacts on gross trade, while impacts on output rose through the 2008 financial crisis and fell modestly afterward. ### Empirical specification and estimation approach - Data: annual data on trade in goods and services for 59 countries over a period of 21 years. - Definitions: - FVA_it = foreign value added embedded in country i’s exports to final demand at time t. - DVA_it = domestic value added embedded in country i’s exports to final demand at time t. - REER_it = country i’s real effective exchange rate. - REER*_it = real effective exchange rate of country i’s intermediate-import partners. - dva (fva) = share of domestic (foreign) value added in country i’s gross exports to final demand. - X_it = vector of controls (controls: foreign demand, oil price, non-oil commodity prices). - Main empirical specifications: - FVA_it = η + α REER_it* + β dva_it × REER_it + γ dva_it × REER_it* + δ X_it + ε_it - DVA_it = η + α REER_it + β fva_it × REER_it* + γ fva_it × REER_it + δ X_it + ε_it - Estimation: error-correction models with short-term heterogeneous coefficients (Pesaran, Shin, and Smith 1999) to allow for different short- and long-term dynamics and cross-country heterogeneity. - Identification logic: - If supply chains are flexible (trade in tasks): β = 0 and γ = 0; only α matters. - If supply chains are inflexible (trade in goods): both foreign and domestic exchange rates matter; in the fully inflexible case β = −γ = α. ### Key empirical results - Table 2.4.1 reports long-term and short-term coefficient estimates and theoretical expectations under the flexible and inflexible cases. - Selected long-term coefficient estimates (empirics): - Importing Partners’ EER (FVA): –2.252 (–5.45)*** - Own EER × DVA Share (FVA): –0.607 (–4.60)*** - Importing Partners’ EER × DVA (FVA): 1.295 (5.07)*** - Own EER (DVA): –0.750 (–6.34)*** - Importing Partners’ EER × FVA (DVA): –0.435 (–0.75) - Own EER × FVA Share (DVA): 1.381 (2.31)** - Selected short-term coefficient estimates (empirics): - Error Correction Term: –0.202 (–7.10)***; –0.155 (–6.49)*** - Importing Partners’ EER (short-term, FVA): –0.640 (–2.94)*** - Own EER × DVA Share (short-term, FVA): –0.477 (–4.43)*** - Importing Partners’ EER × DVA (short-term, FVA): 0.677 (5.56)*** - Own EER (short-term, DVA): –0.297 (–1.54) - Importing Partners’ EER × FVA (short-term, DVA): –0.719 (–1.01) - Own EER × FVA Share (short-term, DVA): 0.757 (1.05) - Number of observations: 1,116. - Statistical indicators: t statistics in parentheses; significance levels noted as * p < 0.1 ** p < 0.05 *** p < 0.01. ### Interpretation and robustness checks - Short-term evidence overwhelmingly rejects supply-chain flexibility: - Estimated β (γ) coefficients are significantly negative (positive) in both FVA and DVA equations. - For FVA, β and γ are approximately equal and opposite and sizable relative to |α|; point estimate suggests this ratio is about two-thirds over the entire 1995–2015 sample, indicating substantial short-term inflexibility. - DVA coefficients show a similar qualitative result but are estimated less precisely. - Time evolution: - Reestimating for 2000–15 (dropping the first five years) indicates production linkages might be fully inflexible in the short term; hypotheses that α, β, and γ are equal in absolute terms cannot be rejected in either equation. - This is consistent with the rising share of foreign inputs in international trade being driven by increasingly complex production chains with more specialized inputs (see Figure 2.4.1: Foreign to Domestic Value Added, World, five-year averages). - Persistence of short-term effects: - Estimated half-life for transition from short- to long-term relationships is about three to five years. - Closing three-quarters of any short-term deviation requires six to nine years. - Short-term coefficients remain relevant for horizons of five years. - Long-term inflexibility: - While elasticities are larger at longer horizons, complementarities in production persist; some β and γ terms remain significant in the long-term equations, indicating continued inflexibility. ### Main conclusions and implications - Supply chains are generally quite inflexible, especially in the short term, implying: - Trade barriers generate larger disruptions than would be the case under flexible task-based trade. - Recreating lost production linkages is costly. - Competitiveness calculations should place greater emphasis on final destinations (countries that consume final goods) than existing practice often does. - Policy relevance: - Because production complementarities persist, exchange-rate and trade shocks pass through complexly to value-added and output; policy assessments of competitiveness and external adjustment need to account for GVC structure and its limited short-term flexibility. *Source: Box 2.3, Chapter 2, 2019 External Sector Report, International Monetary Fund.* ### Box 3.1. Assessing Imbalances: The Role of Policies—An Example ### Box 3.1. Assessing Imbalances: The Role of Policies—An Example ### Argentina — Key Findings and Policy Responses - Overall Assessment: - "The external position in 2018 was weaker than implied by medium-term fundamentals and desirable policies." - "The CA deficit at the end of 2018 was broadly unchanged relative to the previous year." - Official inflows (mainly associated with the IMF program) replaced private portfolio inflows as the main source of funding. - "A significant CA adjustment is currently underway." - Potential Policy Responses: - "The fiscal consolidation envisaged under the IMF-supported program, together with a stronger monetary and exchange policy framework, should help reabsorb the large CA deficit and lower the risks of large peso volatility." - "Supply-side reforms such as eliminating trade restrictions and introducing tax and product market reforms, would increase productivity and competitiveness and attract FDI, reducing the risk of overvaluation." - Foreign Asset and Liability Position and Trajectory: - Background: NIIP fell from its 2013 peak of 10 percent of GDP to 3 percent of GDP by end-2017 after issuance of new external debt; the May 2018 financial crisis and a peso depreciation (by about 70 percent in the peso/US$ rate on average over the year) led to NIIP improvement to about 12.1 percent of GDP by end-2018, mainly driven by lower liabilities due to valuation effects and price changes. - Assessment: "Argentina is likely to maintain a net creditor position although declining gradually over the medium term." Projected NIIP: "about 8 percent of GDP by 2024." - Vulnerabilities: "Greater portfolio liabilities and other investments (projected to rise from 51 percent of overall liabilities in 2012 to 76 percent in 2018) point to continued vulnerability to capital flow reversals." - 2018 (% GDP): NIIP: 12.1; Gross Assets: 70.3; Res. Assets: 12.3; Gross Liab.: 58.2; Debt Liab.: 46.7 - Current Account: - Background: "The CA deficit widened to 5.2 percent of GDP at end-2018." Expected CA: "about 2 percent of GDP in 2019, and about 2.5 percent of GDP in the medium term." Structural income account deficit due to official sector reliance on external borrowing. - Assessment: EBA cyclically adjusted CA: "–6.8 percent of GDP in 2018"; EBA CA norm: "–2.5 percent of GDP." Staff considers CA deficit "to be 2.0 to 4.0 percent of GDP higher than the level implied by fundamentals and desirable policies" after accounting for drought impact on agricultural exports ("about 1.3 percent of GDP"). - Attribution: "The CA gap is largely the result of looser-than-desired fiscal policy and modest credit growth during 2018, only partially offset by reserve buildup." - Actual CA: –5.2; Cycl. Adj. CA: –6.8; EBA CA Norm: –2.5; EBA CA Gap: –4.3; Staff Adj.: 1.3; Staff CA Gap: –3.0 - Real Exchange Rate: - Background: REER depreciated by "about 18 percent on average in 2018 relative to 2017," driven by nominal peso depreciation ("36 percent on average") only partially offset by relative prices. Estimates as of May 2019 suggest REER was "5.3 percent weaker than the 2018 average." - Assessment: "The CA model shows the REER to be overvalued by about 30 percent on average in 2018 (assuming an elasticity of 0.14)." Staff believes the 2018 REER was undervalued in the range of "10 to 15 percent" after a large 2018 depreciation and projects REER overshooting by "about 10 to 15 percent" followed by gradual appreciation in 2019 and the next few years. EBA REER Index model shows REER gap of "–5.9 percent in 2018." - Capital and Financial Accounts: Flows and Policy Measures: - Background: Rise in CA deficit until mid-2018 largely financed by portfolio inflows, notably government liabilities. In 2018:Q2 and 2018:Q3 government lost access to international markets and positions in Argentine assets were unwound. Sudden stop and capital flight were offset by official inflows from the IMF, World Bank, and an increase in the PBoC swap line. Gross official reserves rose by "US$10.8 billion compared with 2017." - Policy measures: Central bank tightened limits on banks’ net long FX positions and introduced caps on government debt holdings by domestic banks following capital account pressures in May 2018. - Assessment: "Greater reliance on short-term, volatile portfolio flows exposed Argentina’s external balance to risks that materialized in 2018." "The elimination of LEBACs and consistent implementation of the stabilization policies underlying the program with the IMF should restore market confidence and help reduce external vulnerabilities going forward." - FX Intervention and Reserves Level: - Background: Central bank intervened in 2018 (selling "about US$16 billion in the spot market, and accumulating US$3.6 billion in the forward market, a position that was later unwound"). In line with FX intervention rule, central bank purchased "about US$1 billion so far in 2019" and reserves stood at "US$65 billion end-May." - Assessment: Reserve coverage at end-2018 was "about 95.2 percent of the ARA metric." Fiscal consolidation combined with IMF disbursements, PBoC swap line drawing, and other multilateral assistance are expected to raise reserve coverage through time. ### Australia — Key Findings and Policy Responses - Overall Assessment: - "The external position in 2018 was broadly in line with the level implied by medium-term fundamentals and desirable policies." - "The CA deficit in 2018 narrowed to about 2 percent of GDP mainly due to stronger terms of trade and a ramp-up in new resource exports." - Potential Policy Responses: - With output below potential, "macroeconomic policy should in the near term remain supportive of Australia’s economic rebalancing after the mining investment boom." - "The current monetary policy stance is appropriately accommodative, although going forward it should remain data-dependent guided by the inflation and growth outlook." - "Budget surpluses should be targeted in the medium term, consistent with the authorities’ medium-term fiscal plans." - Structural reforms to boost productivity, especially of the nonmining sector. - Foreign Asset and Liability Position and Trajectory: - Background: NIIP at "–50.5 percent of GDP at the end of 2018." Liabilities largely in Australian dollars; assets in foreign currency. NIIP improved in 2018 by "3 percent of GDP relative to 2017." NIIP-to-GDP ratio expected to remain around "–50 percent of GDP" over the medium term. - Assessment: NIIP level and trajectory are sustainable. External Stability approach suggests NIIP stabilization with a CA deficit between "2 and 2½ percent." Structure of external balance sheet reduces vulnerability; banking sector’s net foreign currency liability position mostly hedged. Maturity of banks’ external funding has lengthened. - 2018 (% GDP): NIIP: –50.5; Gross Assets: 131.3; Debt Assets: 42.3; Gross Liab.: 181.8; Debt Liab.: 89.3 - Current Account: - Background: Australia has long-run CA deficits reflecting structural saving-investment imbalance. Since early 1980s deficits averaged around "4 percent of GDP." CA deficit in 2018 narrowed to "2.0 percent of GDP." Medium-term CA expected lower than historical average given the end of mining investment boom and a lower interest differential. Key risk: a sharper-than-expected slowdown in China affecting commodity prices. - Assessment: EBA cyclically adjusted CA for 2018: "2.4 percent of GDP"; EBA CA norm: "–0.4 percent of GDP"; EBA CA gap: "–2.0 percent." Staff view: CA norm closer to "–1.3 percent of GDP" and weather-related cyclical adjustment of "0.1 percent of GDP." Staff-assessed CA for 2018 in range "–0.4 to –1.4 percent of GDP." - Actual CA: –2.0; Cycl. Adj. CA: –2.4; EBA CA Norm: –0.4; EBA CA Gap: –2.0; Staff Adj.: 1.1; Staff CA Gap: –0.9 - Real Exchange Rate: - Background: REER depreciated by "4.0 percent relative to the 2017 average" in 2018. As of May 2019, REER was "some 4.5 percent below the 2018 average, but still some 2 percent above its 30-year average." - Assessment: Staff assesses the 2018 REER to be overvalued in the range of "0 to 12 percent." - Capital and Financial Accounts: Flows and Policy Measures: - Background: Mining investment boom funded predominantly offshore. Net FDI inflows into mining partially offset banking sector borrowing abroad. Weighted average maturity of government bonds is "6.2 years," majority maturing after 2026. Net capital inflows remained modest in 2018; composition shifted from mining to nonmining sector. - Assessment: "Credible commitment to a floating exchange rate and a strong fiscal position limit the vulnerabilities." - FX Intervention and Reserves Level: - Background: "A free floater since 1983." Brief but large intervention in 2007–08 when market illiquidity emerged. - Assessment: Authorities strongly committed to a floating regime, reducing need for reserve holding. Reserve needs for prudential reasons are limited because domestic banks’ external liabilities are either in local currency or hedged. ### Belgium — Key Findings and Policy Responses - Overall Assessment: - "The external position in 2018 was weaker than medium-term fundamentals and desirable policies would imply." - "Recent measures to improve competitiveness, together with an improving investment income balance, should support the external position over the medium term." - "The strong NIIP mitigates vulnerabilities associated with the high external public debt." - Potential Policy Responses: - "Steady fiscal consolidation, structural reforms to support labor force participation, linking wages to productivity, improving the business environment, simplifying regulations, and strengthening competition in services and regulated professions can help bring the external position more in line with fundamentals." - Foreign Asset and Liability Position and Trajectory: - Background: NIIP at "42 percent of GDP at end-2018" (compared with 53 percent a year earlier). Gross foreign assets large at "419 percent of GDP," inflated by intragroup corporate treasury activities. Gross foreign assets of banking sector at "79 percent of GDP." External public debt "60 percent of GDP," predominantly denominated in euros. Target 2 balances averaged "–€9.9 billion (–2.2 percent of GDP) in 2018." - Assessment: Large gross positions inflated by corporate treasury units that do not appear to create macrorelevant mismatches. NIIP-to-GDP ratio expected to decline gradually; strong NIIP does not raise sustainability concerns. - 2018 (% GDP): NIIP: 42.4; Gross Assets: 419.5; Debt Assets: 165.6; Gross Liab.: 377.0; Debt Liab.: 171.5 - Current Account: - Background: CA hovered around balance since global financial crisis, averaging "–0.3 percent of GDP over the 2009–17 period." Preliminary data indicate a CA deficit of "1.3 percent of GDP in 2018" after a surplus of "0.7 percent of GDP in 2017." Movements reflect lower primary income outflows related to multinationals and unusually large R&D imports by one firm. Data subject to revision and possible measurement biases. - Assessment: Preliminary EBA model estimates yield a CA gap of "–3.7 percent of GDP for 2018," based on a cyclically adjusted CA balance of "–1.3 percent" relative to an estimated norm of "2.4 percent." Staff CA gap range between "–4.7 to –2.7 percent of GDP" applying standard range ±1 percent of GDP. - Actual CA: –1.3; Cycl. Adj. CA: –1.3; EBA CA Norm: 2.4; EBA CA Gap: –3.7; Staff Adj.: 0.0; Staff CA Gap: –3.7 - Real Exchange Rate: - Background: ULC- and CPI-based REER appreciated nearly "20 percent during 2000–09." In 2014–15 both depreciated by "8 percent," later reversed. In 2018, ULC-based REER appreciated by "1.2 percent" and CPI-based REER appreciated by "2.4 percent" relative to 2017. Through May 2019, CPI-based REER depreciated by "1.2 percent." - Assessment: Preliminary EBA model estimates point to REER overvaluation between "13 and 22 percent" (CPI-based REER index and level models); EBA CA gap model indicates REER overvaluation of "8.8 percent" using an elasticity of 0.42. Staff assesses REER overvaluation in the range of "6 to 11 percent," using standard error bands. - Capital and Financial Accounts: Flows and Policy Measures: - Background: Gross financial outflows and inflows rose precrisis as banks expanded cross-border operations; since the crisis these flows shrunk and became more volatile due to deleveraging. Short-term external debt accounted for "29 percent of gross external debt at end-2018." Capital account is open. - Assessment: Belgium remains exposed to financial market risks, but the structure of financial flows does not point to specific vulnerabilities. Strong NIIP reduces vulnerabilities associated with high public debt. - FX Intervention and Reserves Level: - Background: "The euro has the status of a global reserve currency." - Assessment: Reserves held by the euro area are typically low relative to standard metrics, but the currency is free floating. *Source: Table 3.1–3.3 material from the IMF 2019 External Sector Report chapter text provided.* ### SECTION 3 2018 INDIVIDUAL ECONOMY ASSESSMENTS ### SECTION 3 2018 INDIVIDUAL ECONOMY ASSESSMENTS ### Brazil — Economy Assessment - Overall Assessment: - The external position in 2018 was broadly in line with the level implied by medium-term fundamentals and desirable policies. - The current account is projected to weaken as the cyclical recovery, especially investment, strengthens. - Potential Policy Responses: - Raise national savings to provide room for a sustainable expansion in investment. - Fiscal consolidation, including from the federal spending cap and social security reform, to boost net public savings. - Structural reforms to reduce the cost of doing business to strengthen competitiveness. - Foreign exchange intervention, including through the use of derivatives, can be appropriate to alleviate disorderly market conditions in the foreign exchange market. - Foreign Asset and Liability Position and Trajectory: - Background: - NIIP was –32.1 percent of GDP at end-2018, slightly weaker than the 2011–17 average (about –29 percent of GDP). - Over the medium term, NIIP projected to strengthen gradually to about –30 percent of GDP, as GDP growth and valuation effects deriving from Brazil’s long dollar position are expected to offset current account deficits (of about 2 percent of GDP). - FDI accounts for about half of all liabilities. - External debt rose since the global financial crisis to about 33 percent of GDP and 265 percent of exports. - Assessment: - NIIP has remained negative and is currently at the same level as in 2011. - Short-term gross external financing needs are moderate, at about 6 percent of GDP. - Capital flows and the exchange rate are particularly sensitive to global financing conditions. - The CA deficit required to stabilize the NIIP at –35 percent is 1.5 percent of GDP. - Key statistics (2018 % GDP): - NIIP: –32.1 - Gross Assets: 47.9 - Res. Assets: 20.1 - Gross Liab.: 80.0 - Debt Liab.: 22.9 - Current Account: - Background: - CA deficit widened from 0.5 percent of GDP in 2017 to 0.8 percent in 2018 due in part to a modest pickup in domestic demand. - Expected to gradually widen to about 2 percent of GDP in the medium term as the recovery continues. - Risks from terms-of-trade fluctuations, unwinding of cross-border integration, and trading partner growth remain tilted to the downside. - Assessment: - In 2018, cyclically adjusted CA was –2.1 percent of GDP, reflecting a still large negative output gap. - EBA estimates suggest a CA norm in 2018 of –2.9 percent of GDP. - Staff assesses a CA norm between –1.9 and –2.9 percent of GDP, taking vulnerabilities into account. - Thus, the CA is assessed to be broadly in line with the level implied by fundamentals and desirable policies. - Key statistics: - Actual CA: –0.8 - Cycl. Adj. CA: –2.1 - EBA CA Norm: –2.9 - EBA CA Gap: 0.8 - Staff Adj.: –0.5 - Staff CA Gap: 0.3 - Real Exchange Rate: - Background: - After appreciating in 2016–17, the REER depreciated by about 10 percent in 2018, partly reflecting political uncertainty ahead of the presidential elections. - As of May 2019, the REER had depreciated by 1.4 percent relative to the 2018 average. - Assessment: - EBA REER index and level methodologies indicate a 9.4 percent undervaluation and 2.1 percent overvaluation, respectively, for 2018. - Consistent with the CA gap, staff assesses the REER gap to be in the range of –3 to 6 percent. - Note: The staff assessed REER gap of –1.5 percent is within the (± 5 percent) interval generally described as broadly in line with fundamentals. - Capital and Financial Accounts: Flows and Policy Measures: - Background: - Brazil continues to attract sizable capital flows. - Net FDI has fully financed the CA deficits since 2015 (averaging 3.3 percent of GDP during 2015–18, whereas CA deficits averaged 1.5 percent), although partially offset by net portfolio outflows (0.8 percent of GDP on average during 2016–18). - Interest differentials, broadly adequate external buffers, and envisaged reforms to increase trade openness should support portfolio inflows. - Rigidities in the budget, the financial sector, and labor and product markets may weaken investors’ interest if not addressed. - Assessment: - Weaker than expected global growth, tightening of global financial conditions, and weak implementation of envisaged reforms remain downside risks to capital flows. - FX Intervention and Reserves Level: - Background: - Brazil has a floating exchange rate. - Gross reserves remained broadly constant in 2018, at $375 billion at end-2018, some 20 percent of GDP and about 163 percent of the IMF’s composite reserve adequacy metric. - Assessment: - The flexible exchange rate has been an important shock absorber. - Reserves are adequate relative to various criteria, including the IMF’s reserve adequacy metric. - Authorities should retain strong buffers, with intervention limited to addressing disorderly market conditions. ### Canada — Economy Assessment - Overall Assessment: - The external position in 2018 was weaker than implied by medium-term fundamentals and desirable policies. - It will take time for the economy to adjust to structural shifts in the allocation of resources, restore lost production capacity, and address productivity underperformance. - Recent developments do not suggest a material change in the assessment of the external position for 2018. - The current account is expected to weaken in 2019 and then strengthen over the medium term as nonenergy exports gradually benefit from improved price competitiveness and investment in services and manufacturing capacity. - Potential Policy Responses: - Improve labor productivity, invest in research and development and physical capital, promote foreign direct investment, develop services exports, and diversify export markets to boost nonenergy exports. - Planned increase in public infrastructure investment should boost competitiveness and improve the external position in the medium term. - A credible medium-term consolidation plan for fiscal policy will be necessary to support external rebalancing. - Foreign Asset and Liability Position and Trajectory: - Background: - Despite running a CA deficit, Canada’s NIIP improved since 2010, reaching 23.1 percent of GDP in 2018, up from 20.6 percent in 2017 and –18 percent in 2010. - This largely reflects valuation gains on external assets. - Gross external debt increased to 121 percent of GDP, of which about one-third is short term. - Assessment: - Canada’s foreign assets have a higher foreign currency component than its liabilities, providing a hedge against currency depreciation. - NIIP level and trajectory are sustainable. - Key statistics (2018 % GDP): - NIIP: 23.1 - Gross Assets: 235.1 - Debt Assets: 59.9 - Gross Liab.: 212.0 - Debt Liab.: 105.3 - Current Account: - Background: - CA deficit narrowed to 2.6 percent of GDP in 2018 (from 2.8 percent of GDP in 2017), driven by an improvement in energy exports, partly offset by import growth. - CA deficit has been partially financed by equity portfolio inflow and deposits, which have more than offset direct investment outflows. - Assessment: - EBA estimates a CA norm of 2.0 percent of GDP and a cyclically adjusted CA gap of –5.0 percent of GDP for 2018. - The EBA gap widened relative to 2017, as the improvement in the CA was less than expected given output gap movements. - Staff adjusts for (1) CA measurement issues, (2) the authorities’ demographic projections and current immigration targets, and (3) the steeper-than-usual discount between Canadian oil prices and international prices. - Taking these factors into consideration, staff assesses the CA lower than warranted by fundamentals and desired policies, with a gap in the range between –0.6 and –3.6 percent of GDP. - Key statistics: - Actual CA: –2.6 - Cycl. Adj. CA: –3.0 - EBA CA Norm: 2.0 - EBA CA Gap: –5.0 - Staff Adj.: 2.9 - Staff CA Gap: –2.1 - Real Exchange Rate: - Background: - REER depreciated by about 0.5 percent on an annual average basis between 2017 and 2018. - As of May 2019, the REER had depreciated by about 2.3 percent relative to the 2018 average. - Assessment: - EBA REER index model points to an overvaluation of 2.1 percent in 2018, whereas the REER level model points to an undervaluation of about 6.9 percent. - Staff views the REER level model could overstate the extent of undervaluation. - Consistent with the staff-assessed CA gap, staff assesses the REER to be overvalued in the range of 2 to 13 percent. - Capital and Financial Accounts: Flows and Policy Measures: - Background: - CA deficit in 2018 was partially financed by net portfolio inflows and deposits. - Nonresident investors mostly purchased corporate debt securities. - In 2018, FDI recorded a lower net outflow of 0.6 percent of GDP (3.3 percent of GDP in 2017). - Assessment: - Canada has an open capital account. - Vulnerabilities are limited by a credible commitment to a floating exchange rate. - FX Intervention and Reserves Level: - Background: - Canada has a free-floating exchange rate regime and has not intervened in the foreign exchange market since September 1998 (with the exception of participating in internationally concerted interventions). - Canada has limited reserves, but its central bank has standing swap arrangements with the US Federal Reserve and four other major central banks (it has not drawn on these swap lines). - Assessment: - Policies in this area are appropriate to the circumstances of Canada. - The authorities are strongly committed to a floating regime, which, together with the swap arrangement, reduces the need for reserve holding. ### China — Economy Assessment - Overall Assessment: - The external position in 2018 was broadly in line with the level consistent with medium-term fundamentals and desirable policies. - This represents a change from earlier assessments when the external position was judged to be moderately stronger. - The trend decline in CA surplus since the 2007 peak is largely structural, reflecting progress in rebalancing, while the sharp decline in 2018 was partly supported by higher commodity and semiconductor prices. - It remains important to ensure that rebalancing in China continues to avoid a return of excessive CA surpluses. - Potential Policy Responses: - Gradual closing of domestic policy gaps in fiscal and credit areas accompanied by reforms that address distortions to ensure more sustainable growth with higher consumption and lower overall saving. - Priorities include improving the social safety net; SOE reform and opening markets to more competition; creating a more market-based and robust financial system; steps to attract more inward FDI, including by ensuring equal treatment of foreign and domestic investors; and moving more to a flexible, market-based exchange rate. - Requires a more market-based and transparent monetary policy framework and communications. - Foreign Asset and Liability Position and Trajectory: - Background: - NIIP remains positive but declined to 15.9 percent of GDP by end-2018 after peaking at 33 percent of GDP in 2007. - Deterioration driven by a reduction in the CA surplus, valuation changes, and sustained high GDP growth. - Gross foreign assets were 55 percent of GDP by end-2018 and are dominated by foreign reserves, whereas gross liabilities (40 percent of GDP) mainly reflect inward FDI. - Reserve assets were stable and stood at US$3.1 trillion by end 2018 (about 24 percent of GDP). - Assessment: - NIIP-to-GDP ratio expected to remain strong, with a modest decline over the medium term, in line with the projected CA. - NIIP is not a major source of risk at this point, as assets remain high—reflecting large foreign reserves—and liabilities are mostly FDI related. - Capital outflow pressures have remained subdued, despite pressures on the US dollar–renminbi bilateral exchange rate during the second half of 2018. - There are currently no substantial net outflow pressures, although such pressures may resurface as the private sector seeks to accumulate foreign assets faster than nonresidents accumulate Chinese assets. - Key statistics (2018 % GDP): - NIIP: 15.9 - Gross Assets: 54.6 - Res. Assets: 23.6 - Gross Liab.: 38.7 - Debt Liab.: 13.0 - Current Account: - Background: - The CA surplus declined further in 2018, reaching 0.4 percent of GDP in 2018, about 1 percentage point lower than in *International Monetary Fund | July 2019* ### 2017. This mainly reflects a shrinking trade balance (driven by high import volume growth) and a continued increase in t ### text - 2017. This mainly reflects a shrinking trade balance (driven by high import volume growth) and a continued increase in t ### Current Account (China) - Background: - Decline in CA surplus from peak of about 10 percent of GDP in 2007, driven by strong investment growth, REER appreciation, weak demand in major advanced economies, technological upgrades in manufacturing, and widening services deficit. - 2017 drivers: shrinking trade balance (driven by high import volume growth) and continued increase in the services deficit (mostly driven by tourism), as well as higher commodity and semiconductor prices. - CA surplus expected to gradually decline further over the next few years in line with continued rebalancing. - Assessment (EBA and staff): - EBA cyclically adjusted CA exceeds the norm by 0.8 percent of GDP. - Staff assesses the CA to be broadly in line with fundamentals and desired policies with a CA gap range of –0.7 to +2.3 percent. - EBA-identified policy gaps: net –0.3 percent (loose fiscal policy and excessive credit growth offset by inadequate health spending); residual accounts for other factors including distortions encouraging excessive savings. - Key statistics: - Actual CA: 0.4 - Cycl. Adj. CA: 0.3 - EBA CA Norm: –0.4 - EBA CA Gap: 0.8 - Staff Adj.: 0.0 - Staff CA Gap: 0.8 ### Real Exchange Rate (China) - Background: - 2018 average REER appreciated by about 1.4 percent relative to 2017, driven by NEER appreciation of 1.5 percent. - Estimates through May 2019 indicate REER depreciated by about 0.2 percent relative to the 2018 average. - Assessment: - 2018 EBA REER index regression estimates China’s REER at the same level as warranted by fundamentals and desirable policies—compared with 5.3 percent lower in 2017. - Assessment subject to large uncertainties related to the outlook and shifts in portfolio allocation preferences. - Staff assesses the REER gap to be in the range of –11.5 to 8.5 percent. - Note: The staff assessed REER gap of –1.5 percent is within the (± 5 percent) interval generally described as broadly in line with fundamentals. ### Capital and Financial Accounts: Flows and Policy Measures (China) - Background: - Capital flows: modest inflows in first half of 2018, modest outflows in latter part; net capital inflow of US$30 billion in 2018 (versus net capital outflows of US$103 billion in 2017; record outflows of US$647 billion in 2015 and US$646 billion in 2016). - De jure capital account remains relatively closed. - Policy measures: 20 percent reserve requirement on FX forwards (a CFM) reintroduced; administrative measures to control the exchange rate reimposed in August 2018. - Assessment / Policy guidance: - Sequence of capital control loosening consistent with exchange rate flexibility should consider domestic financial stability. - Further opening likely to create substantially larger two-way gross flows; prioritize shift to an effective float, use FX intervention to counter disorderly market conditions, and strengthen domestic financial stability before substantial further liberalization. - Step up efforts to encourage inward FDI to generate positive growth spillovers and improve corporate governance standards. ### FX Intervention and Reserves Level (China) - Background: - FX reserves declined by US$67 billion in 2018, after rising by US$129 billion in 2017. - Staff estimates (after adjusting for valuation changes and return on reserves) suggest minor net FX sales during episodes of market pressures; estimates subject to margin of error that could include no intervention. - Assessment: - Reserves at end-2018: - 90 percent of IMF’s composite metric unadjusted for capital controls (down from 106 percent in 2016 and 97 percent in 2017). - 143 percent relative to the metric adjusted for capital controls (down from 156 percent in 2017). - Decline in ratio driven by higher broad money (M2) growth, external debt, and other liabilities increasing the metric. - Given capital account considered only partially open, reserves would be considered adequate in the range indicated by adjusted and unadjusted metrics. - Overall staff assessment: current level of reserves adequate. - Policy: as transition to greater flexibility advances, intervention should be limited to smoothing excessive volatility. --- ### Euro Area: Foreign Asset and Liability Position and Trajectory - Background: - NIIP fell to about –17 percent of GDP by end-2009, recovered to about –4 percent by end-2018. - Gross foreign positions in 2018: assets about 228 percent of GDP; liabilities about 232 percent of GDP. - Heterogeneity: elevated net external assets in large creditor countries (Germany, the Netherlands); net external liabilities remain high in some countries (Spain, Portugal). - Assessment: - Continued CA surpluses project NIIP-to-GDP ratio to improve moderately; euro area expected to soon become a net external creditor. - Overall NIIP financing vulnerabilities appear low, but large net external debtor countries still bear greater risk of a sudden stop of gross inflows. - Key statistics (2018, % GDP): - NIIP: –3.8 - Gross Assets: 228.0 - Debt Assets: 89.7 - Gross Liab.: 231.8 - Debt Liab.: 94.6 ### Euro Area: Current Account - Background: - CA increased steadily from 2011, peaked at 3.2 percent in 2016–17, narrowed to 2.9 percent of GDP in 2018 due to higher oil prices and weaker external demand (China, Turkey, United Kingdom) amid rising trade tensions and Brexit uncertainties. - Large creditor countries (Germany, the Netherlands) continued sizable surpluses reflecting strong saving and weak investment. - Assessment: - EBA model: CA norm 1.1 percent of GDP; cyclically adjusted CA 2.9 percent -> gap 1.8 percent of GDP. - Staff analysis indicates higher CA norm than EBA model; staff assesses CA gap to be 1.3 percent for 2018, with a range of 0.5 to 2.1 percent of GDP. - Key statistics: - Actual CA: 2.9 - Cycl. Adj. CA: 2.9 - EBA CA Norm: 1.1 - EBA CA Gap: 1.8 - Staff Adj.: –0.6 - Staff CA Gap: 1.3 ### Euro Area: Real Exchange Rate - Background: - CPI-based REER appreciated by about 3.0 percent from 2017 to 2018; estimates through May 2019 show REER depreciated by 3.1 percent relative to 2018 average. - Assessment: - Staff assesses average euro REER gap in range of –5 to –1 percent, midpoint –3 percent. - Significant heterogeneity across member states: REER gaps range from undervaluation of 8 to 18 percent in Germany to overvaluations of 0 to 10 percent in several small to mid-sized members. - Note: staff assessed REER gap of –3 percent is within (± 5 percent) interval described as broadly in line with fundamentals. ### Euro Area: Capital and Financial Accounts - Background: - Mirroring 2018 CA surplus, euro area experienced net capital outflows, largely driven by portfolio debt and FDI outflows, partly offset by portfolio equity inflows. - Assessment: - Capital outflows in portfolio debt and inflows into portfolio equity likely arose in large part from ECB’s asset purchase program lowering debt yields and spurring equity interest. ### Euro Area: FX Intervention and Reserves - Background: - Euro has status of a global reserve currency. - Assessment: - Reserves held by euro area economies typically low relative to standard metrics, but currency is free floating. --- ### France: Foreign Asset and Liability Position and Trajectory - Background: - Since 2015, NIIP averaged about –16 percent of GDP, driven by public sector and banking sector net external debt; net FDI position positive and over 20 percent of GDP. - NIIP improved from –20 percent of GDP in 2017 to –11 percent of GDP in 2018 due to lower nonfinancial firms’ portfolio equity liabilities partly reflecting valuation effects. - Gross positions large: gross assets 290 percent of GDP; gross liabilities 301 percent of GDP in 2018. - External debt estimated at 200 percent of GDP: public sector 54 percent of GDP; banks 104 percent of GDP. - Target 2 balances averaged about –€36 billion (–1.5 percent of GDP) in 2018. - Assessment: - NIIP negative but size and projected stable trajectory do not raise sustainability concerns. - Vulnerabilities from large public external debt and banks’ gross financing needs—bank debt maturing in 2019 estimated at €75 billion (3.2 percent of GDP); financial derivatives at 30 percent of GDP. - Key statistics (2018, % GDP): - NIIP: –11.4 - Gross Assets: 289.9 - Debt Assets: 153.1 - Gross Liab.: 301.2 - Debt Liab.: 193.1 ### France: Current Account - Background: - CA deficit around 0.7 percent of GDP since 2010; narrowed to 0.3 percent in 2018 (from 0.6 percent in 2017) despite deterioration in oil balance, reflecting lower import growth amid weak investment. - Assessment: - 2018 cyclically adjusted CA deficit estimated at 0.3 percent of GDP; EBA-estimated norm is a surplus of 0.5 percent. - Staff assesses CA gap in 2018 between –1.2 and –0.2 percent of GDP. - Key statistics: - Actual CA: –0.3 - Cycl. Adj. CA: –0.3 - EBA CA Norm: 0.5 - EBA CA Gap: –0.7 - Staff Adj.: 0.0 - Staff CA Gap: –0.7 ### France: Real Exchange Rate - Background: - After depreciating about 4 to 9 percent since 2010 (mainly due to the euro depreciation), ULC-based and CPI-based REER appreciated moderately by 0.6 to 2.2 percent in 2018 relative to 2017 average. - Through May 2019, CPI-based REER depreciated by 1.6 percent. - ULC-based REER appreciated about 3 to 9 percent since late 1990s; France lost about one-third of its export market share in the 2000s and has not regained it. - Assessment: - EBA REER Index model: REER gap –0.4 percent. - EBA REER Level model: REER gap 7.1 percent. - Given elasticity of 0.27, EBA CA gap implies overvaluation of 1 to 4 percent. - Staff assesses REER gap in the 1 to 4 percent range. ### France: Capital and Financial Accounts - Background: - CA deficit financed mostly by debt inflows (portfolio and other investment); outward direct investment generally higher than inward. - Financial derivative flows have grown sizably on asset and liability sides since 2008. - Capital account is open. - Assessment: - France exposed to financial market risks owing to large refinancing needs of sovereign and banking sector. ### France: FX Intervention and Reserves - Background & Assessment: - Euro status as global reserve currency; reserves held by euro area typically low relative to standard metrics; currency is free floating. --- ### Germany: Foreign Asset and Liability Position and Trajectory - Background: - Positive NIIP reached 61 percent of GDP in 2018, more than twice 2012 level. - NIIP of financial corporations other than monetary financial institutions is large and positive (57 percent of GDP); general government NIIP large and negative (25 percent of GDP). - NIIP expected to exceed 80 percent of German GDP by 2023. - TARGET2 claims: €934 billion in May 2019 (27 percent of GDP), down from over €976 billion in mid-2018. - Assessment: - With QE measures by ECB, Germany’s exposure to the Eurosystem remains large. - Key statistics (2018, % GDP): - NIIP: 60.6 - Gross Assets: 252.9 - Debt Assets: 89.8 - Gross Liab.: 192.3 - Debt Liab.: 143.2 ### Germany: Current Account - Background: - CA surplus widened since 2001, peaked at 8.5 percent of GDP in 2015, fell to 7.3 percent of GDP in 2018 (from 8.0 percent in 2017) driven by decline in net exports and higher energy prices. - Bulk of CA surplus reflects large saving-investment surpluses of NFCs and households; rising NFC savings and fiscal consolidation contributed to upward trend. - Assessment: - Cyclically adjusted CA balance: 7.6 percent of GDP in 2018 (0.7 percentage points below 2017). - Staff assesses CA norm at 2 to 4 percent of GDP, with midpoint ½ percent of GDP above EBA model CA norm of 2.5 percent. - Staff assesses 2018 CA gap in range 3.6 to 5.6 percent of GDP. - Key statistics: - Actual CA: 7.3 - Cycl. Adj. CA: 7.6 - EBA CA Norm: 2.5 - EBA CA Gap: 5.1 - Staff Adj.: – 0.45 - Staff CA Gap: 4.6 ### Germany: Real Exchange Rate - Background: - Yearly average CPI-based and ULC-based REERs appreciated 2.4 and 3.5 percent in 2018, respectively. - Estimates through May 2019 show REER depreciated by 1.2 percent relative to 2018 average. - Assessment: - EBA REER Level model yields undervaluation of 16 percent. - Undervaluation implied by assessed CA gap using standard trade elasticities: 12 to 27 percent. - Staff assesses 2018 REER undervaluation in range of 8 to 18 percent. ### Germany: Capital and Financial Accounts - Background: - 2018 net portfolio outflows constituted over three-quarters of capital and financial accounts balance; direct investment about one-fifth. - Destination: 80 percent of outflows to European countries; about 6 percent to the Americas (mostly United States). - Inflows: only 14 percent from EU due to falling investment by noneuro EU countries; emerging markets and North America picked up. - FDI inflows/outflows recovered after 2016 drop, mostly with euro area countries. - Assessment: - Safe-haven status and strong external position limit risks. ### Germany: FX Intervention and Reserves - Background & Assessment: - Euro status as global reserve currency; reserves held by euro area countries typically low relative to standard metrics; currency freely floating. *International Monetary Fund | July 2019* ### CHAPTER 3 2018 INDIVIDUAL ECONOMY ASSESSMENTS ### CHAPTER 3 2018 INDIVIDUAL ECONOMY ASSESSMENTS ### Hong Kong SAR — Overall Assessment and Policy Responses - Overall Assessment: The external position in 2018 was broadly in line with the level implied by medium term fundamentals and desirable policies. - Drivers: The CA surplus has declined relative to its pre-2010 level due to structural factors, including opening of the mainland capital account and changes in offshore merchandise trade activities. - Exchange Rate and Markets: As a result of Hong Kong SAR’s LERS, short-term movements in the REER largely reflect US dollar developments. Hong Kong SAR’s flexible goods, factor, and asset markets continue to support the LERS. - Potential Policy Responses: - Maintain policies that support wage and price flexibility to preserve competitiveness. - Continue robust and proactive financial supervision and regulation, prudent fiscal management, flexible markets, and the LERS to keep the external position broadly in line with medium-term fundamentals. ### Hong Kong SAR — Foreign Asset and Liability Position and Trajectory - Background: - NIIP reached about 357 percent of GDP as of end-2018, up from 275 percent in 2012. - Gross assets: about 1,510 percent of GDP. - Gross liabilities: about 1,154 percent of GDP. - Valuation changes were sizable and positive; the change in NIIP during 2014–18 (150 percent of 2018 GDP) far exceeded the cumulative financial account balances (20 percent of 2018 GDP). - Income on large NIIP modest despite some increase in the last two years, due to relatively low yields on assets and substantially higher payments on liabilities. - Assessment: Vulnerabilities are low given the positive NIIP and its favorable composition. Reserve assets are large and stable (117 percent of GDP at end-2018). Direct investments: 38 percent of assets and 53 percent of liabilities in 2018. Portfolio liabilities accounted for 13 percent of total liabilities at end-2018. - Key statistics (2018, % GDP): - NIIP: 356.7 - Gross Assets: 1,510.3 - Debt Assets: 515.2 - Gross Liab.: 1,153.6 - Debt Liab.: 394.2 ### Hong Kong SAR — Current Account (2018) - Background: - Actual CA: 4.3 percent of GDP in 2018, down from 4.5 percent in 2017. - CA peaked at about 15 percent of GDP in 2008. - Decline in 2018 driven by a larger trade deficit in goods (higher oil prices and robust domestic demand), partially offset by higher services and income balances. - Private saving declined from 34.4 percent of GDP in 2006 to 22.9 percent of GDP in 2018, accounting for most of the CA surplus drop. - Projected CA over the medium term: about 3.5 percent of GDP. - Assessment: - Staff’s quantitative assessment: projected cyclically adjusted CA at 4.5 percent is midpoint of CA norm range of 3.0 to 6.0 percent of GDP. - CA gap range: –1½ to 1½ percent of GDP. - Measurement issues: large valuation effects in the NIIP require CA adjustment. - Key statistics: - Actual CA: 4.3 - Cycl. Adj. CA: 4.5 - EBA CA Norm: — - EBA CA Gap: — - Staff Adj.: — - Staff CA Gap: 0.0 ### Hong Kong SAR — Real Exchange Rate - Background: - REER dynamics largely determined by the HK dollar/US dollar peg and subdued inflation. - REER appreciated by about 20 percent between 2012–17, then depreciated by 1.9 percent in 2018 compared with the 2017 average. - The weak side of the convertibility undertaking was triggered several times since April 2018, prompting HKMA US dollar sales. - Assessment: - Based on elasticity estimates for similar economies and uncertainties of an offshore trading and financial center, the REER gap is assessed by staff to be between –5 and 5 percent. - Note: The midpoint of the staff assessed REER gap is within the (± 5 percent) interval generally described as broadly in line with fundamentals. ### Hong Kong SAR — Capital and Financial Accounts: Flows and Policy Measures - Background: - Open capital account; as a financial center nonreserve financial flows moved from sizable net inflows in 2017 to outflows of similar magnitude in 2018. - Financial account very volatile, reflecting mainland financial conditions, cross-border linkages, and shifting expectations of US monetary policy. - Assessment: - Large financial resources and proactive supervision limit risks from volatile capital flows, aided by deep and liquid markets. - Greater financial exposure to mainland China could pose risks if mainland growth slows sharply and stress emerges in key sectors (export-oriented manufacturing or real estate). - Given high origination and underwriting standards, credit risk appears manageable. ### Hong Kong SAR — FX Intervention and Reserves Level - Background: - Currency board arrangement. International reserves built up as the HK dollar was often pushed to the strong side of its trading range. - Reserves at end-2018: equivalent to about 117 percent of GDP (lower than end-2017 but above end-2015). - Since April 2018, the HK dollar hit the lower convertibility range of 7.85 a few times, prompting HKMA US dollar sales under the LERS. Liquidity drained from the system caused short-term HK dollar money market interest rates to rise gradually, closing the gap with the LIBOR. - Assessment: - Reserves are adequate for precautionary purposes and should continue to evolve in line with the automatic adjustment inherent in the currency board system. - Hong Kong SAR also holds significant fiscal reserves built up through a track record of strong fiscal discipline. --- ### India — Overall Assessment and Policy Responses - Overall Assessment: The external sector position in 2018 was broadly in line with the level implied by fundamentals and desirable policies. - Context: India’s low per capita income, favorable growth prospects, demographic trends, and development needs justify running CA deficits. External vulnerabilities remain, highlighted by bouts of turbulence in 2018. - Risks: Volatility in global financial conditions, an oil price surge, and a retreat from cross-border integration. Trade barriers remain significant. - Potential Policy Responses: - Rein in fiscal deficits while enhancing credit provision via faster cleanup of bank and corporate balance sheets and strengthening governance of public banks. - Improve business climate, ease domestic supply bottlenecks, liberalize trade and investment to attract FDI and improve CA financing mix. - Consider gradual liberalization of portfolio flows while monitoring reversal risks. - Maintain exchange rate flexibility as main shock absorber; limit intervention to disorderly market conditions. ### India — Foreign Asset and Liability Position and Trajectory - Background (as of end-2018): - NIIP: –15.9 percent of GDP (improved from –17.3 percent at end-2017). - Gross foreign assets: 22.2 percent of GDP. - Gross foreign liabilities: 38.1 percent of GDP. - Asset composition: bulk in official reserves and FDI. - Liability composition: other investments 39 percent, FDI 37 percent, portfolio equity 13 percent, debt 10 percent. - External debt: some 20 percent of GDP; about half denominated in US dollars and 36 percent in Indian rupees. - Long-term external debt: about 80 percent of total. - Short-term external debt (residual maturity basis): 43 percent of total external debt and 55.8 percent of FX reserves. - Assessment: With CA deficits projected to continue, NIIP-to-GDP expected to weaken marginally. Moderate foreign liabilities reflect gradual capital account liberalization focused on FDI. External debt moderate compared with other EMs, but short-term rollover risks elevated. ### India — Current Account (Fiscal year 2018/19) - Background: - CA deficit estimated at 2.5 percent of GDP in fiscal year 2018/19, up from 1.9 percent in the previous year. - Drivers: higher commodity prices and strong domestic demand in the first half of the fiscal year. - Robust export growth supported by partners’ demand and rupee depreciation. - Medium-term CA deficit expected to remain about 2½ percent of GDP. - Assessment: - EBA cyclically adjusted CA deficit: 2.5 percent of GDP. - EBA CA regression norm: –3.4 percent of GDP with a standard error of 1.4 percent, implying an EBA gap of 0.9 percent. - Staff judgment: CA deficit of about 2½ percent of GDP is financeable over time. - Historical caution: global markets cannot reliably finance a CA deficit above 3 percent of GDP given past cash flow and capital inflow restrictions. - FDI flows not yet sufficient to cover protracted large CA deficits; portfolio flows volatile. - Staff-assessed CA gap range: –1.0 to 1.0 percent of GDP. - Key statistics: - Actual CA: –2.5 - Cycl. Adj. CA: –2.5 - EBA CA Norm: –3.4 - EBA CA Gap: 0.9 - Staff Adj.: –0.9 - Staff CA Gap: 0.0 ### India — Real Exchange Rate - Background: - Average REER in 2018 depreciated by about 3.8 percent from its 2017 average. - As of May 2019, the rupee had appreciated by about 7.7 percent in real terms compared with the average REER in 2018. - Assessment: - EBA REER Index and REER level models estimate REER gaps of 5.4 and 2.5 percent, respectively, for 2018. - External stability approach estimates a REER gap of about –2.0 percent. - Based on staff-assessed CA gap, REER gap assessed to be in the range of –6 to 6 percent for fiscal year 2018/19. - Note: The midpoint of the staff assessed REER gap is within the (± 5 percent) interval generally described as broadly in line with fundamentals. ### India — Capital and Financial Accounts: Flows and Policy Measures - Background: - Sum of net FDI, portfolio, and financial derivative flows estimated at 0.8 percent of GDP in fiscal year 2018/19, down from 2 percent in fiscal year 2017/18. - Net FDI inflows: 1.3 percent of GDP in fiscal year 2018/19 (unchanged). - Net portfolio flows: negative by 0.5 percent of GDP in fiscal year 2018/19 due to bouts of equity and debt outflows in spring and fall 2018. - Assessment: - Yearly capital inflows relatively small; modest FDI means portfolio and other investments critical to finance the CA. - Portfolio debt flows volatile; exchange rate sensitive to these flows and global risk aversion. - Attracting more stable financing sources needed to reduce vulnerabilities. ### India — FX Intervention and Reserves Level - Background: - Authorities responded to market pressure in fall 2018 with exchange rate flexibility and FX intervention. - Spot foreign exchange sales: US$26 billion (1 percent of GDP) in 2018. - Net forwards decreased by US$31.5 billion in 2018. - International reserves: $411.9 billion at end-March 2019, down about $12.5 billion from March 2018. - Reserve coverage: about 15.2 percent of GDP and about 6.7 months of prospective imports of goods and services. - Assessment: - Reserve levels adequate for precautionary purposes relative to various criteria. - International reserves represent about 155 percent of short-term debt and 149 percent of the IMF’s composite metric. --- ### Indonesia — Foreign Asset and Liability Position and Trajectory (partial) - Background (at end-2018, partial): - NIIP: –30 percent of GDP (compared with –33 percent at end-2017 and –39½ percent at end-2012). - Gross external assets: 33.3 percent of GDP (of which close to 35 percent were reserve assets). - Gross external liabilities: [text cutoff — data not provided in the supplied content]. *International Monetary Fund | July 2019* ### 63.8 percent of GDP. Indonesia’s gross external debt was moderate at 36.2 percent of GDP at end-2018, of which 19 percen ### 63.8 percent of GDP. Indonesia’s gross external debt was moderate at 36.2 percent of GDP at end-2018, of which 19 percent was denominated in rupiah and 87 percent was maturing after one year. About one-third of the government’s external debt was denominated in rupiah. ### Foreign asset and liability position and assessment - NIIP (2018): –30.5 percent of GDP - Gross Assets (2018): 33.3 percent of GDP - Reserve Assets (2018): 11.6 percent of GDP - Gross Liabilities (2018): 63.8 percent of GDP - Debt Liabilities (2018): 36.2 percent of GDP - Nonresident holdings of rupiah-denominated government bonds: 34 percent of the total stock (or 6.4 percent of GDP) at end-2018 - Assessment: - The level and composition of the NIIP and gross external debt indicate that Indonesia’s external position is sustainable and subject to limited rollover risk. - Nonresident holdings of rupiah-denominated government bonds combined with shallow domestic financial markets make Indonesia susceptible to global financial volatility, higher US interest rates, and a stronger US dollar. - Staff projections for the current account suggest that the NIIP position as a percent of GDP will be stable over the medium term. ### Current account (background, figures, and assessment) - Actual CA (2018): –3.0 percent of GDP - Cyclically Adjusted CA (2018): –3.3 percent of GDP - EBA CA Norm: –0.9 percent of GDP - EBA CA Gap: –2.4 percent of GDP - Staff Adjustment: 0.9 percent of GDP - Staff CA Gap: –1.5 percent of GDP - Background: - CA deficit increased to 3 percent of GDP in 2018 from a 1.6 percent deficit in 2017, driven mainly by growing domestic demand and higher oil prices. - The CA deficit is projected to narrow slightly to 2.9 percent in 2019 due to weaker import growth (partly from lagged effects of sharp exchange rate depreciation since mid-2018) and lower oil prices. - A gradual increase in manufacturing exports, underpinned by improved competitiveness and stronger demand from trading partners, should help limit the CA deficit over the medium term. - Assessment: - Staff estimates a CA gap of –1.5 percent for 2018, consistent with an estimated cyclically adjusted CA balance of –3.3 percent of GDP and a staff-assessed norm of –1.8 percent of GDP. - Taking into account uncertainties in the estimation of the norm, the CA gap for 2018 is in the range of –3 percent to 0 percent of GDP. - Offsetting impact of domestic policy gaps implies addressing excess imbalances will require reforms to improve labor markets and competitiveness. - The lagged effects of the weaker rupiah should help improve the CA deficit in the near term. ### Real exchange rate (REER) background and assessment - 2018 average REER depreciation: 6.0 percent relative to the average of 2017 - Nominal exchange rate depreciation in 2018: 7.1 percent - REER appreciation through May 2019 relative to 2018 average: 5.0 percent - Assessment: - The EBA index and level REER models point to an REER gap of about –3.2 percent to –15.5 percent for 2018, driven by the depreciation of the REER. - The CA gap estimate of –1.5 percent of GDP with standard elasticities and uncertainty ranges (± 5 percent) would indicate that the REER is overvalued in the range of 3 to 13 percent. - Taking into account the depreciation in 2018, staff assesses the REER gap to be in the –9 to 1 percent range. - Staff-assessed REER gap of –4 percent is within the (± 5 percent) interval generally described as broadly in line with fundamentals. ### Capital and financial accounts: flows and policy measures - Net capital and financial account inflows (2018): 2.5 percent of GDP - Net FDI inflows (2018): 1.4 percent of GDP - Net portfolio inflows (2018): 0.9 percent of GDP - Net other investment inflows (2018): 0.2 percent of GDP - Assessment: - Net and gross financial flows have been relatively steady since the global financial crisis despite some short periods of volatility. - The contained CA deficit and strengthened policy frameworks, including exchange rate flexibility since mid-2013, have helped reduce capital flow volatility. - Continued strong policies focused on strengthening the fiscal position, keeping inflation in check, and easing supply bottlenecks would help sustain capital inflows in the medium term. ### FX intervention and reserves level - Reserves at end-2018: US$120.6 billion (equal to 12 percent of GDP, about 118 percent of the IMF’s reserve adequacy metric and about 6.4 months of prospective imports of goods and services) - Reserves at end-2017: US$130.2 billion - Contingencies and swap lines in place: about US$92.5 billion - Reserves at end-April (2019): US$124.3 billion - Assessment: - The loss in international reserves from end-2017 to end-2018 reflects mainly FX intervention in response to disorderly market conditions triggered by tightening global financial conditions. - The current level of reserves (US$124.3 billion at end-April) should provide a sufficient buffer against a wide range of possible external shocks, with predetermined drains manageable. - FX intervention, while broadly appropriate in 2018, should continue to aim primarily at preventing disorderly market conditions, while allowing the exchange rate to adjust to external shocks. *Source: 2019 EXTERNAL SECTOR REPORT (excerpts pertaining to Indonesia).* ### 0.4 to 2.4 percent of GDP. Identified policy gaps from significantly tighter than desired fiscal policy and relatively l ### 0.4 to 2.4 percent of GDP. Identified policy gaps from significantly tighter than desired fiscal policy and relatively l ### Current Account: Korea (excerpt) - Background and metrics: - Actual CA: 4.4 - Cycl. Adj. CA: 4.2 - EBA CA Norm: 2.7 - EBA CA Gap: 1.4 - Staff Adj.: 0.0 - Staff CA Gap: 1.4 - Key findings: - Identified policy gaps from significantly tighter than desired fiscal policy and relatively low social spending are key contributors to the CA gap. - Low social spending increases precautionary savings and thus the CA through lack of access to social safety net. ### Real Exchange Rate: Korea (excerpt) - Background: - REER appreciated by 1.0 percent in 2018. - REER up about 10 percent since 2013. - As of May 2019, REER weakened by about 5.1 percent relative to the 2018 average. - Assessment: - EBA REER regression model gaps range from –5.4 (REER Level model) to 3.8 (REER Index model). - Staff assesses the REER gap in 2018 to be in the range of –7 to –1 percent, derived by applying the estimated semielasticity of 0.36 to the staff-assessed CA gap. ### Capital and Financial Accounts: Korea (Flows and Policy Measures) - Background: - Net capital outflows decreased to 4.1 percent of GDP in 2018 from 5.2 percent of GDP in 2017. - Nonresident portfolio inflows surged to US$21.1 billion in 2018. - Nonresidents sold US$6 billion worth of equities (net), contributing to a correction in equity prices of about 20 percent in 2018. - Assessment: - Present configuration of net and gross capital flows appears sustainable over the medium term. - Korea has demonstrated capacity to absorb short-term capital flow volatility of magnitudes experienced in recent years. ### FX Intervention and Reserves Level: Korea (Flows and Policy Measures) - Background: - Korea has a floating exchange rate. - FX intervention appears two-sided since early 2015, based on staff estimates. - Staff estimates total net intervention in 2018 was limited, with spot interventions roughly offsetting change in forward position. - Reserves increased steadily from 2009 through mid-2014, remained broadly stable through 2016, and increased slightly since. - In 2018, reserves increased by US$14.4 billion, including valuation effects. - At end-2018, total reserves stood at US$403 billion (23.4 percent of GDP). - Assessment: - Intervention appears limited to addressing disorderly market conditions since 2015. - Foreign exchange reserves were about 106 percent of the IMF’s composite reserve adequacy metric at end-2018. - According to staff estimates net intervention since 2016 has been slightly negative. --- ### Malaysia: Foreign Asset and Liability Position and Trajectory - Background: - NIIP has averaged about 1 percent of GDP since 2010. - As of end-2018, NIIP: –5.2 percent of GDP (compared with –2 percent of GDP at end-2017). - Total external debt (US dollars) was about 62.4 percent of GDP at end-2018 (compared to 70 percent of GDP at end-2017). - About two-thirds of external debt was in foreign currency and 44 percent in short-term debt, by original maturity. - 2018 (% GDP) snapshot: - NIIP: –5.2 - Gross Assets: 113.6 - Res. Assets: 28.3 - Gross Liab.: 118.9 - Debt Liab.: 51.0 - Assessment: - NIIP should rise gradually over the medium term reflecting projected moderate CA surpluses. - Malaysia’s balance sheet strength, exchange rate flexibility, and increased domestic investor participation support resilience to a variety of shocks. ### Malaysia: Current Account 2018 (% GDP) - Background: - CA surplus declined by about 7 percentage points of GDP between 2010 and 2017. - In 2018, CA surplus declined to 2.1 percent of GDP (from 3 percent in 2017). - Goods balance was in surplus; services and income accounts registered larger deficits. - Metrics: - Actual CA: 2.1 - Cycl. Adj. CA: 2.3 - EBA CA Norm: –0.2 - EBA CA Gap: 2.4 - Staff Adj.: 0.0 - Staff CA Gap: 2.4 - Assessment: - EBA CA regression estimates 2018 CA norm at –0.2 percent of GDP after adjustments. - Estimated 2018 CA gap is 2.4 percent of GDP (about ±1 percent of GDP). - Unidentified residuals explain the entire CA gap, potentially reflecting structural distortions and country-specific factors not included in the model. - Identified domestic policy gaps have an offsetting effect: low public health care spending contributes to excess surplus; FX intervention that prevented further currency depreciation reduces the surplus. - CA balance expected to remain in surplus, albeit lower, over the medium term driven by lower private sector net saving. ### Malaysia: Real Exchange Rate - Background: - In 2018, average REER appreciated by 4.2 percent. - REER had depreciated nearly 2.4 percent since April 2018. - REER about 10 percent lower than its 2013 level. - Through May 2019, REER depreciated by 2.0 percent relative to the 2018 average. - Assessment: - EBA REER Index and Level models estimate REER undervaluation of about 25 and 37 percent, respectively. - Staff assesses the REER gap in 2018 to be –5 percent (± about 2 percent), consistent with the assessed CA gap. ### Malaysia: Capital and Financial Accounts; FX Intervention and Reserves - Capital and Financial Accounts background and assessment: - Malaysia has experienced periods of significant capital flow volatility since the global financial crisis, largely driven by portfolio flows in and out of the local-currency debt market. - Following tightening global financial conditions and general elections in spring 2018, portfolio outflows intensified, but recovered somewhat since late 2018. - Financial Markets Committee has implemented measures to develop the onshore FX market since late 2016. - Assessment: Continued exchange rate flexibility and macroeconomic policy adjustments necessary to manage capital flow volatility; capital flow management measures should be gradually phased out, with due regard for market conditions. - FX Intervention and Reserves background and assessment: - Malaysia faced significant reserve losses between 2014 and 2016 and witnessed an increase of nearly US$8 billion in 2017. - Reserves generally unchanged in 2018, with intrayear volatility: increased by US$7.1 billion through end-April 2018, then fell by US$8.1 billion during remainder of the year, reaching US$101.4 billion as of end-2018. - Under the IMF’s composite reserve adequacy metric (ARA), gross official reserves are about 108 percent of the ARA metric as of end-2018, but reserves adjusted for net forward positions are below 100 percent of the ARA metric. - Assessment: Given limited reserves and increased hedging opportunities since 2017, FX interventions should be limited to preventing disorderly market conditions. In case of an inflow surge, some reserve accumulation would be appropriate to increase the reserve coverage ratio. ### Mexico: Selected External Sector Findings (2018) - Overall assessment: - External sector position in 2018 broadly in line with level implied by medium-term fundamentals and desirable policies. - CA deficit widened slightly to 1.8 percent of GDP in 2018 (1.6 percent cyclically adjusted), from 1.7 percent in 2017. - Foreign assets and liabilities (2018 % GDP): - NIIP: –46.4 - Gross Assets: 46.7 - Res. Assets: 14.4 - Gross Liab.: 93.0 - Debt Liab.: 37.4 - Current account metrics and assessment: - Actual CA: –1.8 - Cycl. Adj. CA: –1.6 - EBA CA Norm: –2.6 - EBA CA Gap: 1.0 - Staff Adj.: 0.0 - Staff CA Gap: 1.0 - EBA model implies a CA gap of 1.0 percent of GDP in 2018, with an estimated policy gap of 0.7 percent of GDP. Staff estimates a similar CA gap within the range of 0.0 and 2.0 percent of GDP. - Real Exchange Rate: - Average REER in 2018 broadly unchanged relative to 2017 average. - By May 2019 REER about 4.3 percent stronger than 2018 average. - EBA REER Level model estimates an undervaluation of 9.5 percent in 2018; REER Index model yields 21.0 percent undervaluation. - External sustainability approach suggests a 3.3 percent undervaluation. - Staff’s assessment (applying semielasticity of 0.16) estimates Mexico’s REER gap in the range of –14 to 2 percent. - Capital and financial accounts: - 2010–14: large share of capital inflows into locally issued government paper and other portfolio investments. - 2015–18: gross portfolio inflows slowed markedly; in 2018 net inflows into private sector turned negative. - Assessment: Long average maturity of sovereign debt and high share of local currency financing reduce depreciation risk exposure. Banking sector well capitalized and liquid. Presence of foreign investors leaves Mexico exposed to capital flow reversals. - FX intervention and reserves: - In 2018, no new NDF sales or other discretionary interventions took place. - At end-2018, FX reserves increased to US$176.4 billion (14.5 percent of GDP) from US$175.4 at end-2017. - Reserves at 117 percent of the Assessing Reserve Adequacy metric at end-2018 and 234 percent of short-term debt (at remaining maturity) — assessed as adequate. - Recommendation: authorities should continue to maintain reserves at an adequate level over the medium term. The Flexible Credit Line arrangement provides protection against global tail risks. *Source: 2019 External Sector Report (selected excerpts).* ### CHAPTER 3 2018 INDIVIDUAL ECONOMY ASSESSMENTS ### CHAPTER 3 2018 INDIVIDUAL ECONOMY ASSESSMENTS ### Netherlands — Overall Assessment and Policy Responses - Overall Assessment: The external position in 2018 was substantially stronger than the level consistent with medium-term fundamentals and desirable policies. The Netherlands’ status as a trade and financial center and natural gas exporter makes an external assessment more uncertain than usual. - Potential Policy Responses: - Implementation of the envisaged expansionary fiscal policy and use of the additional fiscal space under the Medium-Term Objective over the medium term to help support domestic demand and contribute to reducing excess external imbalances. - Reforms aimed at supporting household and small and medium-sized enterprise rebalancing to encourage investment. - Expansion of direct support to research and development. - Public investment in digitalization and lifelong learning. ### Netherlands — Foreign Asset and Liability Position and Trajectory - Background: - NIIP reached 66.7 percent of GDP at the end of 2018. - Gross assets and liabilities totaling 1,062 and 995 percent of GDP, respectively. - Largest component of NIIP: net FDI stock about €943 billion (122 percent of GDP) at the end of 2018. - Netherlands reported the largest inward and outward FDI positions in the world at end-2017. - Top three partner countries by gross bilateral stock positions: United States, Luxembourg, and the United Kingdom, with positions close to €2.2, €1.4, and €1.4 trillion, respectively. - TARGET2 assets of the Eurosystem are estimated at about €100 billion. - Over the medium term, NIIP expected to continue growing to above 100 percent of GDP, in line with projected sizable CA surpluses. - Assessment: The Netherlands’ safe-haven status and its sizable foreign assets limit risks from its large foreign liabilities. - Key 2018 statistics (% GDP): NIIP: 66.7; Gross Assets: 1,061.9; Debt Assets: 205.7; Gross Liab.: 995.2; Debt Liab.: 275.8 ### Netherlands — Current Account 2018 (% GDP) - Background: - CA in surplus since 1981; 2018 CA surplus increased to 10.8 percent of GDP (11 percent cyclically adjusted), driven by continued strong net exports. - Primary income balance is low despite large NIIP, reflecting a dominant role of multinationals. - Nonfinancial corporate net saving has been main driver of surpluses since 2000, financing substantial FDI outflows. - Household net saving contributes only a small part of CA surpluses. - Status as a trade and financial center and natural gas exporter likely contributes to strong structural position. - Assessment: - EBA CA model estimates: CA norm of 3.3 percent of GDP and a CA gap of 7.7 percent of GDP in 2018, with an unexplained residual of 6.2 percent of GDP. - Large unexplained residual primarily reflects high gross saving of Netherlands-based multinationals; data constraints prevent proper quantification. - Staff assesses the norm in a range of 1.3 to 5.3 percent of GDP, and a corresponding CA gap of 4.2 to 8.2 percent of GDP. - CA gap expected to narrow moderately over the medium term, supported by continued strong domestic demand and expedited phasing-out of gas production. - Key 2018 figures: Actual CA: 10.8; Cycl. Adj. CA: 11.0; EBA CA Norm: 3.3; EBA CA Gap: 7.7; Staff Adj.: –1.5; Staff CA Gap: 6.2 ### Netherlands — Real Exchange Rate - Background: - Annual average CPI-based REER appreciated about 2.0 percent in 2018. - Average ULC-based REER depreciated by about 0.5 percent in 2018. - REER appreciation largely driven by the euro appreciation (about 1.8 percent). - As of May 2019, the REER was unchanged relative to the 2018 average. - Assessment: - EBA REER models indicate an overvaluation between 2.2 percent (level model) and 14.5 percent (index model) in 2018, largely attributable to unexplained residuals. - Staff-assessed CA gap implies a REER undervaluation of about 8.6 percent (assuming a semielasticity of 0.72). - Taking into account all estimates and uncertainty, staff assesses the REER remained undervalued by about 5.8 to 11.4 percent. ### Netherlands — Capital and Financial Accounts; FX Intervention and Reserves - Capital and Financial Accounts: - Background: Net FDI and portfolio outflows dominate the financial account; FDI outflows driven by investment of corporate profits abroad, largely by multinationals. On average, gross FDI outflows largely match corporate profits. - Assessment: Strong external position limits vulnerabilities from capital flows. Financial account likely to remain in deficit as long as corporate sector continues to invest substantially abroad. - FX Intervention and Reserves Level: - Background: The euro is a global reserve currency. - Assessment: Reserves held by the euro area are typically low relative to standard metrics, but the currency is free floating. --- ### Poland — Overall Assessment and Policy Responses - Overall Assessment: The external position in 2018 was broadly in line with that suggested by medium-term fundamentals and desirable policies. Increased absorption of EU funds, continued buoyant private consumption, and weaker external demand returned the CA to a small deficit in 2018. Over the medium term, the CA deficit is expected to widen gradually, reflecting further declines in government and household net saving rather than a more desirable increase in private investment. - Potential Policy Responses: - Boost private investment and productivity while restraining fiscal current spending. - Structural reforms to remove barriers to private investment, facilitate access to skilled labor, enhance predictability of policies affecting firms, and provide a level playing field for all investors (including protecting rights of minority shareholders and ensuring competition). - Front-loaded fiscal consolidation to support medium-term objectives, with room for priority spending, especially for health care and public investment, as EU funds are gradually reduced. ### Poland — Foreign Asset and Liability Position and Trajectory - Background: - NIIP estimated at –59 percent of GDP in 2018. - Gross assets and liabilities declined to 48 percent of GDP and 107 percent of GDP, respectively. - Inward FDI accounts for about 46 percent of gross external liabilities. - Gross external debt sizable at 62 percent of GDP at end-2018; more than a quarter corresponds to liabilities to direct investors. - Share of short-term debt (at remaining maturity) is 29 percent of total gross debt; non-FDI short-term debt is 17 percent of total gross external debt (11 percent of GDP). - Over the medium term, negative NIIP expected to narrow, consistent with income convergence. - Assessment: - Sizable external debt, including short-term debt, presents a vulnerability, but rollover risk is mitigated by large share of debt FDI. - Sizable reserves mitigate residual liquidity risk (gross reserves at end-2018 were about 187 percent of non-FDI short-term debt at remaining maturity). - Key 2018 statistics (% GDP): NIIP: –58.8; Gross Assets: 48.1; Res. Assets: 20.1; Gross Liab.: 106.9; Debt Liab.: 45.1 ### Poland — Current Account 2018 (% GDP) - Background: - CA improved since global financial crisis, reaching close to balance during 2015–17. - Low investment and rising saving by the corporate sector (which reached 5 percent of GDP in recent years) partially offset by (declining) net borrowing by households and government. - In 2018, CA returned to a small deficit of 0.7 percent of GDP due to slower external demand, increased absorption of EU funds, and buoyant private consumption. Higher oil prices and larger remittance outflows also reduced the CA. - Under baseline, CA deficit relative to GDP expected to widen further on declining government and household saving. - Assessment: - EBA model estimates cyclically adjusted CA deficit of 0.6 percent of GDP and a CA norm of –2.3 percent of GDP for 2018; resulting EBA gap of 1.7 percent of GDP includes identified policy gaps (1.0 percent of GDP). - Given need to reduce negative NIIP to 45 percent of GDP over next five years, a CA deficit of 1.7 percent of GDP would be more appropriate. - After applying a 0.8 percentage point adjustment to the norm, staff assesses the CA to have been broadly in line with fundamentals and medium-term policies in 2018, with a CA gap of 0.9 (±1) percent of GDP. - Key 2018 figures: Actual CA: –0.7; Cycl. Adj. CA: –0.6; EBA CA Norm: –2.3; EBA CA Gap: 1.7; Staff Adj.: –0.8; Staff CA Gap: 0.9 ### Poland — Real Exchange Rate - Background: - REER appreciated in 2017 by 3.4 percent and marginally by 1.7 percent in 2018. - Zloty appreciated by about 4½ percent against the dollar (annual average) and was stable against the euro in 2018. - Between end-2018 and May 2019, zloty depreciated by 0.1 percent against the dollar and by 1 percent against the euro. - Assessment: - REER index model suggests a gap of –2.7 percent. - Overall staff assesses Poland’s REER gap in 2018 was in the range of –5 to 0 percent. - Note: The staff assessed REER gap of –2.5 percent is within the (± 5 percent) interval generally described as broadly in line with fundamentals. ### Poland — Capital and Financial Accounts; FX Intervention and Reserves - Capital and Financial Accounts: - Background: Capital account dominated by inflows of EU funds for financing investment projects. Net FDI inflows increased significantly in 2018. Net issuance of government debt declined as fiscal position improved. - Assessment: Sizable foreign holdings of government debt securities (about 49 percent of total; 25 percent of GDP) suggest potential vulnerability; declining share since 2016 as domestic banks increased holdings in response to bank asset tax. Diversified foreign investor base mitigates risk. - FX Intervention and Reserves Level: - Background: Gross international reserves stable in 2018 and reached US$117 billion at year-end. Net reserves increased marginally to about US$98 billion at end-2018, reflecting net inflows of EU funds. Zloty is free-floating and the NBP does not intervene. - Assessment: Net reserves at 97 percent of the IMF’s composite reserve adequacy (ARA) metric in 2018; gross reserves about 115 percent of the ARA metric. Net reserves remain adequate to insulate against external shocks. --- ### Russia — Overall Assessment and Policy Responses - Overall Assessment: The external position in 2018 was moderately stronger than that suggested by fundamentals and desirable policies. Favorable commodity prices boosted exports, whereas worsening geopolitical tensions weakened the exchange rate and contained imports; as a result, the CA surplus reached a historical high. Uncertainty about sanctions has weighed on capital flows and complicates the assessment. - Potential Policy Responses: - Fiscal policy should operate within the parameters of the new fiscal rule to reduce the impact of oil price volatility on the non-oil sector while rebalancing government expenditure toward health, education, and infrastructure in the medium term. - Focus on structural reforms to improve the business climate and boost private sector investment, especially in the non-oil sector. - Reorientation of fiscal expenditure to key areas and increased private sector investment to raise growth potential and bring the external position into balance. ### Russia — Foreign Asset and Liability Position and Trajectory - Background: - NIIP rose to US$370.9 billion at end-2018, 22 percent of GDP. - Gross assets at 81 percent of GDP; liabilities declined from 68 percent of GDP in 2017 to 59 percent of GDP in 2018 on private sector deleveraging. - Liabilities composed of 53 percent equity and 47 percent debt. - Debt liabilities to nonresidents declined from 32 percent of GDP in 2017 to 28 percent of GDP by end-2018; three-quarters in foreign currencies. - Nonresidents cut holdings of ruble-denominated government debt to about 25 percent of total stock from a peak of 34.5 percent in 2018:Q1 due to heightened geopolitical tensions. - No obvious maturity mismatches between gross asset and liability positions. - Historically, NIIP has not kept pace with CA surpluses due to unfavorable valuation changes and treatment of “disguised” capital outflows. - Assessment: - Projected CA surpluses suggest gradual rise of positive NIIP, lowering risks to external stability. - Official external assets have been increasing rapidly since introduction of new fiscal rule, despite temporary suspension of associated FX purchases between August 2018 and January 2019. - Recent external deleveraging by private sector further reduced risks. - Key 2018 statistics (% GDP): NIIP: 22.4; Gross Assets: 80.9; Res. Assets: 28.3; Gross Liab.: 58.5; Debt Liab.: 18.9 ### Russia — Current Account 2018 (% GDP) - Background: - CA balance reached 6.9 percent of GDP in 2018, the highest level in more than a decade, driven by strong energy exports and moderate import growth. - Nonenergy CA remains in deficit (8.6 percent of GDP in 2018), reflecting relatively weak competitiveness in the nonenergy sector. - Medium-term CA surplus expected to taper off to about 3 percent of GDP on moderating oil prices and a pickup in imports. - Assessment: - EBA CA model yields a norm for 2018 of 3.1 percent of GDP, compared with a cyclically adjusted CA surplus of (text truncated in source). *CHAPTER 3 2018 INDIVIDUAL ECONOMY ASSESSMENTS* ### 6.6 percent of GDP. This implies an EBA CA gap of 3.5 percent of GDP, for which identified policies contributed 2.8 perc ### Russia: Economy Assessment ### Current Account - Actual CA: 6.9 - Cycl. Adj. CA: 6.6 - EBA CA Norm: 3.1 - EBA CA Gap: 3.5 - Staff Adj.: –1.9 - Staff CA Gap: 1.6 - Findings: - CA balance was 6.6 percent of GDP cyclically adjusted, implying an EBA CA gap of 3.5 percent of GDP. - Identified policies contributed 2.8 percent of GDP to the gap, mainly reflecting lower-than-desirable health spending and the large fiscal surplus in 2018. - Staff considers the EBA model may underestimate cyclical effects related to the oil price increase in 2018; staff assesses the CA gap to be about 1.6 percent of GDP in 2018, with a confidence interval between 0.6 and 2.6 percent of GDP. - Large uncertainty also reflects difficulties in estimating the impact and duration of sanctions (protracted sanctions could lead to higher precautionary savings, lower investment, and a higher CA norm). ### Real Exchange Rate - Background: - The REER depreciated by 7.6 percent in 2018, despite higher oil prices, mainly reflecting sanctions, both those imposed in 2018 and the threat of new measures. - As of May 2019, the ruble has appreciated by 3.4 percent in real terms relative to the 2018 average. - Assessment: - EBA Level and Index REER models indicate an undervaluation of 20 percent and 15 percent, respectively. - Both approaches generate large residuals (about –10 percent). - Among model determinants, the most important contributor to undervaluation is health expenditure. - Using an elasticity parameter of 0.27, staff assesses that the 2018 REER was undervalued by between 2 and 10 percent. ### Capital and Financial Accounts: Flows and Policy Measures - Background: - Net private capital outflows continued in 2018: lower net liabilities generated an outflow of US$38 billion, and the net acquisition of financial assets resulted in an outflow of US$39 billion. - In the banking sector, outflows mainly took the form of a reduction in foreign liabilities, whereas the nonbanking private sector built up foreign assets during this period. - Sanctions and the projected moderation of oil prices are expected to weigh on flows over the medium term. - Assessment: - Russia is exposed to risks of continued outflows due to geopolitical uncertainties. - The large FX reserves and the floating exchange rate regime provide substantial buffers to help absorb external shocks. ### FX Intervention and Reserves Level - Background: - Since the floating of the ruble in November 2014, FX interventions have been limited. - International reserves rose to US$469 billion (more than 16 months of imports) by end-2018. - Assessment: - International reserves at end-2018 were equivalent to 275 percent of the IMF’s reserve adequacy metric, considerably above the adequacy range of 100 to 150 percent. - Taking into account Russia’s vulnerability to oil price shocks and sanctions, an additional commodity buffer of $65 billion is appropriate, translating into a ratio of reserves to the buffer-augmented metric to 204 percent. - The ratio remains above the adequacy level but is justifiable given the high degree of geopolitical uncertainty. - Policy implication: Large FX interventions should be limited to episodes of market distress. *Source: 2019 EXTERNAL SECTOR REPORT — excerpt from the IMF chapter on individual economy assessments.* ### 2018. Reserves stand below the IMF’s composite adequacy metric (63 percent of the metric without considering existing ca ### 2018. Reserves stand below the IMF’s composite adequacy metric (63 percent of the metric without considering existing ca ### Assessment of reserves and policy implication - Reserves stand below the IMF’s composite adequacy metric: 63 percent of the metric without considering existing capital flow management measures and 68 percent of the metric after considering them. - Assessment: If conditions allow, reserve accumulation would be desirable to strengthen the external liquidity buffer, subject to maintaining the primacy of the inflation objective. ### Spain: Overall assessment and policy implications - Overall Assessment: The external position in 2018 was moderately weaker than consistent with medium-term fundamentals and desirable policies. - Context and trajectory: - CA remained in surplus for the sixth consecutive year in 2018. - Despite sharp improvement since the 2007 deficit peak, achieving a sufficiently strong NIIP and further reductions in unemployment will continue to require a relatively high CA surplus and a moderately weaker REER for a sustained period. - Potential Policy Responses: - Structural reforms (notably labor market reform), wage moderation, and fiscal adjustment supported the reduction in imbalances. - To sustain progress and lower external vulnerability: restart structural fiscal consolidation and implement additional reforms to address labor market duality. - To boost productivity and competitiveness: accelerate product and service market reforms, enhance education outcomes, worker training, and firms’ innovation capacity. ### Spain: Foreign assets and liabilities (key statistics and assessment) - Background: - NIIP dropped from –35 percent of GDP in 2000 to –94 percent of GDP in 2009. - NIIP remained elevated at –74 percent of GDP in 2018:Q4, improved by 21 percentage points since 2014. - Gross liabilities: 231 percent of GDP in 2018:Q4, with more than two-thirds as external debt. - Share of NIIP accounted for by general government and central bank rose from about one-quarter in 2010 to over three-quarters in 2018:Q4. - TARGET2 liabilities reached 33 percent of GDP by end-2018. - Assessment: - Large negative NIIP implies external vulnerabilities, including large gross financing needs from external debt and potentially adverse valuation effects. - Mitigating factors: favorable maturity structure of outstanding sovereign debt (averaging seven years) and ECB measures (such as QE) that lower cost of debt. - 2018 (% GDP) key figures: - NIIP: –74.3 - Gross Assets: 156.4 - Res. Assets: 70.8 - Gross Liab.: 230.7 - Debt Liab.: 143.6 ### Spain: Current account (key statistics, background, and assessment) - Background: - Peak CA deficit in 2007 of 9.6 percent of GDP; exports and imports have since grown strongly with recovery. - CA surplus estimated at 0.9 percent of GDP in 2018. - Trade surplus declined relative to 2017 due to exchange rates, external demand, and oil prices. - Moderate CA surpluses projected to continue in the medium term. - Assessment and norms: - EBA CA model norm for 2018: 1.1 percent of GDP; cyclically adjusted CA: 0.9 percent of GDP. - Staff objective: strengthen NIIP to above –50 percent over the medium to long term, yielding a CA norm of about 2 percent of GDP, with a range of 1 to 3 percent of GDP. - Resulting CA gap: –2.1 to –0.1 percent of GDP (staff places more weight on external sustainability). - Consideration: high uncertainty about the output gap could imply a larger desirable CA gap. - 2018 current account figures: - Actual CA: 0.9 - Cycl. Adj. CA: 0.9 - EBA CA Norm: 1.1 - EBA CA Gap: –0.2 - Staff Adj.: –0.9 - Staff CA Gap: –1.1 ### Spain: Real exchange rate (background and assessment) - Background: - CPI-based REER appreciated by 2.1 percent from average 2017 level in 2018; ULC-based REER unchanged. - ULC-based REER depreciated by 18 percent since its 2008 peak. - As of May 2019, CPI-based REER and ULC-based REER had depreciated by 1.3 and 0.7 percent relative to their 2018 averages, respectively. - Assessment: - EBA REER models estimate an overvaluation of 6.0 to 6.8 percent for 2018. - CA model implies a close-to-zero overvaluation. - Taking competitiveness gains and NIIP risks into account, staff assesses a 2018 REER gap in the range of 1 to 9 percent. ### Spain: Capital and financial accounts; FX intervention and reserves - Background: - Financing conditions favorable with sovereign yields near historical lows. - Private sector continued deleveraging against rest of world in 2018. - Financial account balance largely driven by net outflows of loans and other bank-related instruments and portfolio equity. - TARGET2 liabilities accumulation moderated from close to 6 percent of GDP in 2015–2016 to less than 2 percent of GDP in 2018. - Assessment: - ECB monetary accommodation, domestic reforms, and fiscal consolidation improved investor sentiment. - Large external financing needs in public and private sectors leave Spain vulnerable to sudden increases in market volatility. - FX intervention and reserves: - Background: the euro has the status of a global reserve currency. - Assessment: Reserves held by the euro area are typically low relative to standard metrics, but the currency is free floating. ### Sweden: Overall assessment and policy implications - Overall Assessment: The external position in 2018 was moderately stronger than the level consistent with medium-term fundamentals and desirable policies. - Potential Policy Responses: - A mildly expansionary fiscal policy stance—consistent with converging to the lower medium term surplus target—should support demand. - Implement reforms to help restore residential investment following recent slump. - Reforms to facilitate migrant integration into the labor market to raise potential output and reduce household uncertainties. - Over time, some appreciation of the krona is expected when inflation returns to target. ### Sweden: Foreign assets and liabilities (key statistics and assessment) - Background: - NIIP reached 6.7 percent of GDP in 2018, up 2.5 percentage points in the year. - Expected to rise further in the medium term due to continued CA surpluses. - Average annual increase in NIIP over last decade: about 1.5 percent of GDP, below average CA surplus of 4.6 percent of GDP; may reflect negative valuation effects or measurement issues. - E&O averaged –1.8 percent of GDP in past decade. - Assessment: - Gross liabilities: 243 percent of GDP in 2018, about two-thirds being external debt (168 percent of GDP). - Rollovers of external debt (including covered bonds) pose vulnerability, but banks’ liquidity and capital buffers moderate risks. - Sweden’s strong FX reserves and low public debt help ensure capacity to manage pressures. - 2018 (% GDP) key figures: - NIIP: 6.7 - Gross Assets: 249.6 - Debt Assets: 88.8 - Gross Liab.: 243.0 - Debt Liab.: 134.8 ### Sweden: Current account (key statistics and assessment) - Background: - CA balance estimated at 2 percent of GDP in 2018, down from 2.8 percent in 2017 and well below decade average of 4.6 percent. - Decline led by trade balance, including a decline in oil balance of 0.4 percent of GDP. - Assessment: - Cyclically adjusted CA estimated at 2.3 percent of GDP in 2018. - EBA cyclically adjusted norm: 1.0 percent of GDP; EBA CA gap: 1.3. - Staff adjustment: 0.0; Staff CA Gap: 1.3. - Given EBA’s underestimation for Sweden historically, staff assesses Sweden’s CA gap at 1.3 percent of GDP in 2018, within a range of ± 1.5 percent of GDP. - 2018 current account figures: - Actual CA: 2.0 - Cycl. Adj. CA: 2.3 - EBA CA Norm: 1.0 - EBA CA Gap: 1.3 - Staff Adj.: 0.0 - Staff CA Gap: 1.3 ### Sweden: Real exchange rate, capital flows, and reserves - Real exchange rate background and assessment: - Krona depreciated by 4.1 percent in real effective terms in 2018 relative to 2017 average; CPI-based REER depreciated by 5.2 percent through May 2019. - EBA REER models suggest gaps of –16.7 and –17.7 percent using REER Index and Level approaches for 2018. - ULC-based REER index is 6 percent below its 25-year average, within ± 12.5 percent historical fluctuation range. - Applying a 0.35 semielasticity of CA to REER to the CA gap of 1.3 percent ± 1.5 percent of GDP gives a valuation range for the krona of 1 to –8 percent. - Staff gives greater weight to EBA REER models and ULC-based REER and assesses the krona to be undervalued by 5 to 15 percent; this gap is expected to be temporary. - Capital and financial accounts: - Sweden’s large banks remain vulnerable to liquidity risks from global wholesale markets despite improved structural liquidity measures. - Macroprudential policies (increased capital buffers; mortgage amortization regulations) help contain vulnerabilities. - Monitoring an extended (three-month) liquidity coverage ratio in US dollars and euros remains useful. - FX intervention and reserves: - Background: exchange rate is free floating. - Foreign currency reserves: US$61 billion in December 2018, equivalent to 21 percent of the short-term external debt of monetary and financial institutions and about 11 percent of GDP. - Assessment: Given high dependence of Swedish banks on wholesale funding in foreign currency, and past disruptions, Sweden should maintain adequate foreign reserves. *Italic: Source — IMF 2019 External Sector Report, Chapter 3: 2018 Individual Economy Assessments (excerpts).* ### CHAPTER 3 2018 INDIVIDUAL ECONOMY ASSESSMENTS ### CHAPTER 3 2018 INDIVIDUAL ECONOMY ASSESSMENTS ### Switzerland: Economy Assessment - Overall Assessment: - The external position in 2018 was broadly in line with the level implied by medium-term fundamentals and desirable policies. - This assessment is subject to especially high uncertainty: REER overvaluation following the exit from the floor in 2015 had been unwound by 2017. Were real depreciation to resume, future assessments could be affected. - Potential Policy Responses: - Macroeconomic policies should be geared toward ensuring balanced contributions to GDP growth from domestic and external demand. - Move to—and maintain—a structurally neutral fiscal stance to ease the burden on monetary policy that faces operational limits during periods of economic weakness or safe-haven appreciation pressures. - Monetary policy should continue to be directed at maintaining inflation within the definition of price stability, with foreign currency intervention reserved for addressing large exchange market pressures. - Use macroprudential policies to address excessive private credit (related to mortgage lending) and reduce financial sector risks. - Reform the corporate income tax to encourage small and medium-sized enterprise investment and reduce corporate net saving. - Foreign Asset and Liability Position and Trajectory: - Background: - Switzerland is a financial center with a positive NIIP of 128 percent of GDP and gross foreign asset and liability positions of 694 and 565 percent of GDP, respectively, as of end 2018. - The NIIP reflects both CA surpluses, which average nearly 10 percent of GDP, and large, bidirectional valuation changes, although valuation losses tend to dominate. - These valuation changes reflect fluctuations in exchange rates and prices of securities and precious metals that interact with mismatches between assets and liabilities in terms of currencies and financial instruments. - Assessment: - Switzerland’s large gross liability position and the volatility of financial flows present some risk, but these are mitigated by the large gross asset position and the fact that about two-thirds of external liabilities are denominated in Swiss francs. - Given the large gross positions and compositional mismatch between assets and liabilities, relatively modest changes in exchange rates and asset prices can have a material effect on the NIIP. - Key statistics (2018, % GDP): - NIIP: 128.2 - Gross Assets: 693.6 - Debt Assets: 217.3 - Gross Liab.: 565.4 - Debt Liab.: 192.1 - Current Account: - Background: - Switzerland has run large CA surpluses, averaging nearly 10 percent of GDP since 2006. - The CA balance is estimated at 10.2 percent of GDP for 2018, an increase from the downwardly revised surplus of 6.7 percent for 2017. - Ex post CA revisions are frequent, mainly due to changes in estimated investment income. - Surpluses on trade of goods and services (including merchanting) have been driving the overall positive CA balance. - Assessment: - Based on a cyclically adjusted CA surplus of 10.4 percent of GDP and an EBA CA norm of 5.9 percent of GDP, the overall EBA estimated CA gap equaled 4.5 percent of GDP in 2018. - Domestic policy gaps account for –1.0 percentage points of the CA gap and consist of excessive private sector credit (1.3) and fiscal underspending (–0.4), while policy gaps in the rest of the world contribute 0.3 percentage point. - Some Switzerland-specific factors not appropriately treated in the income account lower the CA gap: (1) inclusion of estimated retained earnings on portfolio equity investment and (2) compensation for valuation losses on fixed income securities arising from inflation. - After accounting for these factors, staff estimates a CA gap of about 0.9 percent of GDP (with a range of ±2 percentage points). - Key statistics (2018, % GDP): - Actual CA: 10.2 - Cycl. Adj. CA: 10.4 - EBA CA Norm: 5.9 - EBA CA Gap: 4.5 - Staff Adj.: –3.5 - Staff CA Gap: 0.9 - Real Exchange Rate: - Background: - The CPI-based REER appreciated by 16 percent during 2008–18, including two episodes of rapid appreciation in response to safe-haven inflows. - The first spike occurred in July 2011 and led the Swiss National Bank (SNB) to establish a floor of 1.20 for the Swiss franc–euro exchange rate in September 2011. - After appreciating sharply following the exit from the floor in 2015, the REER moderated, initially on account of a partial unwinding of the overshooting of the nominal effective exchange rate and, subsequently, on lower inflation in Switzerland than in its trading partners. - The average REER for 2018 weakened by 2.8 percent relative to the 2017 average. As of May 2019, the REER had depreciated by 0.1 percent compared with the 2018 average. - Assessment: - The EBA REER Index and Level models suggest that the average REER in 2018 was 11 to 17 percent overvalued, with policy gaps accounting for a modest amount of the total gap. - To a large extent, this finding reflects the “reversion to trend” property of the empirical model in the context of the prior rapid appreciation episodes. - Due to measurement issues, these results may not fully capture the secular improvement in productivity, especially in knowledge-based sectors. - Based on the CA gap, staff assesses the REER gap to have been in the range of –6.5 to 1 percent in 2018. - The staff assessed REER gap of –3.75 percent is within the (± 5 percent) interval generally described as broadly in line with fundamentals. - Capital and Financial Accounts: Flows and Policy Measures: - Background: - Switzerland has experienced large inflows in the form of currency and deposits, in part due to its status as a safe haven. Since 2007, these cumulative net inflows amounted to about 75 percent of GDP. - Since 2015, banks’ placements at the SNB (above a certain threshold) have been subject to a negative interest rate of 0.75 percent to reduce attractiveness of inflows. - These inflows stopped in mid-2017 and foreigners reduced holdings of currency and deposits in 2018. - There are no restrictions on financial flows. - Assessment: - Financial flows are large and volatile, reflecting Switzerland’s status as a financial center and a safe haven, with inflows tending to accelerate during periods of heightened global and regional uncertainty. - FX Intervention and Reserves Level: - Background: - Foreign exchange reserves amounted to US$788 billion (114 percent of GDP) at end-2018, down US$24 billion (including valuation changes) since end-2017. - About 75 percent of reserves were accumulated during 2009–15, including to defend the previous exchange rate floor. - Since exiting the floor, the SNB has intervened periodically, purchasing sizable volumes in response to large appreciation pressures from safe-haven surges, as well as more frequently but in smaller amounts. Purchases dwindled since mid-2017, amounting to only Sw F 2.3 billion in 2018. - Assessment: - Reserves are large relative to GDP but more moderate when compared with short-term foreign liabilities. - The high level of reserves reflects monetary policy operations aimed at avoiding persistent undershooting of inflation (which averaged –0.15 percent during 2012–18) as a result of inflow surges and given the limited scope for significant further easing via other monetary policy tools. - The supply of domestic assets available for purchase is very limited, and the marginal interest rate on banks’ deposits at the SNB is –0.75 percent, which is the lowest in the world. - Past interventions also helped to avoid potentially large exchange rate overvaluation. --- ### Thailand: Economy Assessment - Overall Assessment: - The external position in 2018 was substantially stronger than warranted by medium-term fundamentals and desirable policies. - While the CA surplus has narrowed since peaking in 2016, it remains sizable, continuing to reflect the tepid recovery of domestic demand amid political uncertainty. - Potential Policy Responses: - Mutually reinforcing macro policy stimulus, led by a fiscal expansion and structural reforms, should support domestic demand and lower the CA surplus over time. - A strategy that facilitates REER appreciation through a growth-driven process would boost real incomes. - Higher public infrastructure within available fiscal space should crowd in private investment. - Reform and expand social safety nets, notably the fragmented pension program, to reduce precautionary saving and widespread informality. - Reforms to reduce barriers to investment, especially in the services sector, are necessary. - The exchange rate should move flexibly as the key shock absorber; intervention should be limited to avoiding disorderly market conditions. - With reserves exceeding all adequacy metrics, there is no need to build up reserves for precautionary purposes. - Foreign Asset and Liability Position and Trajectory: - Background: - Thailand’s NIIP continued to strengthen in 2018 to about –0.5 percent of GDP, compared with –9.1 percent of GDP in 2017 and –24 percent of GDP in 2014. - Gross assets declined to about 96 percent of GDP (41 percent being reserve assets), whereas gross liabilities declined 3 percentage points to 97 percent of GDP (dominated by direct about half and portfolio a third investment). - Net FDI continued to decline as outward investment (particularly by corporates) increased; portfolio (equities) and other investment also declined (by about 2 percentage points of GDP). - Assessment: - External vulnerabilities have been reduced with the strengthening of the NIIP, which is projected to reach a small creditor position over the medium term. - With external debt steady at about 32 percent of GDP, of which short-term debt (on a remaining maturity basis) amounts to 16 percent of GDP, external debt sustainability and liquidity risk are limited. - Key statistics (2018, % GDP): - NIIP: –0.5 - Gross Assets: 96.4 - Res. Assets: 43.2 - Gross Liab.: 96.9 - Debt Liab.: 29.5 - Current Account: - Background: - Thailand’s CA surplus declined sharply to 7 percent of GDP in 2018, following the continued strengthening of the CA surplus since 2013, with an all-time high of 11.7 percent in 2016. - The reduction in the surplus in 2018 reflects a consumption-led strengthening of domestic demand and a decline in net exports. - Exports slowed due to US-China trade tensions and a moderation in global external demand; imports remained robust, but the broader regional trade slowdown weighed on imports of intermediate goods toward the end of the year. - The services account contracted by about 0.1 percent of GDP relative to 2017, due to a temporary slowdown in tourism receipts. - Assessment: - The EBA CA model estimates a cyclically adjusted CA of 7.0 percent of GDP and a CA norm of 0.1 percent of GDP for 2018. - The CA gap of 6.9 percent of GDP consists of an identified policy gap of 1.5 percent of GDP and an unexplained residual of 5.4 percent of GDP, which partly reflects Thailand-specific features and structural challenges not fully captured by the EBA model. - Political uncertainty continued to weigh on investment in 2018, although its effect has moderated somewhat (0 to 1.5 percent of GDP), including following the confirmation of the elections date. - Taking all of this into account, staff assesses the CA balance to be about 3.8 to 7.0 percent of GDP higher than warranted by fundamentals and desired policies. This CA gap is expected to narrow over the medium term as policy stimulus is deployed, political uncertainty dissipates, private confidence recovers, and steps are taken to reform the safety net. - Key statistics (2018, % GDP): - Actual CA: 7.0 - Cycl. Adj. CA: 7.0 - EBA CA Norm: 0.1 - EBA CA Gap: 6.9 - Staff Adj.: –1.5 - Staff CA Gap: 5.4 - Real Exchange Rate: - Background: - The baht has been on a gradual real appreciation trend since the mid-2000s, despite occasional bouts of volatility. - In 2018, despite some volatility through the year, with marked depreciations in 2018:Q2 and 2018:Q3, the REER appreciated overall by 3.0 percent relative to 2017. - As of May 2019, the baht had appreciated an additional 4 percent relative to the 2018 average. - Assessment: - Using an elasticity of 0.64, the 2018 REER would be assessed as undervalued by about 6 to 11 percent. - Capital and Financial Accounts: Flows and Policy Measures: - Background: - In 2018, the capital and financial account weakened to –4.5 percent of GDP from –2.8 percent in 2017, driven primarily by net portfolio flows, which strengthened to 1.1 percent of GDP. - Nonresident holdings of Thai bonds declined in 2018:S1 and reversed in 2018:S2 as nonresident flows rebounded. - Outward FDI remained robust at 4 percent of GDP owing to Thai firms’ overseas investment. Net other investment outflows were about 1 percent of GDP. - The authorities continued gradual and prudent financial account liberalization, encouraging outward investment by residents. - The capital and financial account balance has been negative since 2013. - Assessment: - Since 2013, Thailand has experienced episodes of volatility reflecting changes in external financial conditions, continued political uncertainty, and more recently concerns about the impact of US-China trade tensions. - Thailand has been able to weather such episodes well, given its strong external buffers and fundamentals, which have supported the ability of investors to distinguish Thailand from others in the emerging market asset class. - FX Intervention and Reserves Level: - Background: - The exchange rate regime is classified as (de jure and de facto) floating. - International reserves stood at 47.4 percent of GDP in 2018, standing at over three times short-term debt and 12 months of imports, and over 200 percent of the IMF’s standard reserve adequacy metric (unadjusted for capital controls). - Assessment: - Interventions were two-sided over the course of 2018, as proxied by the increase and then decrease in reserves over the course of the year (official intervention data are not published). - Gross international reserves (including net forward position) remained stable during 2018. - Reserves are higher than the range of the IMF’s adequacy metrics, and there continues to be no need to build up reserves for precautionary purposes. - The exchange rate should move flexibly to act as a shock absorber, with FX intervention limited to avoiding disorderly market conditions. *International Monetary Fund | July 2019 — CHAPTER 3 2018 INDIVIDUAL ECONOMY ASSESSMENTS (text - CHAPTER 3 2018 INDIVIDUAL ECONOMY ASSESSMENTS).* ### CHAPTER 3 2018 INDIVIDUAL ECONOMY ASSESSMENTS ### CHAPTER 3 2018 INDIVIDUAL ECONOMY ASSESSMENTS ### Turkey — Overall Assessment and Policy Responses - Overall Assessment: The external position in 2018 was broadly in line with the level implied by fundamentals and desirable policies. This reflects the ongoing and lagged adjustment of external balances following the sharp REER depreciation in 2018, which is projected to gradually unwind. Large external financing needs and relatively low reserves make Turkey vulnerable to financial account reversals. - Potential Policy Responses: - Monetary policy should aim to reanchor inflation expectations and strengthen central bank credibility, while rebuilding reserves. - Fiscal policy should allow automatic stabilizers to operate and reorient spending toward the most vulnerable. - Focused structural reforms to enhance productivity and ensure more stable domestic funding sources, including reducing labor market rigidities and improving the business climate by reforming insolvency and corporate restructuring frameworks. ### Turkey — Foreign Asset and Liability Position and Trajectory - Background: - After peaking at –54 percent of GDP at end-2017, Turkey’s NIIP narrowed to –48 percent of GDP at end-2018. - Total foreign liabilities reached 78 percent of GDP in 2018, dominated by debt at 55 percent of GDP. - A significant portion of external debt is short term (22 percent of GDP); about 40 percent of long-term debt is at variable rates. - Assessment: - Size and composition of external liabilities, coupled with low reserves, expose Turkey to liquidity shocks and sudden shifts in investor sentiment. - FX exposure of nonfinancial corporates is high, with potential to worsen bank asset quality. - Turkey’s NIIP is projected to gradually fall to about –40 percent of GDP by 2021, driven by a decline in liabilities, mainly loans, as the economy rebalances. - Key statistics (2018 (% GDP)): - NIIP: –47.8 - Gross Assets: 29.9 - Res. Assets: 12.1 - Gross Liab.: 77.7 - Debt Liab.: 55.1 ### Turkey — Current Account - Background: - CA deficit averaged 4 percent during 2014–16, widened to 5.6 percent of GDP in 2017, narrowed to 3.5 percent in 2018. - CA expected to swing to a slight surplus of 0.5 percent in 2019. - Assessment: - EBA CA model norm: –1.6 percent of GDP; large standard error close to 2 percent. - Cyclically adjusted CA deficit in 2018: –2.5 percent of GDP; CA gap estimated at –0.9 percent of GDP. - After accounting for temporary large imports of gold (0.7 percent of GDP higher than normal), staff assesses 2018 CA to be broadly in line with fundamentals and desired policies, with a gap in the range of –1.2 to 0.8 percent of GDP. - Key figures: - Actual CA: –3.5 - Cycl. Adj. CA: –2.5 - EBA CA Norm: –1.6 - EBA CA Gap: –0.9 - Staff Adj.: 0.7 - Staff CA Gap: –0.2 ### Turkey — Real Exchange Rate - Background: - In 2018, average REER depreciated by 14 percent relative to 2017; stood some 37 percent below its 2010 peak. - As of May 2019, REER had depreciated by 10.3 percent relative to the 2018 average. - Assessment: - EBA REER index and level approaches suggest REER was undervalued in 2018 by 21 to 23 percent. - Staff-assessed CA gap suggests a REER gap close to zero. - Giving more weight to EBA REER approaches as CA continues to adjust, staff assesses REER to be undervalued in the range of 10 to 20 percent, with a midpoint around 15 percent. ### Turkey — Capital and Financial Accounts: Flows and Policy Measures - Background: - Net capital flows switched from an inflow of US$38.5 billion (4.5 percent of GDP) in 2017 to an outflow of US$0.5 billion (0.1 percent of GDP) in 2018 (both excluding reserves and E&O). - Positive E&O increased from US$0.6 billion in 2017 to US$17.2 billion in 2018. - Net FDI flows remained low at about 1 percent of GDP. - Annual gross external financing needs about 22 percent of GDP. - Policy response: limits to bank swaps and other derivative transactions with foreign counterparties introduced in August; partially unwound as volatility receded. - Assessment: - Quality of financing worsened in 2018 with shortened maturity structure, lower rollover rates, and financing dominated by E&O and reserve drawdown. - Turkey remains vulnerable to adverse shifts in global investor sentiment. ### Turkey — FX Intervention and Reserves Level - Background: - De facto and de jure exchange rate is floating. - Gross reserves declined to US$93 billion (12 percent of GDP) at end-2018, US$14.7 billion (1.9 percent of GDP) lower than at end-2017. - Net international reserves at US$30 billion (3.9 percent of GDP) at end-2018, declining by US$0.8 billion (0.1 percent of GDP). - Assessment: - Gross reserves amounted to 76 percent of the IMF’s ARA metric at end-2018, down from 80 percent at end-2017. - Reserve coverage of external financing requirements dropped to 45 percent in 2018, from 51 percent in 2017. - Accumulation of reserves over the medium term is needed given sizable external liabilities and dependence on short-term and portfolio funding. --- ### United Kingdom — Overall Assessment and Policy Responses - Overall Assessment: The external position in 2018 was weaker than implied by medium-term fundamentals and desirable policies. The CA deficit remained high in 2018, reflecting low public and private savings. Over the medium term, the deficit is set to narrow somewhat helped by ongoing fiscal consolidation. Uncertainty around the assessment is significant due to measurement issues and uncertainty about the future trade arrangement with the European Union. - Potential Policy Responses: - Continue fiscal consolidation within a medium-term framework to support external rebalancing. - Structural reforms to broaden the skill base and invest in public infrastructure (within the budget envelope) to boost productivity and competitiveness. - Maintain financial stability through macroprudential policies to support private sector saving. ### United Kingdom — Foreign Asset and Liability Position and Trajectory - Background: - NIIP strengthened to –6.7 percent of GDP in 2018 from –8.1 percent in 2017. - Over past five years, NIIP strengthened by 11.3 percentage points (CA contribution –20.6 p.p.; valuation and growth effects 28.9 p.p. and 3.0 p.p.). - Composition: assets roughly match liabilities; liabilities in debt securities (95 percent of GDP) exceed assets in debt securities (55 percent of GDP). - Investments in Europe, Japan, and the United States account for around 75 percent of total UK assets and liabilities. - External liabilities have a larger share denominated in sterling than assets. - Assessment: - NIIP sustainability not an immediate concern. - Fluctuations in large gross stock positions (derivatives; gross assets and liabilities both exceed 500 percent of GDP) are potential vulnerabilities. - Key statistics (2018 (% GDP)): - NIIP: –6.7 - Gross Assets: 521.6 - Debt Assets: 256.2 - Gross Liab.: 528.4 - Debt Liab.: 272.0 ### United Kingdom — Current Account - Background: - CA deficit worsened to –3.9 percent of GDP in 2018 (from –3.3 percent in 2017); expected to worsen marginally to –4.2 percent of GDP in 2019. - Trade balance broadly stable at about –1.5 percent of GDP in 2018. - Reduction in gross national savings by 1 percent of GDP driven by reduction in corporate savings (from 9.8 to 8.2 percent of GDP). - Assessment: - EBA CA model estimates CA gap of –4.4 percent of GDP for 2018 (cyclically adjusted CA balance –3.9 percent vs norm 0.5 percent). - Cyclically adjusted CA is assessed to be understated due to measurement biases and large NIIP valuation effects. - Staff assesses the 2018 cyclically adjusted CA balance to be 1 to 4.8 percent of GDP lower than the CA norm, with a midpoint of 2.9 percent of GDP. - Key figures: - Actual CA: –3.9 - Cycl. Adj. CA: –3.9 - EBA CA Norm: 0.5 - EBA CA Gap: –4.4 - Staff Adj.: 1.5 - Staff CA Gap: –2.9 ### United Kingdom — Real Exchange Rate - Background: - Sterling appreciated by 1.8 percent in 2018 in real effective terms relative to 2017 but has depreciated since mid-2016 by about 7 percent. - Assessment: - EBA REER Level and Index approaches suggest gaps of –8.5 and –13.2 percent, respectively, for 2018. - Given uncertainties related to the UK’s new trading relationship with the EU, overall staff assesses the REER to be overvalued by between 0 and 15 percent. ### United Kingdom — Capital and Financial Accounts - Background: - Portfolio investment and other investments are key components of the financial account. - CA financed in 2018 by recovery in net FDI inflows and repatriation of portfolio assets (worth –4.1 percent of GDP) combined with increase in portfolio liabilities of 6.8 percent of GDP; other investments saw capital flows worth 7.8 percent of GDP in net terms. - Assessment: - Large fluctuations in capital flows are inherent and a potential source of vulnerability, mitigated by sound financial regulation and a strong financial sector. - Risk that FDI and portfolio investment inflows may decelerate due to concerns about future trade relations with the EU. ### United Kingdom — FX Intervention and Reserves Level - Background: - Pound has status of a global reserve currency; share of global reserves in sterling about 4.5 percent since 2015. - Assessment: - Reserves held by the United Kingdom are typically low relative to standard metrics; the currency is free floating. --- ### United States — Overall Assessment and Policy Responses - Overall Assessment: The external position was moderately weaker than implied by medium-term fundamentals and desirable policies in 2018. A strong economy and fiscal stimulus imply a sustained CA deficit in coming years. Effects of changes in trade, taxation, and labor market policies add uncertainty. - Potential Policy Responses: - Fiscal consolidation aiming at a medium-term general government primary surplus of about 1.2 percent of GDP (a federal government primary surplus of about 1 percent of GDP) would be appropriate to put debt-to-GDP on a downward path and address external imbalances. - Structural policies: upgrade infrastructure; enhance schooling, training, and mobility of workers; encourage labor force participation. - Roll back recently imposed tariff barriers; resolve trade and investment disagreements without tariffs and nontariff barriers. ### United States — Foreign Asset and Liability Position and Trajectory - Background: - NIIP estimated to have decreased from –39.6 percent of GDP in 2017 to –47.4 percent of GDP in 2018 (before valuation effects). - Valuation effects amounted to 2.9 percent of GDP through 2018:Q3. - Under staff baseline, negative NIIP projected to expand by 4 percent of GDP over next five years due to sustained CA deficits. - About 64 percent of US assets are in the form of FDI and portfolio equity claims. - Assessment: - Financial stability risks from rising negative NIIP could surface if foreign demand for US fixed income securities declines unexpectedly, but risk remains moderate given the dominant status of the US dollar. - Key statistics (2018 (% GDP)): - NIIP: –47.4 - Gross Assets: 123.9 - Debt Assets: 38.3 - Gross Liab.: 171.3 - Debt Liab.: 85.0 ### United States — Current Account - Background: - US CA deficit unchanged between 2017 and 2018 at 2.3 percent of GDP (compared with 2.1 percent in 2014). - Non-oil balance deficit reached 2.8 percent of GDP in 2018 vs 1.7 percent in 2014. - US CA deficit expected to rise to 2.6 percent of GDP by 2020 as US demand rises above potential output, partly driven by projected fiscal easing. - Assessment: - EBA model estimates cyclically adjusted CA of –2.1 percent of GDP and cyclically adjusted CA norm of –0.9 percent of GDP; cyclically adjusted CA gap –1.2 percent of GDP for 2018. - CA gap reflects policy gaps (–0.7 percent of GDP, of which –0.6 percent corresponds to fiscal policy) and an unidentified residual (about –0.5 percent of GDP). - External Sustainability Approach estimates CA gap of –1.2 percent of GDP. - On balance, staff assesses 2018 cyclically adjusted CA to be 0.9 to 1.9 percent of GDP lower than the level implied by fundamentals and desirable policies. - Key figures: - Actual CA: –2.3 - Cycl. Adj. CA: –2.1 - EBA CA Norm: –0.9 - EBA CA Gap: –1.2 - Staff Adj.: –0.2 - Staff CA Gap: –1.4 ### United States — Real Exchange Rate - Background: - REER depreciated about 7 percent in 2017 (eop); appreciated about 4 percent in 2018 (eop). - As of end-2018, REER about 18 percent higher than average for 2014. - Through May 2019, US dollar appreciated 3.4 percent in real terms relative to 2018 average. - Assessment: - Indirect estimates (based on EBA CA assessment) imply exchange rate overvalued by 10 percent in 2018 (applying estimated elasticity of 0.12). - EBA REER index model suggests overvaluation of 8.0 percent. - EBA REER level model suggests overvaluation of 11.9 percent. *Source: CHAPTER 3 2018 INDIVIDUAL ECONOMY ASSESSMENTS (text - CHAPTER 3 2018 INDIVIDUAL ECONOMY ASSESSMENTS).* ### 10.3 percent. Considering all the estimates and their uncertainties, staff assesses the 2018 average REER to be somewhat ### United States — 2018 Individual Economy Assessment ### REER valuation and external position - Staff assesses the 2018 average REER to be somewhat overvalued, in the 6 to 12 percent range. - Small adjustor reflects correction to the terms-of-trade contribution, which does not include recent increases in oil production. ### Capital and financial accounts: flows and policy measures - Background: Net financial inflows were about 2.3 percent of GDP in 2018, compared with 1.6 percent of GDP in 2017. - Portfolio and other investment flows in 2018: - Net portfolio investments decreased by 0.8 percent of GDP in 2018. - Net other investments decreased by 0.6 percent of GDP in 2018. - These decreases were offset by stronger net direct investments. - Assessment: The United States has an open capital account. - Vulnerabilities are limited by the dollar’s status as a reserve currency, with foreign demand for US Treasury securities supported by the status of the dollar as a reserve currency and, possibly, by safe-haven flows. ### FX intervention and reserves level - Background: The dollar has the status of a global reserve currency. - Assessment: - Reserves held by the United States are typically low relative to standard metrics. - The currency is free floating. *Source: IMF 2019 EXTERNAL SECTOR REPORT — CHAPTER 3 2018 INDIVIDUAL ECONOMY ASSESSMENTS* --- _Source: https://www.imf.org/-/media/files/publications/esr/2019/english/text.pdf_