## CHAPTER 1 EXTERNAL POSITIONS AND POLICIES ## Source details **Canonical URL:** [CHAPTER 1 EXTERNAL POSITIONS AND POLICIES](https://www.imf.org/-/media/files/publications/esr/2020/english/ch1.pdf) ## Other formats - [Markdown version](/-/media/files/publications/esr/2020/english/ch1.pdf.md) - [Structured JSON version](/-/media/files/publications/esr/2020/english/ch1.pdf.json) --- ### Overview - Chapter summarizes IMF staff external sector assessments for 2019 (benchmark before COVID-19); external developments during the COVID-19 crisis in 2020 (exchange rates, trade in goods and services, capital flows, current account balances, using recent data and IMF staff forecasts); significant risks to the external outlook; and policy priorities (policy responses to risks and crisis, and reforms to reduce excess imbalances over the medium term while supporting global growth). ### Global imbalances before the COVID-19 crisis - Global current account balance (absolute sum of surpluses and deficits) declined by 0.2 percentage point of world GDP in 2019, to 2.9 percent of world GDP. - Regional and country movements in 2019: - Euro area surplus declined by 0.4 percentage point of GDP, to 2.7 percent of GDP. - China’s current account surplus rose by 0.8 percentage point of GDP to 1.0 percent of GDP. - US current account deficit decreased by 0.1 percentage point of GDP to 2.3 percent of GDP. - Japan’s surplus remained at 3.6 percent of GDP. - Current account balances rose toward surplus in some emerging market and developing economies (Argentina, South Africa, Turkey) in 2019 due to tighter financial conditions, lower domestic demand, or currency depreciation. - Global excess imbalances (the sum of absolute excess surpluses and deficits) represented about 1.2 percent of world GDP in 2019. ### Currency movements and trade tensions (2019–early 2020) - Exchange rate movements in 2019 (real effective terms unless noted): - US dollar and Japanese yen appreciated about 3 percent. - Euro depreciated by 3 percent. - Renminbi depreciated by 0.8 percent. - India, Indonesia, Mexico, Thailand: currencies appreciated by 3 percent to 6 percent. - Argentina peso depreciated almost 42 percent vis-à-vis the US dollar; real effective depreciation limited to 11 percent. - Brazil, South Africa, Turkey: depreciated vis-à-vis the US dollar by 8 percent to 14 percent, with smaller real effective depreciations. - Tariff and trade policy changes 2018–2019: - US average tariff on Chinese imports increased from 12.0 percent to 21.0 percent. - China’s average tariff on US imports rose from 16.5 percent to 21.1 percent. - Trade policy changes triggered significant declines in equity prices and offsetting currency movements; much of renminbi depreciation driven by trade policy announcements. - Early 2020 developments: United States and China agreed to a “Phase One” agreement with partial rollback of tariffs; United States–Mexico–Canada Agreement signed and went into effect on July 1, 2020. ### Stocks of external assets and liabilities and currency exposures - External assets and liabilities as a share of GDP more than tripled from the early 1990s to the years preceding the COVID-19 crisis. - The United States has the largest net debtor position as a share of world GDP. - Largest net creditor economies in percent of world GDP: China, Germany, and Japan. - Currency exposure shifts: - Most emerging market and developing economies went from short positions in foreign currency in 1990 to long positions in 2017; reflects shift from foreign currency debt to equity financing and accumulation of foreign exchange reserves. - Most advanced economies were already long in foreign currency in 1990, and net positions have continued to grow. - Emerging market and developing economy compositions: - Foreign exchange reserves are about 40 percent of external assets. - Foreign-currency-denominated debt is about 79 percent of total external debt. - Emerging markets’ foreign exchange positions turned long in the mid-2000s and have continued to increase since the global financial crisis. ### Normative assessment of external positions in 2019 (IMF staff assessments) - Assessment approach: - Multilateral approach matching positive and negative excess external imbalances. - Combines numerical inputs from the latest vintage of the EBA methodology with a series of external indicators and country-specific judgment. - EBA methodology produces multilaterally consistent estimates for current account and real exchange rate norms (benchmarks). - IMF staff estimate current account (CA) and real effective exchange rate (REER) gaps by comparing actual CA (stripped of temporary components) and REER with staff-assessed norms, using judgment and country-specific insights. - Holistic overall external sector assessment for the world’s 30 largest economies based on estimated gaps and other indicators (net international investment position, capital flows, foreign exchange reserves). - 2019 assessment outcomes: - For most of the 30 economies, overall external position assessments for 2019 remained broadly similar to 2018; about one-third of economy assessments changed categories in 2019. - Economies with estimated excess current account surpluses (deficits) generally also had an undervalued (overvalued) REER. - Economies assessed “stronger than the level consistent with medium-term fundamentals and desirable policies” (10 economies): euro area, Germany, Malaysia, the Netherlands, Singapore, Thailand, Poland, Sweden, Switzerland, and Turkey. - Economies assessed “weaker than the level consistent with medium-term fundamentals and desirable policies” (9 economies): Belgium, Canada, the United Kingdom, the United States, Argentina, South Africa, and several commodity exporters. ### Summary of staff-assessed CA gaps and selected quantitative indicators (2019) - Examples of staff-assessed CA gap midpoints and related figures (percent of GDP, as reported): - Argentina: Staff-assessed CA gap midpoint = –2.0; Staff adjustments total = 0.0; CA [A] = –0.8; Cycl. Adj. CA Balance [B] = –1.7; EBA CA Norm [C] = –1.2. - Germany: Staff-assessed CA gap midpoint = 4.3; Staff adjustments total = –0.4; CA [A] = 7.1; Cycl. Adj. CA Balance [B] = 7.3; EBA CA Norm [C] = 2.5. - Netherlands: Staff-assessed CA gap midpoint = 4.9; Staff adjustments total = –2.3; CA [A] = 10.2; Cycl. Adj. CA Balance [B] = 10.5; EBA CA Norm [C] = 3.3. - United States: Staff-assessed CA gap midpoint = –1.3; Staff adjustments total = 0.0; CA [A] = –2.3; Cycl. Adj. CA Balance [B] = –2.0; EBA CA Norm [C] = –0.7. - Staff adjustments reflect measurement issues, country-specific factors (terms of trade, demographics, NIIP/financing risk considerations), and rounding. ### External developments during the COVID-19 crisis (early 2020) - Trade contraction: - Global volume of goods trade in the first five months of 2020 was about 20 percent lower than in 2019. - June 2020 WEO Update forecast for goods and services trade volume (2020): a contraction of about 12 percent. - Falling output identified as main driver; services trade contraction more severe due to travel restrictions and other special factors. - Financial conditions and market volatility: - Expected equity price volatility (Chicago Board Options Exchange Volatility Index) peaked on March 16 at levels last seen during the peak of the global financial crisis. - Corporate and emerging market sovereign spreads widened significantly; since late March risky asset prices rebounded and global financial conditions eased, supported by strong policy actions. - Capital flows and currency movements: - Emerging market and developing economies experienced sudden capital flow reversals in late February and March 2020; outflows exceeded those during early stages of the global financial crisis in US dollar terms. - Portfolio flows stabilized in April and May 2020 after policy easing; some emerging market economies regained access to sovereign debt markets. - Advanced-economy reserve currencies generally appreciated during worst volatility; emerging market and developing economy currencies generally depreciated. - Commodity exporters with flexible exchange rates saw especially sharp depreciations reflecting falling oil prices. - Emerging market and developing economies with stronger pre-crisis fundamentals or perceived institutional quality generally experienced smaller depreciations and stronger rebounds. - Outlook for current account balances in 2020: - Outlook highly uncertain given limited balance of payments data. - Recent data and IMF staff forecasts point to a modest narrowing in current account surpluses and deficits on average, with high uncertainty and substantial cross-country variation. - Key channels affecting CA evolution in 2020 include contraction in economic activity, tighter global financial conditions, lower commodity prices, and changes in macro fundamentals that may affect equilibrium values. ### Impact on commodity, tourism, and remittance balances (2020) - Commodity trade balances: - Crude oil price expected to be 41 percent lower in 2020 than in 2019. - Global oil demand expected to be about 8 percent lower in 2020 than in 2019. - Prices of metals, food, and raw materials expected to decline, but by significantly less than oil. - Estimated direct impact on oil trade balances in 2020 ranges from –7 percent to 3 percent of GDP across economies. - Norway, Russia, and Saudi Arabia expected losses to exceed 3 percent of GDP. - Positive effects exceed 2 percent of GDP for Thailand and Turkey. - Tourism trade balances: - International tourism arrivals during the first four months of 2020 were about 50 percent lower than over the same period in 2019. - UN World Tourism Organization (2020) scenario with gradual lifting of travel restrictions starting in September implies tourism receipts 73 percent below their 2019 levels. - Under that scenario, direct impact on tourism trade balances in 2020 ranges from –6 percent of GDP to 2 percent of GDP. - Losses exceeding 2 percent of GDP expected for major net tourism exporters: Costa Rica (CRI), Egypt (EGY), Greece (GRC), Morocco (MAR), New Zealand (NZL), Portugal (PRT), Spain (ESP), Sri Lanka (LKA), Thailand (THA), and Turkey (TUR). - UN World Tourism Organization survey: 40 percent of respondents expect international tourism demand to start recovering only in 2021. - Remittances: - World Bank 2020 forecasts an average 20 percent fall in remittance flows in 2020. - Economies where remittances > 5 percent of GDP include Egypt (EGY), Guatemala (GTM), Pakistan (PAK), the Philippines (PHL), and Sri Lanka (LKA); direct annual impact on CA balances for some could exceed 1 percent of GDP. - Remittances expected to rebound only partially (by 5 percent) in 2021 per World Bank 2020. ### Current account forecasts and global aggregate effects (2020) - IMF staff forecasts underpinning June 2020 WEO Update imply narrowing of global current account deficits and surpluses in 2020 both in percent of world GDP and on average in percent of domestic GDP, with high uncertainty. - Monthly trade data for first four months of 2020 suggest trade balances closer to zero; lower surpluses for oil exporters and narrower trade deficits for some emerging market and developing economies. - Among five largest economies, expected changes in current account balances in 2020 compared with 2019 are modest—below ½ percent of GDP: - United States: current account deficit projected to narrow by 0.3 percentage point of GDP to about 2.0 percent of GDP. - China: current account surplus expected to increase by 0.3 percentage point of GDP to 1.3 percent of GDP. - Euro area: current account surplus projected to narrow by 0.4 percentage point of GDP to 2.3 percent of GDP. - United Kingdom: current account deficit projected to narrow by 0.3 percentage point of GDP to 3.5 percent of GDP. - Japan: current account surplus projected to narrow by 0.4 percentage point of GDP to 3.2 percent of GDP. - Saudi Arabia: largest expected change in current account balance in absolute terms — a decline of more than 10 percent of GDP to a deficit of 4.9 percent of GDP. - At the global level, IMF staff forecasts imply a modest narrowing in current account balances by some ⅓ percent of world GDP; this narrowing is smaller than the 1.4 percent of world GDP decline observed in 2009. ### Significant uncertainty and risks to the external outlook - Near-term uncertainties: - More persistent falls in activity, trade, and commodity prices would enlarge CA effects via tourism, commodity balances, and remittances. - Persistent tightening in global financial conditions would strengthen reserve currencies, hinder recovery in capital inflows to emerging market and developing economies, and constrain financing of current account deficits. - Medium-term uncertainties: - Lasting decline in global trade and supply chain integration could reduce investment demand in emerging market and developing economies and raise their CAs toward surplus. - A rise in precautionary saving could raise current account balances and decrease global equilibrium interest rates. - Large and persistent fiscal expansions, if not withdrawn appropriately, could contribute to persistently higher debt and weaker current account balances. ### External implications of a second wave and scenarios (Box 1.6) - Scenario analysis using IMF’s G20 Model: two alternative scenarios relative to June 2020 WEO Update baseline. - Scenario 1 — A Second Outbreak (early 2021) assumptions and results: - Assumes second major global outbreak in early 2021 with domestic disruptions ~ half the size of 2020 baseline disruptions; tightening in international financial conditions about one-half of the increase in sovereign and corporate spreads seen since pandemic start; conventional monetary policy reacts endogenously where room exists. - Results (deviation from baseline): global trade declines by an additional 6 percent in 2021; global GDP declines by about 5 percent in 2021; oil prices are higher by about 12 percent. - Distributional effects: EM non-oil exporters see CAs move toward surplus; net oil exporters see reduced CAs; advanced economies see less import compression and lower CAs; net effect is uphill capital flows from EMs to AEs and little narrowing in overall global CA surpluses and deficits. - Scenario 2 — A Faster Recovery (starting in second half of 2020) assumptions and results: - Assumes faster recovery due to greater confidence, looser financial conditions, and maintained discretionary fiscal measures. - Results (deviation from baseline): global trade rises by an additional 4 percent in 2021; oil prices higher by 8 percent. - Distributional effects: EMs see CAs move toward deficit (easing financial conditions, higher oil prices, rising domestic demand); net oil exporters see higher CAs; advanced economies’ government saving rises modestly via automatic stabilizers. - Caveats: considerable uncertainty; potential amplification from financial pressures and sustained negative trade effects from global value chain disruptions not fully captured. ### Risks to cross-border trade integration - Historical trend: global trade as a share of world GDP peaked in 2008 and has plateaued since; global supply chain integration has declined since 2008. - Pandemic-related measures: - As of May, countries had imposed 120 new export restrictions in 2020 on a net basis. - More than one-fifth of these restrictions were on pharmaceutical and medical products. - Sectors most affected by these measures comprise about 10 percent of global trade. - Implications: - Potential retreat from trade integration, reshoring, and higher trade barriers could reduce trade growth, foreign direct investment, and efficiency gains from international supply chains. - Reshoring may not increase GDP resilience to pandemics and could reduce FDI in emerging market and developing economies. - Another round of US–China trade tensions is a further risk. - Calls for modernizing the multilateral rules-based trading system (e-commerce, services, subsidies, technology transfer, WTO dispute settlement) and caution against currency-based countervailing duties (C-CVDs) which could increase trade tensions and impede effective monetary policy. ### Empirical evidence on financial market responses and investor pullout (COVID-19 episode) - US–China trade policy news (2018–19) effects: - News of rising US–China trade tensions caused China’s currency to depreciate significantly in trade-weighted terms; US dollar appreciated by about half as much. - News depressed stock prices in both China and the United States; US stock prices fell by about half as much as China’s. - US firms with high sales to China experienced stock price impacts almost three times the US average. - Drivers of the COVID-19 sudden stop: - VIX alone explains 45 percent of variance of EPFR flows during the sample period. - Economies with commodity terms of trade falling by 20 percent experienced cumulative outflows up to 50 percent larger than economies with improved terms of trade. - Cumulative outflows about 20 percent larger in economies with a CA deficit of 3 percent of GDP or more versus those with a CA surplus of 3 percent of GDP or more. - Outflows nearly 30 percent lower for economies with high rather than low reserves-to-imports ratios. - Capital outflows 30 percent lower for economies whose central banks obtained access to US Federal Reserve swap lines during the episode. - Economies with 20 percent of exports in tourism experienced capital outflows 20 percent larger relative to economies with no tourism proceeds. - Speed of virus spread mattered: a 20 percent difference between extreme cases in outflow magnitude. - Emerging market and developing economy currency movements (mid-February to late March 2020): - Currencies depreciated by an average of 5 percent; some depreciated more than 20 percent; partial recoveries since March. - Drivers: global factors (VIX, oil price changes) played a strong role; oil exporters depreciated more when oil fell; stronger institutional quality mitigated depreciations. - Sample estimation diagnostics: Observations 1,848 (various columns); R-squared up to 0.324; sample February–May 2020 for 25 EMDEs. ### Policy priorities — Providing relief and promoting economic recovery - Near-term focus: - Policies should focus on the health emergency and easing the burden of containment measures on households and firms. - As of June 12, governments had put forward emergency lifelines totaling about $10.7 trillion, or about 13 percent of global GDP. - Necessary support should include temporary and targeted policies: cash transfers, wage subsidies, tax relief, and extension or postponement of debt repayments. - Monetary policy and liquidity: - Central banks: policy rate cuts, liquidity support, asset purchase programs, and US Federal Reserve swap lines extended to additional foreign central banks. - These measures contributed to easing global financial conditions. - Liquidity provision in emerging markets generally more limited amid currency depreciation pressures. - Recovery-phase actions for countries with fiscal space: - Adopt a front-loaded package increasing investment (including infrastructure) and support household consumption. - Provide substantial targeted fiscal and financial measures for sectors hit by the crisis (for example, tourism and travel). - Support countries vulnerable to remittance falls by: supporting access to social services for migrants and families; offering incentives to remittance service providers to reduce service costs; extending cash transfer programs to support international migrants. ### Policy priorities — Managing capital outflows, currency pressures, and external crisis risks - Exchange-rate policy: - Countries with flexible exchange rates should allow adjustments where feasible. - For economies with adequate reserves, exchange rate intervention can be appropriate to alleviate disorderly market conditions and limit financial stress, particularly with large balance sheet mismatches. - Example: Swiss franc—FX intervention may partially mitigate appreciation pressures but should not preclude secular real appreciation. - Other measures: - Foreign exchange funding facilities can alleviate foreign currency funding pressures. - In imminent crisis circumstances, countries with limited reserves facing reversals could use capital flow management measures on outflows as part of a broad package, provided they do not substitute for warranted macroeconomic and structural policy actions. - If used, capital flow management measures should be broad based, tightly enforced, implemented transparently, clearly communicated, temporary, and lifted once crisis conditions abate. - Official financing and multilateral cooperation: - Official financing essential for EMDEs experiencing disruptive balance of payments pressures and without access to private external financing. - IMF lending facilities cited: Rapid Credit Facility, Rapid Financing Instrument, and the Short-Term Liquidity Line (precautionary credit lines expansion). - Calls made to official bilateral creditors to suspend debt service payments from poorest countries; Group of Twenty heeded this call in April. - Broader net of bilateral and multilateral swap lines would strengthen global financial safety net and reduce financing risks. - For economies likely to face foreign currency liquidity shocks, prudent steps include: - (1) Monitor and contain further buildup of foreign-currency-denominated debt through targeted macroprudential policies. - (2) Encourage shift from foreign-currency-debt toward equity liabilities, including equal treatment of domestic and foreign investors to encourage inward direct investment. - (3) Seize opportunities to strengthen international reserve buffers when they arise. - (4) Deepen domestic financial markets. ### Policy priorities — Avoiding trade restrictions and currency-based trade measures - Trade policy recommendations: - Avoid tariff and nontariff barriers to trade in medical equipment and supplies; roll back recent new restrictions. - International supply chains important for production of essential medical equipment and vaccine/test development. - Policies encouraging repatriation of supply chains could lead to retaliation and slow recovery. - Currency-based trade measures: - Treating undervalued currencies as countervailable subsidies (C-CVDs) poses a significant risk to multilateral trade and monetary systems. - Adoption of C-CVDs would, other things equal, further appreciate the currency of the adopting country; could lead to retaliation and wider use of trade restrictions. - Threat of trade penalties could impinge on monetary policy decisions and complicate effective dialogue on macro-structural distortions. - Broader trade guidance: - Avoid policies that distort trade; refrain from using tariffs to target bilateral trade balances. - Tariff barriers should be rolled back; trade and investment disagreements should be resolved to support an open, stable, and transparent global trading system. - Focus on modernizing multilateral rules to capture e-commerce and services, strengthen rules on subsidies and technology transfer, and ensure enforceability of WTO commitments. - Social safety nets and place-based policies can foster support for these initiatives and help workers affected by trade-induced dislocations. ### Policy priorities — Avoiding excess external imbalances over the medium term - Distortions affecting external positions before COVID-19 may persist after the crisis, implying need for policy reforms. - Economies with larger-than-warranted current account deficits in 2019 (example: Argentina) should pursue: - Fiscal consolidation over the medium term that safeguards growth-enhancing items and social safety nets; prioritize entitlement reform to promote debt sustainability and reduce CA gap. - Strengthen international reserves to enhance resilience to FX liquidity shocks. - Structural policies to increase export competitiveness and diversification for commodity exporters (example: Saudi Arabia). - Infrastructure investment and active labor market policies to address crisis scars. - Economies with stronger-than-warranted external positions should: - Promote investment and discourage excessive private saving. - Use fiscal space for public sector investment in digitalization, infrastructure, and climate mitigation to support private investment and narrow excess CA surplus. - Implement structural reforms to boost corporate investment, competition, and productivity; active labor market policies. - Consider reforms to reduce excessive precautionary saving by expanding social safety nets. - Economies broadly in line with fundamentals should: - Address domestic imbalances to prevent excessive external imbalances. - Former excess surplus countries: narrow larger-than-desirable fiscal deficits, reform state-owned enterprises, relax FDI restrictions, strengthen social safety nets. - Former excess deficit countries: manage public debt, enhance competitiveness, and implement reforms to improve education and innovation. ### Selected country-specific short-term and medium-term recommendations (summary) - Examples by assessment label (2019 overall assessment in parentheses): - Argentina (Weaker): Short Term — balance support with stability amid limited financing; Medium Term — gradual fiscal consolidation, rebuild reserves, reforms to strengthen competitiveness and exports. - Germany (Substantially stronger): Short Term — mitigate outbreak effects and support households/businesses; Medium Term — increase public sector investment; structural reforms to foster entrepreneurship; pension reforms. - Saudi Arabia (Weaker): Short Term — fiscal support to health and hit sectors; Medium Term — consolidation, diversification, boost non-oil tradable sector. - United States (Moderately weaker): Short Term — direct fiscal efforts, infrastructure investment, consumption subsidies; Medium Term — fiscal consolidation, structural policies to increase competitiveness and labor force growth; roll back tariff barriers and resolve trade disagreements. - (Full list includes Australia, Belgium, Brazil, Canada, China, Euro Area, France, Hong Kong SAR, India, Indonesia, Italy, Japan, Korea, Malaysia, Mexico, Netherlands, Poland, Russia, Singapore, South Africa, Spain, Sweden, Switzerland, Thailand, Turkey, United Kingdom; see chapter excerpts for detailed short- and medium-term recommendations.) - Selected quantitative indicators from Table 1.7 (staff-assessed REER gaps and CA/REER elasticities, 2019) — selected country values: - Argentina: Staff-Assessed REER Gap = –1.5; REER Gap Implied from Staff-Assessed CA Gap = 14.6; CA/REER Elasticity = 0.14; REER Avg 19/Avg 18 = –10.7; May 20/Avg 19 = 18.2. - Germany: Staff-Assessed REER Gap = –11.0; REER Gap Implied from Staff-Assessed CA Gap = –11.8; CA/REER Elasticity = 0.36; REER Avg 19/Avg 18 = –1.7; May 20/Avg 19 = 1.0. - Saudi Arabia: Staff-Assessed REER Gap = 13.0; REER Avg 19/Avg 18 = –1.1; May 20/Avg 19 = 2.9. - Thailand: Staff-Assessed REER Gap = –9.5; CA/REER Elasticity = 0.62; REER Avg 19/Avg 18 = 25.6; May 20/Avg 19 = –4.2. - United States: Staff-Assessed REER Gap = 11.0; CA/REER Elasticity = 0.12; REER Avg 19/Avg 18 = 22.8; May 20/Avg 19 = 4.9. - Note: Table 1.7 contains additional country entries and some cells with ". . ." where data are not available in the extract provided. Discrepancy (GDP-weighted average sum of staff-assessed REER gaps) reported as 2.0 in the extract. ### Empirical methodology and key econometric findings - Financial market local projections and panel regressions used to estimate impact of trade-policy news and drivers of investor pullout and currency movements. - IAD (import-intensity-adjusted demand) specification fits trade–demand relationship better than GDP specification; Aggregate Demand coefficients (IAD) reported as 1.56*** (Tot.), 1.55*** (Exp.), 1.63*** (Rec.). - Drivers of EMDE capital outflows: VIX explains large share of variance; commodity terms of trade, precrisis CA deficits, reserve buffers, access to Fed swap lines, tourism exposure, and speed of virus spread significantly affect outflows. - Currency panel estimation (dependent variable: 30-day percent change in NEER) finds statistically significant effects for VIX, Floater regime, Oil Exporter × Δ Oil Price, and interactions of composite/institutional scores with VIX; sample February–May 2020, observations up to 1,848; R-squared up to 0.324. *Source: CHAPTER 1 EXTERNAL POSITIONS AND POLICIES (excerpts).* ### 2019. It also presents IMF staff external sector assess- ### ch1 - 2019. It also presents IMF staff external sector assess- ### Overview - Chapter summarizes: IMF staff external sector assessments for 2019 (benchmark before COVID-19); external developments during the COVID-19 crisis in 2020 (exchange rates, trade in goods and services, capital flows, current account balances, using recent data and IMF staff forecasts); significant risks to the external outlook; and policy priorities (policy responses to risks and crisis, and reforms to reduce excess imbalances over the medium term while supporting global growth). ### Global imbalances before the COVID-19 crisis - Global current account balance (absolute sum of surpluses and deficits) declined by 0.2 percentage point of world GDP in 2019, to 2.9 percent of world GDP. - Regional and country movements in 2019: - Euro area surplus declined by 0.4 percentage point of GDP, to 2.7 percent of GDP, reflecting weaknesses in services and investment income balances. - China’s current account surplus rose by 0.8 percentage point of GDP to 1.0 percent of GDP, reflecting the economic slowdown, lower commodity and semiconductor import prices, and import response to expected and realized tariff hikes. - US current account deficit decreased by 0.1 percentage point of GDP to 2.3 percent of GDP. - Japan’s surplus remained at 3.6 percent of GDP. - Current account balances rose toward surplus in some emerging market and developing economies (Argentina, South Africa, Turkey) in 2019 due to tighter financial conditions, lower domestic demand, or currency depreciation. ### Currency movements and trade tensions - Exchange rate movements in 2019: - US dollar and Japanese yen appreciated about 3 percent in 2019 in real effective terms. - Euro depreciated by 3 percent; renminbi depreciated by 0.8 percent (real effective terms). - Some emerging market and developing economies (India, Indonesia, Mexico, Thailand) saw currencies appreciate by 3 percent to 6 percent in real effective terms. - Argentina peso depreciated almost 42 percent vis-à-vis the US dollar; real effective depreciation limited to 11 percent because of relatively high inflation. - Currencies of Brazil, South Africa, and Turkey depreciated vis-à-vis the US dollar by 8 percent to 14 percent, with smaller real effective depreciations. - Trade tensions and policy actions: - The average US tariff on Chinese imports increased from 12.0 percent to 21.0 percent during 2018–2019. - China’s average tariff on US imports rose from 16.5 percent to 21.1 percent during 2018–2019. - Trade policy changes in 2018–2019 triggered significant declines in equity prices and offsetting currency movements; much of the depreciation in the renminbi during this period driven by trade policy announcements. - In early 2020 the United States and China agreed to a “Phase One” economic and trade agreement with partial rollback of previously implemented tariffs and a truce on new tariffs. - United States–Mexico–Canada Agreement signed and went into effect on July 1, 2020. ### Stocks of external assets and liabilities and currency exposures - External assets and liabilities as a share of GDP more than tripled from the early 1990s to the years preceding the COVID-19 crisis. - The United States has the largest net debtor position as a share of world GDP. - The largest net creditor economies in percent of world GDP are China, Germany, and Japan. - Currency exposure shifts: - Most emerging market and developing economies went from having short positions in foreign currency in 1990 to long positions in 2017, reflecting a shift in foreign liabilities from foreign currency debt to equity financing and sustained accumulation of foreign exchange reserves. - Most advanced economies were already long in foreign currency in 1990, and their net positions have continued to grow. - Emerging market and developing economy compositions: - Foreign exchange reserves are about 40 percent of external assets. - Foreign-currency-denominated debt is about 79 percent of total external debt. - Emerging markets’ foreign exchange positions turned long in the mid-2000s and have continued to increase since the global financial crisis. ### Normative assessment of external positions in 2019 (IMF staff assessments) - IMF staff external sector assessments for 2019 provide a benchmark for external positions before COVID-19. - Assessment approach: - Multilateral approach matching positive and negative excess external imbalances. - Combines numerical inputs from the latest vintage of the EBA methodology with a series of external indicators and country-specific judgment. - EBA methodology produces multilaterally consistent estimates for current account and real exchange rate norms (benchmarks), depending on country fundamentals and desired policies. - IMF staff estimate current account and real effective exchange rate gaps by comparing actual current accounts (stripped of temporary components) and real effective exchange rates with staff-assessed norms, using judgment and country-specific insights where appropriate. - Holistic overall external sector assessment for the world’s 30 largest economies based on estimated gaps and other indicators (net international investment position, capital flows, foreign exchange reserves). - 2019 assessment outcomes: - For most of the 30 economies, overall external position assessments for 2019 remained broadly similar to 2018; about one-third of economy assessments changed categories in 2019. - Economies with estimated excess current account surpluses (deficits) generally also had an undervalued (overvalued) real effective exchange rate, according to IMF staff estimates. - Economies assessed “stronger than the level consistent with medium-term fundamentals and desirable policies” (10 economies): euro area, Germany, Malaysia, the Netherlands, Singapore, Thailand, Poland, Sweden, Switzerland, and Turkey (Turkey entered category in 2019 driven by increases in current account balances). - Economies assessed “weaker than the level consistent with medium-term fundamentals and desirable policies” (9 economies): Belgium, Canada, the United Kingdom, the United States, and a number of emerging market and developing economies (Argentina, South Africa), as well as commodity exporters (listed broadly in text). ### Key statistics and country figures cited - Global current account balance in 2019: 2.9 percent of world GDP. - Change in global current account balance (2019): declined by 0.2 percentage point of world GDP. - Euro area surplus 2019: 2.7 percent of GDP (declined by 0.4 percentage point). - China current account surplus 2019: 1.0 percent of GDP (rose by 0.8 percentage point). - US current account deficit 2019: 2.3 percent of GDP (decreased by 0.1 percentage point). - Japan current account surplus 2019: 3.6 percent of GDP (remained unchanged). - Exchange rate movements (2019): - US dollar and Japanese yen: appreciated about 3 percent (real effective terms). - Euro: depreciated by 3 percent (real effective terms). - Renminbi: depreciated by 0.8 percent (real effective terms). - Emerging market currency appreciations: 3 percent to 6 percent (real effective terms) for India, Indonesia, Mexico, Thailand. - Argentina peso depreciation vis-à-vis US dollar: almost 42 percent; real effective depreciation: 11 percent. - Brazil, South Africa, Turkey depreciations vis-à-vis US dollar: 8 percent to 14 percent (with smaller real effective depreciations). - Tariff changes: - US average tariff on Chinese imports: from 12.0 percent to 21.0 percent (2018–2019). - China average tariff on US imports: from 16.5 percent to 21.1 percent (2018–2019). - External assets and liabilities growth: “more than tripled” from early 1990s to pre-COVID-19 years (Figure 1.2). - Emerging market and developing economies: foreign exchange reserves ≈ 40 percent of external assets; foreign-currency-denominated debt ≈ 79 percent of total external debt. *Source: IMF staff chapter content (2019 assessments and 2020 External Sector Report excerpts).* ### CHAPTER 1 EXTERNAL POSITIONS AND POLICIES ### CHAPTER 1 EXTERNAL POSITIONS AND POLICIES ### Summary of external assessment indicators, 2019 - Global excess imbalances (the sum of absolute excess surpluses and deficits) represented about 1.2 percent of world GDP in 2019. - IMF staff combined EBA numerical inputs with country-specific judgment to assess CA and REER gaps for 29 largest systemically important economies and the euro area. - Staff-assessed CA gaps and REER gaps generally moved consistently with each other in 2019. - Staff assessments placed economies into qualitative categories including: Substantially stronger, Stronger, Moderately stronger, Broadly in line, Moderately weaker, Weaker. - The report notes that persistent excess global imbalances and historically high stocks of external assets and liabilities implied vulnerabilities and remaining policy challenges on the eve of the pandemic. ### IMF staff–assessed current account gaps and staff adjustments, 2019 - Table highlights (staff-assessed CA gaps, midpoint of staff-assessed CA gap, and staff adjustments are reported in percent of GDP for each economy). - Examples of staff-assessed midpoints and notable staff adjustments (percent of GDP): - Argentina: Staff-assessed CA gap midpoint = –2.0; Staff adjustments total = 0.0; CA [A] = –0.8; Cycl. Adj. CA Balance [B] = –1.7; EBA CA Norm [C] = –1.2. - Germany: Staff-assessed CA gap midpoint = 4.3; Staff adjustments total = –0.4; CA [A] = 7.1; Cycl. Adj. CA Balance [B] = 7.3; EBA CA Norm [C] = 2.5. - Netherlands: Staff-assessed CA gap midpoint = 4.9; Staff adjustments total = –2.3; CA [A] = 10.2; Cycl. Adj. CA Balance [B] = 10.5; EBA CA Norm [C] = 3.3. - United States: Staff-assessed CA gap midpoint = –1.3; Staff adjustments total = 0.0; CA [A] = –2.3; Cycl. Adj. CA Balance [B] = –2.0; EBA CA Norm [C] = –0.7. - Staff adjustments reflected a combination of measurement issues, country-specific factors (terms of trade, demographics, NIIP/financing risk considerations), and rounding; breakdown between the norm and other factors is tentative. ### Evolution of staff-assessed CA and REER gaps, 2018–19 - Staff-assessed CA gaps narrowed for some economies in 2019, but the global sum of excess imbalances in percent of world GDP was broadly unchanged from 2018. - Staff-assessed REER gaps generally moved consistently with CA gaps. - Noted movements: CA gaps moved down (smaller excess surpluses or larger deficits) for some commodity exporters (Brazil, Russia, Saudi Arabia) and certain euro area economies (e.g., the Netherlands); these changes mirrored increased CA gaps for some emerging market and developing economies (Argentina, Turkey). ### External developments during the COVID-19 crisis (early 2020) - Trade contraction - The global volume of goods trade in the first five months of 2020 was about 20 percent lower than in 2019. - For 2020 as a whole, the June 2020 WEO Update forecast for goods and services trade volume is a contraction of about 12 percent. - Falling output is identified as the main driver of the trade contraction; services trade contraction is more severe than implied by demand alone due to special factors (for example, travel restrictions). - Financial conditions and market volatility - Financial market sentiment deteriorated sharply in mid- to late February and in March 2020; expected equity price volatility (Chicago Board Options Exchange Volatility Index) reached levels last seen during the peak of the global financial crisis, peaking on March 16. - Corporate and emerging market and developing economy sovereign spreads widened significantly amid a rebalancing toward cash and safe assets. - Since late March, risky asset prices rebounded and global financial conditions eased, supported by strong policy actions. - Policy response - Central bank actions included policy rate cuts, liquidity support, asset purchase programs, and US Federal Reserve swap lines extended to additional foreign central banks. - Fiscal policy expansion was, in many cases, stronger than during the global financial crisis. - The policy response contributed to easing in global financial conditions since late March. - Capital flows and currency movements - Emerging market and developing economies experienced sudden capital flow reversals in late February and March 2020; available high-frequency portfolio flow data indicate outflows that exceed those during the early stages of the global financial crisis in US dollar terms. - Following significant policy easing by central banks, portfolio flows stabilized in April and May 2020, with some emerging market economies regaining access to sovereign debt markets. - Exchange rates experienced large swings through late March and eased thereafter; advanced economy reserve currencies generally appreciated during the worst volatility, while emerging market and developing economy currencies generally depreciated. - Commodity exporters with flexible exchange rates saw especially sharp depreciations reflecting falling oil prices. - Emerging market and developing economies with stronger pre-crisis fundamentals or perceived institutional quality generally experienced smaller depreciations and stronger rebounds. - Outlook for current account balances in 2020 - Outlook is highly uncertain given limited balance of payments data for 2020. - Recent data and IMF staff forecasts point to a modest narrowing in current account surpluses and deficits on average, with high uncertainty and substantial cross-country variation. - Key channels affecting CA evolution in 2020 include contraction in economic activity, tighter global financial conditions, lower commodity prices, and changes in macroeconomic fundamentals that may affect equilibrium values (for example, worse commodity terms of trade may come with a depreciated equilibrium exchange rate). *Source: IMF staff assessments and estimates, CHAPTER 1 EXTERNAL POSITIONS AND POLICIES (2020).* ### CHAPTER 1 EXTERNAL POSITIONS AND POLICIES ### CHAPTER 1 EXTERNAL POSITIONS AND POLICIES ### Impact on Commodity Trade Balances - Crude oil price expected to be 41 percent lower in 2020 than in 2019. - Global oil demand expected to be about 8 percent lower in 2020 than in 2019. - Prices of metals, food, and raw materials are expected to decline, but by significantly less than the price of oil. - Estimated direct impact on oil trade balances in 2020 ranges from –7 percent to 3 percent of GDP across economies. - Estimated trade balance losses concentrated among significant net oil exporters; Norway, Russia, and Saudi Arabia expected losses to exceed 3 percent of GDP. - Positive effects on trade balances spread across net oil importers; expected to exceed 2 percent of GDP for Thailand and Turkey. - Direct impact on current account balances arises from both lower oil prices and lower oil consumption and could be substantial for some oil-exporting economies. ### Impact on Tourism Trade Balances - International tourism arrivals during the first four months of 2020 were about 50 percent lower than over the same period in 2019. - Related indicators (international flight arrivals and hotel reservations) showed deeper declines in early 2020. - UN World Tourism Organization (2020) scenario with gradual lifting of travel restrictions starting in September implies tourism receipts 73 percent below their 2019 levels. - Under that scenario, direct impact on tourism trade balances in 2020 ranges from –6 percent of GDP to 2 percent of GDP. - Losses in tourism proceeds exceeding 2 percent of GDP expected for major net tourism exporters, including Costa Rica (CRI), Egypt (EGY), Greece (GRC), Morocco (MAR), New Zealand (NZL), Portugal (PRT), Spain (ESP), Sri Lanka (LKA), Thailand (THA), and Turkey (TUR). - Rise in tourism trade balances among net tourism importers expected to be more evenly spread. - UN World Tourism Organization survey: 40 percent of respondents expect international tourism demand to start recovering only in 2021; professionals in the Americas slightly more pessimistic. - Effects on tourism may persist to some extent in 2021 and beyond. ### Impact on Remittances Balances - Migrant workers are typically more exposed to unemployment and wage losses during recessions and work disproportionately in sectors hit by the crisis (food and hospitality, retail and wholesale, tourism and transportation). - World Bank 2020 forecasts an average 20 percent fall in remittance flows in 2020. - Economies where remittances represented more than 5 percent of GDP include Egypt (EGY), Guatemala (GTM), Pakistan (PAK), the Philippines (PHL), and Sri Lanka (LKA); these economies face significant hardship from the projected decline. - Direct annual impact on current account balances for some economies could exceed 1 percent of GDP. - Remittances expected to rebound only partially (by 5 percent) in 2021 per World Bank 2020. - Monthly remittance data for selected economies showed a sharp decline in April 2020 followed by a partial rebound in May 2020. ### Current Account Forecasts - Latest IMF staff forecasts underpinning the June 2020 WEO Update imply a narrowing of global current account deficits and surpluses in 2020 both in percent of world GDP and on average in percent of domestic GDP, with high uncertainty. - Monthly trade data for the first four months of 2020 suggest trade balances are closer to zero, with lower surpluses for oil exporters and narrower trade deficits for a number of emerging market and developing economies. - Among the five largest economies, expected changes in current account balances in 2020 compared with 2019 are modest—below ½ percent of GDP. - United States: current account deficit projected to narrow by 0.3 percentage point of GDP to about 2.0 percent of GDP. - China: current account surplus expected to increase by 0.3 percentage point of GDP to 1.3 percent of GDP. - Euro area: current account surplus projected to narrow by 0.4 percentage point of GDP to 2.3 percent of GDP. - United Kingdom: current account deficit projected to narrow by 0.3 percentage point of GDP to 3.5 percent of GDP. - Japan: current account surplus projected to narrow by 0.4 percentage point of GDP to 3.2 percent of GDP. - Saudi Arabia: largest expected change in current account balance in absolute terms — a decline of more than 10 percent of GDP to a deficit of 4.9 percent of GDP, reflecting the sharp decline in oil revenues. - At the global level, IMF staff forecasts imply a modest narrowing in current account balances by some ⅓ percent of world GDP; this narrowing is smaller than the 1.4 percent of world GDP decline observed in 2009. - Explanatory factors for a more limited narrowing in 2020 include: - Initial global current account surpluses and deficits were smaller in 2019 (2.9 percent of world GDP) than before the global financial crisis (5.8 percent of world GDP in 2006). - Larger reductions in public saving are expected in 2020 than in 2009 but are, as a share of world GDP, concentrated among current account deficit economies and expected to be offset to a greater extent by increases in private saving, including precautionary saving. - In 2009, a large decline in investment by a major deficit economy (the United States) played a central role in narrowing global imbalances; by contrast, the synchronized global downturn in 2020 produced a sharper decline in global GDP with a smaller and less concentrated fall in the ratio of investment to world GDP. ### Significant Uncertainty Surrounds the External Outlook - Near-term uncertainties: - If the fall in economic activity, global trade, and commodity prices is more persistent than currently assumed, associated effects on current account balances (via tourism, commodity balances, and remittances) could be larger. - A more persistent tightening in global financial conditions would strengthen global reserve currencies, hinder recovery in capital inflows to emerging market and developing economies, and constrain financing of current account deficits. - Medium-term uncertainties: - If the crisis hastens a lasting decline in global trade and global supply chain integration, weaker growth prospects for emerging market and developing economies may reduce investment demand and raise their current account balances toward surplus. - A rise in precautionary saving, especially where social safety nets are limited, could contribute to raising current account balances. - A widespread rise in private saving would decrease global equilibrium interest rates. - Large and necessary fiscal expansions, especially in advanced economies with greater access to financing, could, if not withdrawn appropriately, contribute to persistently higher debt and weaker current account balances. ### External Implications of a Second Wave of the Crisis - A second wave of the pandemic could be more persistent than the baseline assumes, with attendant impacts on trade, commodity prices, tourism, and remittances. - Global financial conditions could tighten again, implying capital reversals and currency pressures for emerging market and developing economies, with differentiation across economies based on preexisting fundamentals. - Conversely, recovery from initial lockdown measures could accelerate, improving investor sentiment and easing global financial conditions. *Italic: Source — CHAPTER 1 EXTERNAL POSITIONS AND POLICIES (excerpt).* ### Box 1.6 considers scenarios that combine these aspects, ### ch1 - Box 1.6 considers scenarios that combine these aspects, ### Scenarios and simulation results - Scenarios are based on simulations of the IMF’s G20 Model. - Key simulation findings: - A second wave of the crisis could narrow the scope for running current account deficits for emerging market and developing economies. - A second wave could further reduce the current account balances of commodity exporters. - A second wave could deepen the decline in global trade. - Related analysis in Chapter 2: - A rise in global financial stress could increase the risk of debt default, debt restructuring, or the need for more IMF financial support in economies with preexisting vulnerabilities. - Rising default risks from nonfinancial corporations could further contribute to supply chain disruptions. ### Risks to cross-border trade integration - Historical trend: - Global trade as a share of world GDP peaked in 2008 following decades of steady growth and has plateaued since then. - Integration of global supply chains has declined since 2008. - Pandemic-related developments and implications: - The pandemic could cause a further retreat from trade integration, with greater trade barriers and moves toward reshoring production. - As of May, countries had imposed 120 new export restrictions in 2020 on a net basis, a significant rise over previous years (Global Trade Alert data). - More than one-fifth of these export restrictions were imposed on pharmaceutical and medical products. - The sectors most affected by these measures comprise about 10 percent of global trade, implying risks to the outlook for trade growth. - Some new restrictions may reflect efforts to increase local availability of medical supplies during the pandemic. - Calls for repatriation (reshoring) of international supply chains may not necessarily increase resilience of GDP to pandemics (Bonadio and others 2020): less reliance on foreign inputs increases reliance on domestic inputs, which are also subject to lockdowns. - Reshoring could endanger efficiency gains from international supply chain management and reduce foreign direct investment in emerging market and developing economies. - Another round of escalating US–China trade tensions constitutes a further risk. - A retreat from trade globalization could thwart efforts to agree on a more open, stable, and transparent rules-based international trade system. ### Policy priorities — Providing relief and promoting economic recovery - Near-term focus: - Policies should focus on the health emergency and easing the burden of infection containment measures on households and firms. - As of June 12, governments had put forward swift and significant emergency lifelines totaling about $10.7 trillion, or about 13 percent of global GDP. - Necessary support should continue to include temporary and targeted policies: cash transfers, wage subsidies, tax relief, and extension or postponement of debt repayments to provide relief to businesses. - Monetary policy and liquidity: - Central banks have provided a significant expansion in liquidity, including through asset purchase programs, especially in advanced economies. - These strong policy measures have contributed to an easing in global financial conditions. - Monetary policy has also provided support in emerging market and developing economies, although liquidity provision has generally been more limited there amid currency depreciation pressures. - Recovery-phase actions for countries with fiscal space: - Adopt a front-loaded package that increases investment, including in infrastructure where appropriate, and support household consumption. - Provide substantial targeted fiscal and financial measures to help affected households and businesses in sectors particularly hit by the crisis (for example, tourism and travel). - Support countries vulnerable to a fall in remittance inflows by: supporting access to social services for migrants and their families; offering incentives (such as subsidies) to remittance service providers to reduce the cost of remittance services; and extending cash transfer programs to support international migrants, especially those who have lost their jobs. ### Policy priorities — Managing capital outflows and currency pressures - Exchange-rate policy: - Countries with flexible exchange rates should allow them to adjust as needed to external shocks, where feasible. - For economies with adequate reserves (Table 1.3), exchange rate intervention can be appropriate to alleviate disorderly market conditions and limit financial stress, particularly where there are large balance sheet mismatches. - For some currencies (example given: the Swiss franc), foreign exchange intervention may be used to partially mitigate appreciation pressures that would otherwise push the economy toward deflation, but should not preclude secular real appreciation. - Other measures: - Foreign exchange funding facilities can help alleviate foreign currency funding pressures. - In imminent crisis circumstances, countries with limited reserves and facing reversals of external financing could use capital flow management measures on outflows as part of a broad package, provided they do not substitute for warranted macroeconomic and structural policy actions. - If used, capital flow management measures should be broad based, tightly enforced, implemented transparently, clearly communicated, temporary, and lifted once crisis conditions abate. ### Policy priorities — Addressing risks of external crisis - Official financing and multilateral cooperation: - For emerging market and developing economies already experiencing disruptive balance of payments pressures and without access to private external financing, official financing will be essential, including to ensure that health care spending is not compromised. - Fighting the global pandemic requires strong multilateral cooperation to help countries facing twin health and external financing shocks. - The IMF is actively supporting vulnerable countries through various lending facilities, including the Rapid Credit Facility and the Rapid Financing Instrument. - The IMF has expanded its precautionary credit lines for countries with strong fundamentals by creating the Short-Term Liquidity Line. - Calls were made by the IMF managing director and the World Bank Group president on official bilateral creditors to suspend debt service payments from the poorest countries; this call was heeded by the Group of Twenty in April. - IMF and World Bank staff are providing technical support in implementation of this initiative. - A broader net of bilateral and multilateral swap lines would further strengthen the global financial safety net and reduce financing risks across emerging market and developing economies. - For economies likely to face foreign currency liquidity shocks, prudent steps include: - (1) Monitoring and containing further buildup of foreign-currency-denominated debt through targeted macroprudential policies. - (2) Encouraging a shift from foreign-currency-debt liabilities toward equity liabilities, including by ensuring equal treatment of domestic and foreign investors and encouraging more inward direct investment. - (3) Seizing opportunities to strengthen international reserve buffers, where needed, when they arise. - (4) Deepening domestic financial markets. ### Policy priorities — Avoiding trade restrictions, especially regarding critical supplies - Trade policy recommendations: - Tariff and nontariff barriers to trade in medical equipment and supplies should be avoided, and recent new restrictions on trade should be rolled back. - International supply chain trade can play an important role in supporting production of essential medical equipment and the development of vaccines and medical tests. - Policies encouraging repatriation of supply chains could lead to retaliation across interlinked economic sectors and could slow economic recovery during gradual reopenings. - On currency-based trade measures: - Treating undervalued currencies as a countervailable subsidy (currency-based countervailing duties, C-CVDs) represents a significant risk to the multilateral trade and international monetary systems. - Adoption of C-CVDs would, other things equal, further appreciate the currency of the country adopting such measures. - C-CVDs could lead to retaliation and to other countries pursuing similar policies with their own standards and methodologies, expanding use of trade restrictions and increasing trade tensions. - Threat of trade penalties could impinge on desirable monetary policy decisions and discourage beneficial exchange rate flexibility; it could also complicate effective dialogue and economic surveillance over underlying macro-structural distortions affecting external positions. - Broader trade policy guidance: - Policies that distort trade should be avoided. - Countries should refrain from using tariffs to target bilateral trade balances; tariffs are costly for trade, investment, and growth, and generally not effective for reducing excess external imbalances. - Tariff barriers should be rolled back, and trade and investment disagreements should be resolved in ways that support an open, stable, and transparent global trading system. - Efforts should focus on modernizing the multilateral rules-based trading system to capture the increasing importance of e-commerce and trade in services, strengthen rules on subsidies and technology transfer, and ensure continued enforceability of WTO commitments through a well-functioning WTO dispute settlement system. - Social safety nets and policies to promote flexibility in adjustment (including place-based policies targeted at lagging regions) can foster support for these initiatives; such policies must be carefully calibrated to help rather than hinder beneficial adjustment. - There is limited evidence that trade integration itself—particularly greater import competition in external markets—drives economic inequality (see October 2019 WEO), but trade can cause job dislocations; a robust social safety net is important for facilitating regional adjustment and protecting particular regions and segments of the labor force. ### Policy priorities — Avoiding excess external imbalances over the medium term - Distortions affecting external positions before the COVID-19 crisis may, in some cases, persist after the crisis, implying the need for policy reforms. - Example guidance for economies with weaker-than-warranted external positions: - In cases where excess current account deficits in 2019 partly reflected larger-than-desirable fiscal deficits (example cited: the United States) and where such imbalances persist beyond the crisis, fiscal policy adjustments are implied (details continue in the chapter and Tables 1.6 and 1.8). *Source: Excerpts from Chapter 1 text and Box 1.6 of the 2020 External Sector Report (IMF).* ### CHAPTER 1 EXTERNAL POSITIONS AND POLICIES ### CHAPTER 1 EXTERNAL POSITIONS AND POLICIES ### Overall framework for assessing external positions - Current account (CA) balances are evaluated by comparing the actual CA (stripped of cyclical and temporary factors) with the level assessed by IMF staff to be consistent with fundamentals and desirable policies; the difference is the staff-assessed CA gap. - A CA balance higher (lower) than implied by fundamentals and desirable policies corresponds to a positive (negative) CA gap. - Assessments include a view of the real effective exchange rate (REER) consistent with the assessed CA gap: a positive (negative) REER gap implies an overvalued (undervalued) exchange rate. - The overall external position judgment also considers financial account balances, the international investment position, reserve adequacy, and other competitiveness measures (such as unit-labor-cost–based REER). - External position labels: - "Weaker" (or "weaker than warranted"): low CA relative to staff-assessed norm and/or overvalued REER. - "Stronger" (or "stronger than warranted"): high CA relative to staff-assessed norm and/or undervalued REER. - "Broadly in line": CA and REER at or close to IMF staff–assessed norms. - Elimination of CA or REER gaps is desirable over the medium term, allowing for gradual adjustment where temporary gaps are justified. - External Balance Assessment (EBA) models and complementary tools are used in forming staff judgments. 1 ### Major policy guidance by country-group and cross-country findings - Economies with larger-than-warranted current account deficits in 2019 (example given: Argentina): - Fiscal consolidation over the medium term that safeguards growth-enhancing items and social safety nets and prioritizes entitlement reform would both promote debt sustainability and reduce the CA gap. - Fiscal consolidation would support raising international reserves to adequate levels, enhancing resilience to global foreign currency liquidity shocks. - Structural policies to increase export competitiveness—and, for commodity exporters (example given: Saudi Arabia), diversification—would further support rebalancing. - Infrastructure investment and active labor market policies may be widely needed to address crisis scars. - Countries with lingering competitiveness challenges would benefit from: - Upgrading infrastructure to reduce bottlenecks; - Labor market policies: enhancing schooling, training, and mobility of workers; - Supporting the working poor; and - Encouraging growth in the labor force (including through skill-based immigration reform). - Economies with stronger-than-warranted external positions: - Prioritize reforms that encourage investment and discourage excessive private saving. - In economies with remaining fiscal space, adopt growth-oriented fiscal policy with greater public sector investment in digitalization, infrastructure, and climate change mitigation to support private investment, promote potential growth, increase resilience, and narrow excess CA surplus. - Examples of announced/ proposed packages: - Germany announced a new package (€130 billion, or 4 percent of GDP, over 2020–21) in June to support the recovery, with measures to boost activity in green and digital economies. - The European Union has proposed an additional €750 billion (6 percent of its GDP) in support over 2021–27, including a grant-based recovery fund, which could promote green recovery and reduce uneven pandemic impacts on member states’ debt sustainability if approved. - Structural reforms recommended: boost corporate investment, competition, and productivity; active labor market policies to facilitate access to skilled labor and raise potential growth (example: Poland). - Reforms to discourage excessive precautionary saving by expanding the social safety net may be warranted (examples: Malaysia and Thailand). - Economies with external positions broadly in line with fundamentals: - Continue addressing domestic imbalances to prevent excessive external imbalances. - Former excess surplus countries should, where relevant: - Address domestic imbalances by gradually narrowing larger-than-desirable fiscal deficits; - Reform state-owned enterprises and open markets to more competition (example: China); - Relax restrictions on foreign direct investment; and - Strengthen the social safety net. - Former excess deficit countries (examples: Indonesia and Spain) should, where relevant: - Carefully manage the public debt load; - Enhance competitiveness through productivity gains and continued wage flexibility; - Implement reforms to enhance education outcomes and innovation. - As more data become available on crisis effects, comprehensive and multilaterally consistent analysis is needed to advance a shared understanding of distortions and necessary reforms for global rebalancing. ### Selected country-specific policy recommendations (short-term and medium-term) — summary of Table 1.8 - Argentina (Overall 2019 Assessment: Weaker) - Short Term: Balance need to support the economy during the pandemic while ensuring domestic and external stability in the context of very limited access to financing. - Medium Term: Implement gradual fiscal consolidation and prudent monetary policies; rebuild international reserves; introduce reforms to strengthen competitiveness and export capacity. - Australia (Broadly in line) - Short Term: Maintain monetary policy easing and fiscal stimulus to support the economy. - Medium Term: Provide fiscal and monetary stimulus to support domestic demand, limiting the projected increase in the CA balance. - Belgium (Weaker) - Short Term: Continue fiscal policies to bolster the healthcare system and support affected firms and individuals. - Medium Term: Rebuild fiscal space; improve competitiveness via reinvigorated structural reforms. - Brazil (Moderately weaker) - Short Term: Stand ready for prudent FX interventions to alleviate possible disorderly market conditions. - Medium Term: Implement fiscal consolidation to raise national savings; introduce structural reforms to reduce cost of doing business and strengthen competitiveness. - Canada (Moderately weaker) - Short Term: Calibrate monetary and fiscal policy support to limit pandemic health and economic impact. - Medium Term: Implement medium-term fiscal consolidation; boost nonenergy exports via improved labor productivity, investment in R&D and public infrastructure; promote FDI. - China (Broadly in line) - Short Term: Continue support focusing on employment stabilization and poverty alleviation; strengthen public health and social safety net if needed. - Medium Term: Implement gradual fiscal consolidation and continue reform agenda to support rebalancing; allow ER flexibility; improve social safety net; attract more FDI by ensuring equal treatment of foreign and domestic investors. - Euro Area (Moderately stronger) - Short Term: Contain COVID-19 outbreak and economic consequences; provide relief to households and corporates; maintain accommodative monetary policy. - Medium Term: Implement area-wide initiatives (banking and capital markets union and fiscal capacity for macro-stabilization) to reinvigorate investment. - France (Moderately weaker) - Short Term: Provide fiscal support to bolster health care and support affected firms and households. - Medium Term: Improve competitiveness via structural reforms; rebuild fiscal space post-recovery. - Germany (Substantially stronger) - Short Term: Continue mitigating outbreak effects while supporting households and businesses to minimize scarring. - Medium Term: Increase public sector investment; implement structural reforms to foster entrepreneurship; introduce additional tax relief for lower-income households; adopt pension reforms prolonging working lives. - Hong Kong SAR (Broadly in line) - Short Term: Implement expansionary fiscal policy. - Medium Term: Continue robust financial supervision; maintain flexible wages and prices; prudent fiscal management. - India (Broadly in line) - Short Term: Preserve lives and productive capacity via fiscal, monetary, and financial policies; protect vulnerable households/firms including informal sector. - Medium Term: Implement fiscal consolidation; enhance credit provision; improve business climate; liberalize trade and investment to attract FDI. - Indonesia (Broadly in line) - Short Term: Continue ER flexibility with limited FX interventions amid market volatility. - Medium Term: Boost competitiveness; improve labor market flexibility; increase infrastructure and social spending (with additional revenue mobilization); ease non-tariff trade barriers and FDI restrictions. - Italy (Broadly in line) - Short Term: Continue fiscal and liquidity measures to support families, businesses, and health system. - Medium Term: Focus on policies to improve competitiveness (align wages with productivity); implement credible fiscal consolidation; strengthen bank balance sheets to reduce external vulnerabilities. - Japan (Broadly in line) - Short Term: Continue fiscal and monetary support to vulnerable households, workers, and firms. - Medium Term: Implement coordinated package with gradual fiscal consolidation and structural reforms to boost wages and labor productivity and supply; reduce barriers to entry; accelerate deregulation in agriculture and professional services. - Korea (Broadly in line) - Short Term: Maintain fiscal and monetary stimulus post-COVID-19 outbreak. - Medium Term: Continue accommodative policies; implement structural policies to stimulate investment and rebalance toward services and new growth drivers. - Malaysia (Stronger) - Short Term: Provide relief to stressed firms and households and preserve production capacity while maintaining FX market stability. - Medium Term: Implement fiscal consolidation with policies to strengthen social safety net and encourage investment; allow continued exchange rate flexibility. - Mexico (Broadly in line) - Short Term: Provide sufficient policy support in response to COVID-19; maintain floating ER as main shock absorber with FX interventions to prevent disorderly conditions. - Medium Term: Implement pro-growth and inclusive fiscal reforms and structural reforms; improve competitiveness and business climate. - Netherlands (Substantially stronger) - Short Term: Use fiscal space and the escape clause to support health sector and help households and businesses face the pandemic. - Medium Term: Promote recovery and support investment in physical and human capital to foster robust potential growth. - Poland (Stronger) - Short Term: Use fiscal policy to bolster health system, provide liquidity to businesses, and support incomes of vulnerable households; prevent tightening of financial conditions using monetary and financial policies. - Medium Term: Reduce fiscal deficit and prioritize spending for health care and public investment; boost corporate investment and productivity; implement active labor market policies. - Russia (Broadly in line) - Short Term: Focus fiscal policy on managing public health emergency and compensating those most affected. - Medium Term: Mitigate impact of oil price volatility on non-oil sector; rebalance government expenditure toward health, education, and infrastructure. - Saudi Arabia (Weaker) - Short Term: Provide fiscal support to health care sector and sectors hard hit by the pandemic. - Medium Term: Implement further consolidation to ensure savings for future generations; diversify the economy and boost the non-oil tradable sector. - Singapore (Substantially stronger) - Short Term: Continue monitoring fiscal stimulus implementation and stand ready to provide further stimulus if needed. - Medium Term: Increase public investment (health care, physical infrastructure, human capital); introduce structural reforms to improve productivity. - South Africa (Moderately weaker) - Short Term: Cushion negative impact of COVID-19 and protect the vulnerable through temporary and targeted fiscal support. - Medium Term: Introduce structural reforms to improve competitiveness; implement gradual fiscal consolidation while providing space for infrastructure and social spending; seize opportunities to build up reserves. - Spain (Broadly in line) - Short Term: Mitigate Great Lockdown impact via targeted and temporary income and liquidity support. - Medium Term: Foster competitiveness through wage flexibility and reforms addressing labor market duality; carefully manage public debt load. - Sweden (Stronger) - Short Term: Adopt sizable targeted policies complemented by broader stimulus to minimize scarring and ensure quick recovery. - Medium Term: Raise potential output and reduce household uncertainties around sustainability of Sweden’s social model. - Switzerland (Moderately stronger) - Short Term: Use fiscal policy to respond to the pandemic; use FX intervention to partially mitigate safe-haven appreciation pressures if needed while not precluding secular real appreciation. - Medium Term: Use fiscal policy to address structural challenges (competitiveness, aging, climate change); implement macroprudential policies to reduce financial sector risks; consider more frequent and timely publication of FXI data. - Thailand (Substantially stronger) - Short Term: Deploy fiscal expansion toward targeted social transfers and relief measures; allow ER flexibility with limited intervention to avoid disorderly conditions. - Medium Term: Boost domestic demand and public infrastructure; reform and expand social safety nets; reduce barriers to investment, especially in services. - Turkey (Moderately stronger) - Short Term: Cushion COVID-19 impact and protect most vulnerable through temporary and targeted fiscal support. - Medium Term: Rein in rapid credit growth; rebuild reserves; strengthen public sector balance sheet; bolster business climate. - United Kingdom (Weaker) - Short Term: Support economy, address coronavirus impact, and facilitate recovery via accommodative monetary policy and fiscal support to vulnerable households and businesses. - Medium Term: Implement structural reforms including broadening skill base to boost productivity and international competitiveness after the pandemic. - United States (Moderately weaker) - Short Term: Direct fiscal efforts to ease shutdown burden on households and firms; increase infrastructure investment; facilitate transition to lower carbon economy; offer consumption subsidies to kick-start demand. - Medium Term: Implement fiscal consolidation and structural policies to increase competitiveness and labor force growth; roll back tariff barriers and resolve trade and investment disagreements to support an open, stable, and transparent global trading system. ### Selected quantitative indicators from Table 1.7 (staff-assessed REER and CA/REER elasticities, 2019) - Table 1.7 columns and some country values (selected): - Argentina: Staff-Assessed REER Gap = –1.5; REER Gap Implied from Staff-Assessed CA Gap = 14.6; EBA REER-Level Gap = . . .; EBA REER-Index Gap = –6.4; CA/REER Elasticity = 0.14; REER Avg 19/Avg 18 = –10.7; May 20/Avg 19 = 18.2 - Australia: Staff-Assessed REER Gap = –4.0; REER Gap Implied from Staff-Assessed CA Gap = –4.0; EBA REER-Level Gap = 10.2; EBA REER-Index Gap = –1.4; CA/REER Elasticity = 0.20; REER Avg 19/Avg 18 = –4.5; May 20/Avg 19 = –1.9 - Belgium: Staff-Assessed REER Gap = 8.5; REER Gap Implied from Staff-Assessed CA Gap = 8.3; EBA REER-Level Gap = 17.1; EBA REER-Index Gap = 9.3; CA/REER Elasticity = 0.42; REER Avg 19/Avg 18 = –1.5; May 20/Avg 19 = 0.8 - Brazil: Staff-Assessed REER Gap = 3.5; REER Gap Implied from Staff-Assessed CA Gap = 11.4; EBA REER-Level Gap = 2.3; EBA REER-Index Gap = –10.7; CA/REER Elasticity = 0.10; REER Avg 19/Avg 18 = –1.9; May 20/Avg 19 = –26.8 - Canada: Staff-Assessed REER Gap = 7.1; REER Gap Implied from Staff-Assessed CA Gap = 6.8; EBA REER-Level Gap = –6.0; EBA REER-Index Gap = 2.1; CA/REER Elasticity = 0.27; REER Avg 19/Avg 18 = –1.0; May 20/Avg 19 = –3.6 - China: Staff-Assessed REER Gap = –2.0; REER Gap Implied from Staff-Assessed CA Gap = –4.4; EBA REER-Level Gap = 11.4; EBA REER-Index Gap = –1.1; CA/REER Elasticity = 0.23; REER Avg 19/Avg 18 = –0.8; May 20/Avg 19 = 1.8 - Germany: Staff-Assessed REER Gap = –11.0; REER Gap Implied from Staff-Assessed CA Gap = –11.8; EBA REER-Level Gap = –16.0; EBA REER-Index Gap = 3.6; CA/REER Elasticity = 0.36; REER Avg 19/Avg 18 = –1.7; May 20/Avg 19 = 1.0 - India: Staff-Assessed REER Gap = –5.6; REER Gap Implied from Staff-Assessed CA Gap = –5.6; EBA REER-Level Gap = 10.2; EBA REER-Index Gap = 13.4; CA/REER Elasticity = 0.18; REER Avg 19/Avg 18 = 5.8; May 20/Avg 19 = –0.4 - Malaysia: Staff-Assessed REER Gap = –7.2; REER Gap Implied from Staff-Assessed CA Gap = –7.2; EBA REER-Level Gap = –38.0; EBA REER-Index Gap = –25.0; CA/REER Elasticity = 0.46; REER Avg 19/Avg 18 = –1.4; May 20/Avg 19 = –3.5 - Mexico: Staff-Assessed REER Gap = –7.0; REER Gap Implied from Staff-Assessed CA Gap = –6.9; EBA REER-Level Gap = –3.5; EBA REER-Index Gap = –15.4; CA/REER Elasticity = 0.13; REER Avg 19/Avg 18 = 3.3; May 20/Avg 19 = –15.0 - Russia: Staff-Assessed REER Gap = –0.4; REER Gap Implied from Staff-Assessed CA Gap = –0.4; EBA REER-Level Gap = –14.5; EBA REER-Index Gap = –9.3; CA/REER Elasticity = 0.27; REER Avg 19/Avg 18 = 2.5; May 20/Avg 19 = –5.0 - Saudi Arabia: Staff-Assessed REER Gap = 13.0; REER Gap Implied from Staff-Assessed CA Gap = . . .; EBA REER-Level Gap = . . .; EBA REER-Index Gap = . . .; CA/REER Elasticity = . . .; REER Avg 19/Avg 18 = –1.1; May 20/Avg 19 = 2.9 - Switzerland: Staff-Assessed REER Gap = –3.5; REER Gap Implied from Staff-Assessed CA Gap = –3.5; EBA REER-Level Gap = 19.7; EBA REER-Index Gap = 13.5; CA/REER Elasticity = 0.52; REER Avg 19/Avg 18 = 21.0; May 20/Avg 19 = 3.9 - Thailand: Staff-Assessed REER Gap = –9.5; REER Gap Implied from Staff-Assessed CA Gap = –9.8; EBA REER-Level Gap = –1.3; EBA REER-Index Gap = 14.0; CA/REER Elasticity = 0.62; REER Avg 19/Avg 18 = 25.6; May 20/Avg 19 = –4.2 - Turkey: Staff-Assessed REER Gap = –15.0; REER Gap Implied from Staff-Assessed CA Gap = –7.3; EBA REER-Level Gap = –20.5; EBA REER-Index Gap = –22.8; CA/REER Elasticity = 0.22; REER Avg 19/Avg 18 = –2.2; May 20/Avg 19 = 7.8 - United States: Staff-Assessed REER Gap = 11.0; REER Gap Implied from Staff-Assessed CA Gap = 10.8; EBA REER-Level Gap = 10.9; EBA REER-Index Gap = 8.1; CA/REER Elasticity = 0.12; REER Avg 19/Avg 18 = 22.8; May 20/Avg 19 = 4.9 - Note: Table 1.7 also provides EBA REER gaps and CA/REER semi-elasticities used by IMF country teams; some table cells contain ". . ." indicating not available in the extract provided. - Discrepancy (GDP-weighted average sum of staff-assessed REER gaps) reported as 2.0 in the available extract. *Source: CHAPTER 1 EXTERNAL POSITIONS AND POLICIES, 2020 External Sector Report (excerpts).* ### Box 1.1. External Assessments: Objectives and Concepts ### Box 1.1. External Assessments: Objectives and Concepts ### US–China Trade Tensions and Asset Price Movements - News regarding US–China trade policy tensions in 2018–19 had persistent effects on currencies and stock prices in China and the United States. - Much of the renminbi’s depreciation during this period reflects the escalation of trade tensions. - Standard macroeconomic models predict that raising tariffs leads to currency depreciation for the economy on whose products the tariff is imposed and a currency appreciation for the economy imposing the tariff. High-frequency analysis of news announcements related to US–China trade tensions during 2018–19 broadly confirms this prediction. - The analysis focuses on 43 trade policy announcements cited in news reports, classified by importance, and estimates the responses of exchange rates and stock prices using daily data. - Responses reported for an impulse of 3 in the measure of trade-barrier-related news with 90 percent confidence bands derived from Jordà (2005); local projections estimated with ordinary least squares and Newey-West standard errors up to i = 40 days after time t. ### Currency Responses and Renminbi Depreciation - News of a rise in US–China trade tensions causes China’s currency to depreciate significantly in trade-weighted terms and the US dollar to appreciate by about half as much. - News of a tightening in US trade policy regarding China in 2018–19 explains much of the 10 percent depreciation in the value of the renminbi vis-à-vis the US dollar over this period. - The impact on the currency corresponds to about two-thirds of the rise in the average US tariff on imports of goods from China. - Additional analysis indicates that the renminbi fixing rate (the daily reference rate of the People’s Bank of China) has responded significantly less to announcements regarding US trade policy on impact, suggesting a role in smoothing currency movements. Looking at episodes of escalating and easing trade tensions separately provides no evidence that the fixing rate responded asymmetrically to weaken the renminbi. ### Stock Market Effects - News of a rise in US–China trade tensions depressed stock prices in both China and the United States, with US stock prices falling by about half as much as China’s. - The impact on US firms with high sales to China is almost three times the US average. - Additional analysis finds persistent negative effects on stock prices in other major economies as well. - For economies that potentially benefited from trade and foreign direct investment diversion effects in 2018–19 (for example, Mexico), the estimated stock market reaction is relatively small. ### Methodology Notes (Financial Market Local Projections) - Local projections estimated based on the equation reported in the source using ordinary least squares with Newey-West standard errors: - y_{t + i} = ϕ_i + β_i T_t + Σ_{k=1}^4 γ_{k,i} T_{t−k} + Σ_{k=1}^4 δ_{k,i} y_{t−k} + Σ_{k=0}^4 ψ_{k,i} X_{t−k} + e_{t,i} - where i denotes the time horizon (days after time t), y_{t + i} denotes the financial market variable at time t + i, and T_t is the indicator of trade policy announcements at time t. - Additional controls include announcements by China of trade action targeting the United States and announcements by the United States of trade action targeting Mexico. - NEER = nominal effective exchange rate, RMB = Chinese renminbi, USD = US dollar. ### Trade and Economic Activity in the COVID-19 Crisis - Forecasts of falling global trade in 2020 reflect primarily the expected weakness in economic activity. - Recent data and IMF staff forecasts suggest that global trade will decline by about 12 percent in 2020, comparable to what was observed during the global financial crisis. - The historical relationship between trade and aggregate demand fully explains the expected global decline in trade in goods; the expected contraction in trade in services is more severe than could be expected by the expected fall in aggregate demand, suggesting a strong role for other factors, such as travel restrictions. - The analysis uses an import-intensity-adjusted measure of aggregate demand following Bussière and others (2013): a weighted average of aggregate demand components in which the weights are the import content of each component computed from national accounts input-output tables. This measure distinguishes between components such as investment (import-rich) and private consumption (less-import-rich). - Based on this measure, the analysis estimates the historical relationship with trade, measured by import volume growth, for 33 economies during 1998–2019 using the equation: - ∆lnM_{c,t} = δ_c + β_D ∆lnD_{c,t} + β_P ∆lnP_{c,t} + ε_{c,t}, - where ∆ denotes first difference, δ_c denotes country dummies, D_{c,t} is aggregate demand, and P_{c,t} is the relative price of imports. - Estimation results confirm that using the import-intensity-adjusted measure of aggregate demand provides a better fit than using GDP, including during recessions. - The historical relationship explains the full expected decline in goods trade in 2020; for services imports, the decline currently expected is sharper than what could be expected based on the historical relationship. ### Empirical Model of Real Imports (1998–2019) — Select Results - IAD specification versus GDP specification reported for total (Tot.), expansions (Exp.), and recessions (Rec.). - Aggregate Demand coefficients (IAD specification): 1.56*** (Tot.), 1.55*** (Exp.), 1.63*** (Rec.). - Relative Import Price coefficients (IAD specification): –0.17** (Tot.), –0.13 (Exp.), –0.15*** (Rec.). - Observations: 693 (Tot.), 577 (Exp.), 116 (Rec.). - R-squared (IAD specification): 0.78 (Tot.), 0.61 (Exp.), 0.86 (Rec.). - Note: ***, **, and * denote statistical significance at the 1, 5, and 10 percent level, respectively, based on robust standard errors. Recessions defined as years with real GDP growth below the country-specific 10th percentile. Country-fixed effects included. ### Drivers of the COVID-19 Sudden Stop (Investor Pullout from Emerging Market and Developing Economies) - The investor pullout largely reflected the tightening in global financial conditions. - A panel regression exploits cross-country and weekly variation during the COVID-19 episode in debt and equity flows to emerging market and developing economy mutual funds from Emerging Portfolio Fund Research (EPFR). - The equation estimated: - Flows_{i,t} = α + β VIX_t + γ VIX_t × Fundamentals_{i,t} + θ Fundamentals_{i,t} + δ COVID_features_{i,t} + ε_{i,t}. - Key findings: - The VIX alone explains 45 percent of the variance of EPFR flows during the sample period. - Economies facing a simultaneous deterioration in commodity terms of trade (mainly oil exporters) experienced larger outflows: economies whose commodity terms of trade fell by 20 percent experienced cumulative outflows up to 50 percent larger than economies whose commodity terms of trade improved by a similar magnitude. - Precrisis vulnerabilities mattered: cumulative outflows are estimated to have been about 20 percent larger in economies with a current account deficit of 3 percent of GDP or more than in an economy with a current account surplus of 3 percent of GDP or more. - Outflows were nearly 30 percent lower for economies with high rather than low reserves-to-imports ratios. - Capital outflows were 30 percent lower for economies whose central banks obtained access to the US Federal Reserve’s swap lines during the episode relative to other economies. - COVID-19–related factors: economies with 20 percent of exports concentrated in tourism experienced capital outflows 20 percent larger relative to economies with no tourism proceeds. The speed of spread of the virus also played a role, with a 20 percent difference in the magnitude of outflows between extreme (10th and 90th percentiles) cases. ### Policy Implications and Risks - Preventing another tightening of global financial conditions and maintaining healthy liquidity buffers in emerging market and developing economies—including through cross-country financial arrangements—will be essential to support healthy capital flows to these economies. - Risks to future trade growth include a rise in trade barriers and a retreat from cross-border integration, reflecting factors such as rising protectionism. *Source: IMF staff estimates.* ### Box 1.4 (continued) ### Box 1.4 (continued) ### Predicted cumulative portfolio flows and differentiation by fundamentals - Figure 1.4.2 reports predicted cumulative portfolio flows (percent of initial stock position, cumulative since February 19, 2020), differentiated by: - Commodity TOT change (Decrease (–20%) / Increase (20%)) - Current account balance (CA deficit (–3% GDP) / CA surplus (+3% GDP)) - International liquidity (Low / High; based on 2019 ICRG subcomponent reflecting availability of international reserves in months of imports) - Access to Federal Reserve foreign exchange swap lines (No / Yes; dummy = 1 from week of March 19, 2020 for Brazil, Korea, Mexico) - Share of tourism in exports (Low (0% exports) / High (20% exports)) - COVID-19 cases (weekly log difference in number of confirmed COVID-19 cases) - Predictions are reported with 10th percentile and 90th percentile bounds and with dates along the x-axis (Feb. 2020, Mar. 20, Apr. 20, May 20). - Note: CA = current account; TOT = terms of trade. Source: IMF staff estimates. ### Emerging market and developing economy currency movements during the COVID-19 crisis - Aggregate movements: - From mid-February to late March 2020, emerging market and developing economy currencies depreciated by an average of 5 percent; some depreciated more than 20 percent. - These currencies, in many cases, partially recovered since March. - Range of currency movement was broadly comparable to the global financial crisis and significantly larger than during the 2013 taper tantrum (Figure 1.5.1). - Drivers and estimation approach: - A panel equation relates the change in the nominal effective exchange rate (NEER) over a 30-day period with global factors, country-specific variables, and interactions: - ∆NEER_{i,t} = α + β1 VIX_t + β2 ∆Oil Price_t + γ1 Floater_i + γ2 Oil Exporter_i + γ3 Fundamentals_i + θ1 ∆Oil Price_t Oil Exporter_i + θ2 VIX_t Fundamentals_i + ε_{i,t} - Global factors (VIX and oil price changes) played a strong role in driving depreciations. - The first principal component of VIX, US equity prices, and oil prices is strongly correlated with variance in currency movements. ### Key empirical findings on amplification/mitigation by country characteristics - Oil exporters: - The currencies of oil-exporting emerging market and developing economies depreciated more strongly than others when oil prices declined. - Interaction term Oil Exporter × Δ Oil Price is positive and significant (0.08** in Table 1.5.1). - Institutional quality and fundamentals: - Economies with stronger perceived institutional quality or stronger economic and financial fundamentals (ICRG scores) experienced smaller currency depreciations when VIX was high. - An economy at the 75th percentile of the ICRG score for economic or financial fundamentals experienced, on average, a 2½ percent smaller NEER depreciation than an economy at the 25th percentile when the VIX increased to peak levels in March 2020. - Within ICRG subcomponents, debt service, international liquidity, and current account deficit mattered for cross-country differences. - Exchange rate regime: - Economies classified as managed floating or free floating ("Floater") experienced larger currency depreciations. - Implication: - Recent easing in global financial conditions, reflecting swift central bank actions, should reduce pressure on emerging market and developing economy currencies. - Economies with stronger perceived economic and financial fundamentals are likely to face less downward pressure on their currencies if global financial and economic conditions worsen. ### Selected estimation results (Table 1.5.1, dependent variable: 30-day percent change in NEER) - Coefficients and significance (columns pooled summary as reported): - Δ Oil Price: 0.03* / 0.03** / 0.03** / 0.03* - VIX: –0.51*** / –0.28** / –0.33*** / –0.33*** - Floater: –3.22*** / –3.24*** / –3.46*** / –3.05*** - Oil Exporter: 1.03 / 0.99 / 0.95 / 0.88 - Oil Exporter × Δ Oil Price: 0.08** / 0.07** / 0.08** / 0.08** - Composite Score: –0.14* - Composite Score × VIX: 0.01*** - Political Risk Score: –0.13** - Political Risk Score × VIX: 0.00** - Economic Risk Score: –0.11 - Economic Risk Score × VIX: 0.01*** - Financial Risk Score: –0.08 - Financial Risk Score × VIX: 0.01*** - Sample and diagnostics: - Observations: 1,848; 1,838; 1,823; 1,843 (columns 1–4). - R-squared: 0.316; 0.290; 0.319; 0.324. - Sample is February–May 2020 for 25 emerging market and developing economies. - Standard errors corrected for serial correlation of type MA(30) using Newey-West; outliers removed using Cook’s distance > 4/N. - “Floater” per Ilzetzki, Reinhart, and Rogoff (2019). NEER = nominal effective exchange rate; VIX = Chicago Board Options Exchange Volatility Index. ### Scenario analysis using the IMF’s G20 Model (Box 1.6): two alternative scenarios relative to the June 2020 WEO Update baseline - Scenario 1: A Second Outbreak (early 2021) - Assumptions: - Second major global outbreak in early 2021 with domestic disruptions ~ half the size of 2020 baseline disruptions. - Tightening in international financial conditions about one-half of the increase in sovereign and corporate spreads seen since pandemic start; larger increases for emerging market economies. - Conventional monetary policy reacts endogenously where room exists to reduce policy rates (mainly in emerging market economies). - Unconventional policies not explicitly modeled but implicitly reflected in limited tightening in advanced economies. - Governments implement additional discretionary fiscal measures depending on fiscal space; overall spending response assumed about twice as strong as typical business cycle response in advanced economies. - Results (deviation from baseline): - Global trade declines by an additional 6 percent in 2021 compared with baseline. - Global GDP declines by about 5 percent compared with baseline in 2021 (as reported in the June 2020 WEO Update downside scenario). - Oil prices are higher by about 12 percent. - For emerging market economies (non-oil exporters): higher borrowing costs, lower oil prices, and subdued domestic demand raise current account balances toward surplus. - For net oil exporters: lower oil prices reduce current account balances. - For advanced economies: limited tightening in external financing conditions and greater fiscal policy space lead to less import compression and lower current account balances. - Net effect: uphill flow of capital from emerging market economies to advanced economies; little narrowing in overall global current account surpluses and deficits. - Scenario 2: A Faster Recovery (starting in second half of 2020) - Assumptions: - Faster recovery due to greater confidence in effective post-lockdown measures and less precautionary behavior. - Financial conditions loosen more than in baseline. - Discretionary fiscal measures in baseline are maintained; automatic stabilizers imply less fiscal support as supply recovers faster. - Results (deviation from baseline): - Global trade rises by an additional 4 percent in 2021 compared with baseline. - Oil prices are higher by 8 percent. - For emerging market economies: easing in global financial conditions and improved investor sentiment lower borrowing costs; combined with higher oil prices and rising domestic demand, current account balances move toward deficit. - For net oil exporters: higher oil prices raise current account balances. - For advanced economies: larger rise in government saving via automatic fiscal stabilizers implies current account balances rise modestly. - Caveats: - Considerable uncertainty surrounds simulations, including potential amplification from financial pressures during a second outbreak and sustained negative trade effects from global value chain disruptions not fully captured. ### Results illustrated (Figure 1.6.1; deviations from baseline) - World trade and oil price (percent deviations in 2021 and subsequent years shown in figure). - CA/GDP deviations by group (percentage points): - AE CA/GDP, EM CA/GDP (excluding oil exporters), Oil Exporters CA/GDP. - Panel in figure shows 2020 CA/GDP in baseline (percent) on x-axis and 5. Second Outbreak Scenario: CA/GDP in 2021 (percentage points) across country groups (Oil exporters, Deficit EMs, Deficit AEs, Surplus EMs, Surplus AEs) with world trade and oil price effects. *Source: IMF staff estimates.* --- _Source: https://www.imf.org/-/media/files/publications/esr/2020/english/ch1.pdf_