## _0599ch2pdf — Chapter excerpts (Boxes 1.1, 2.1, 2.2 and selected chapter material)

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### Brazil: sequence of events and immediate market reactions (Box 1.1)
- Market developments:
  - Spreads on Brazil’s external debt rose to about 1,000 basis points in December 1998.
  - Minas Gerais’s debt with the federal government then totaled $15 billion.
  - Net outflow of capital intensified to reach $1.2 billion on January 12.
- Policy actions and market effects:
  - Exchange rate band widened on January 13.
  - Currency allowed to float on January 15; subsequent official interest rate increases stemmed capital outflows.
  - Currency broadly stabilized at about R$2 until revised adjustment program in March; thereafter appreciated to R$1.7–R$1.8.
- Immediate budgetary impact of higher rates:
  - Selic increased from 30 percent to about 40 percent; estimated to have added about 1!/4percent of GDP to the budget deficit through March (excluding higher inflation effects).

### Determinants of likely recovery path for Brazil (Box 1.1)
- Four key factors:
  - Domestic imbalances contributing to precrisis current account deficits.
  - External environment at time of crisis.
  - Public and private sector internal and external debt.
  - Fragilities in the financial sector.
- Current account deficits in crisis countries ranged from around 4 percent of GDP in Brazil to almost 8 percent of GDP in Thailand.
- Saving-investment patterns:
  - Asian crisis countries: high investment and exceptionally high saving.
  - Mexico: buoyant private consumption and low private saving.
  - Brazil: growing fiscal imbalance appears at root of external current account deficit.
- Implications for recovery timing and shape:
  - Fiscal imbalances can in principle be addressed quickly but implementation delays are common; failure to act can prolong high interest rates and raise confidence costs.
  - Private-sector imbalances may respond quickly to policy and market signals (example: Mexico).
  - Financial-sector problems (notably in Asia) can prolong recessions.
- IMF staff projection for Brazil cited: contraction of about 3#/4 percent in 1999; some private forecasters expect larger output declines.

### Financial sector fragilities and implications for Brazil (Box 1.1)
- Comparative conditions:
  - Mexico: authorities intervened to prevent deposit runs and clean up bank balance sheets.
  - Asian crisis countries: deeper structural banking problems (foreign-currency borrowing without hedging, directed lending, low-return investments, currency exposure) requiring time-consuming restructuring and insolvency processes.
  - Brazil: recent reforms reduced the likelihood of long delays from banking-sector restructuring; level of financial intermediation is much lower.
- Recovery hinges on:
  - Speed of fiscal deficit correction.
  - Containment of inflation expectations.
  - Restoration of confidence to allow interest rates to be brought down.

### Russia: aftermath of August 1998 crisis (Box 1.1)
- Key empirical outcomes (late 1998 and 1998 totals):
  - Over last five months of 1998, consumer prices rose by more than 75 percent.
  - Ruble depreciated by more than 70 percent against the U.S. dollar.
  - 1998 real GDP fell by about 5 percent.
  - Real investment declined by close to 10 percent.
  - Foreign direct investment fell to $1.2 billion from $6.2 billion in 1997.
  - Federal government revenues fell to below 10 percent of GDP in 1998.
  - Federal government deficit amounted to 6 percent of GDP in 1998.
- Causes and policy consequences:
  - Persistent fiscal imbalances; structural weaknesses in enterprise and banking sectors.
  - De facto devaluation, payment moratorium on private external obligations, unilateral restructuring of government domestic currency debt.
  - Treasury bill market trading suspended; equity market collapsed; many banks had large net foreign currency liabilities.
  - Central bank credits to budget and banks intensified inflationary pressures after devaluation; tightening in January–February 1999 contributed to exchange rate stabilization and slower inflation.
  - Bank restructuring program announced October 1998 but progress slow; risk of large-scale ad hoc bailouts remains.
- IMF staff baseline scenario (selected figures):
  - Real GDP: 1997 actual 0.8; 1998 preliminary –4.8; 1999 baseline scenario –7.0.
  - Consumer prices, annual average: 1997 14.7; 1998 27.8; 1999 baseline 101.5.
  - Consumer prices, 12-month year-end: 1997 11.0; 1998 84.5; 1999 baseline 50.0.
  - Federal government fiscal balance (including noncash revenue and expenditure for 1997–98): 1997 –7.0 percent of GDP; 1998 –6.0 percent of GDP.
  - Revenue: 1997 12.0 percent of GDP; 1998 9.9 percent of GDP.
  - Expenditure: 1997 19.0 percent of GDP; 1998 15.9 percent of GDP.
  - Total exports, f.o.b.: 1997 $88.7 billion; 1998 $73.3 billion; 1999 baseline $74.0 billion.
  - Total imports, f.o.b.: 1997 $74.8 billion; 1998 $60.4 billion; 1999 baseline $47.5 billion.
  - Foreign direct investment: 1997 $6.2 billion; 1998 $1.2 billion; 1999 baseline $0.8 billion.
  - Stock of external government debt: 1997 $123.5 billion; 1998 $149.0 billion.
  - Exchange rate, rubles per U.S. dollar: 1997 5.8; 1998 9.7.
  - GDP in billions of U.S. dollars: 1997 $446.0; 1998 $329.0.
- Prospects and risks:
  - Russia risks protracted high inflation and prolonged recession unless fiscal and structural issues and crisis consequences are addressed.
  - Financial intermediation and borrowing prospects severely impaired; low precrisis financial intermediation limited some negative activity spillovers.

### Lessons on inflation control after devaluation (Box 1.1 conclusion)
- Comparative evidence:
  - Initial devaluations in Mexico, Korea, and Brazil were much larger than in Italy and the United Kingdom after ERM; within five weeks post-crisis the peso, won, and real depreciated over 50 percent relative to the dollar, while the Italian lira and pound sterling fell less than 20 percent.
  - Recoveries reflect state of domestic economy, credibility of policy response, and progress resolving macroeconomic and structural weaknesses including financial fragilities.
  - U.K. and Italy: weak precrisis demand limited price pass-through; 12-month inflation rates declined during the following year.
  - U.K.: official interest rates were reduced after abandoning ERM, aiding activity rebound because inflationary pressures from devaluation were perceived as limited.

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### Exchange Rate Crashes and Inflation: Lessons for Brazil (Box 2.1) — overview and implications
- Data/timing conventions:
  - Exchange and interest rates measured in weeks around crisis; price levels in months around crisis.
  - Week or month zero is the week or month prior to the devaluation.
  - Crisis dates: United Kingdom September 1992; Italy September 1992; Mexico December 1994; Korea December 1997; Brazil January 1999.
  - Exchange rates and price levels indexed to 100 for week zero and month zero; interest rates in percent.
- Immediate inflationary implications for Brazil:
  - Given a 60 percent initial rise in the price of foreign exchange and a 9 percent ratio of imports to GDP, the initial jump in the overall price level is roughly estimated at just over 5 percent.
  - Annualized monthly inflation could easily rise to the middle double digits in the near term with only moderate spillover to domestically produced prices.
  - If expectations extrapolate the initial jump into sustained inflation and continued depreciation, an inflation spiral could ensue—underscoring early establishment of credible monetary policy.
- Policy framework and tradeoffs:
  - Authorities announced intention in early February 1999 to introduce an inflation-targeting framework as the nominal anchor; goal of annualized monthly inflation in the middle single digits by year-end.
  - Central bank committed to keeping growth of net domestic assets within rates consistent with target inflation path and projected real GDP and overall balance of payments.
  - Credibility requires strong fiscal support; high nominal interest rates likely unavoidable for a period to ensure public debt refinancing and avoid liquidity injections that could fuel an inflation spiral.
  - Initial weeks after floating: nominal rates seemed not high enough given cancellation or reduction of some government debt auctions; after announcing inflation targeting and further short-term rate increases, refinancing difficulties eased.
  - Though nominal rates will be relatively high near term, real interest rates will have increased by less because inflation expectations rose.
  - Tight monetary conditions need not be prolonged if credibility is rapidly established and strong fiscal adjustment implemented; if private sector views price-level increase as one-time, nominal rates should begin to fall as exchange rate stabilizes.
- Structural and cyclical factors affecting pass-through in Brazil:
  - Weak activity prior to devaluation and Brazil’s low import share (8.6 percent average 1970–98) support resistance to inflationary buildup.
  - Main determinants of pass-through include output position relative to trend, extent of initial overvaluation, and initial rate of inflation.
  - Historical averages (1970–98 unless indicated):
    - Inflation: United Kingdom 8.0; Italy 9.6; Korea 9.6; Mexico 33.0; Brazil 180.1
    - Exchange rate depreciation (relative to U.S. dollar): United Kingdom 1.3; Italy 3.7; Korea 5.5; Mexico 26.6; Brazil 164.8
    - Import share of GDP: United Kingdom 26.5; Italy 20.4; Korea 33.1; Mexico 16.5; Brazil 8.6
    - GDP growth: United Kingdom 2.3; Italy 2.6; Korea 7.6; Mexico 4.1; Brazil 4.4
    - Current account balance to GDP: United Kingdom –0.5; Italy –0.1; Korea –1.1; Mexico –2.9; Brazil –2.4
    - Fiscal balance to GDP (consolidated general government; Italy average computed for 1977–98 and Brazil for 1980–98): United Kingdom –2.8; Italy –9.2; Korea –0.5; Mexico –5.9; Brazil –4.2
- Broader lessons and illustrative scenario for Russia:
  - To return inflation in Russia to the moderate range (low double digits) by next year a scenario would include strong fiscal adjustment limiting central bank credit to the budget, revenue-boosting and noninterest expenditure cuts, debt rescheduling, international financial support, and reinvigorated structural reform.
  - Priority structural measures for Russia:
    1. Establish hard budget constraints to tackle economy-wide nonpayment, starting with government and energy sector.
    2. Encourage industrial restructuring and exit of nonviable enterprises.
    3. Foster small and medium private enterprises and foreign participation (including revitalized privatization).
    4. Strengthen the legal system, including property rights.
  - Without early progress—especially correcting government revenue and payment arrears—sustained recovery is unlikely.

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### Underlying current account balances and global imbalances (selected chapter material)
- Key estimate:
  - Underlying current account deficit of the United States about 3.3 percent of GDP, which is 0.6 percent of GDP larger than the actual deficit in 1998.
- Selected country current account positions (percent of GDP; preserved exactly as in table excerpts):
  - United States: –1.9 (1997), –2.7 (1998), –3.5 (1999), –3.3 (2000)
  - Japan: 2.2 (1997), 3.2 (1998), 3.6 (1999), 3.4 (2000)
  - Korea: –1.8 (1997), 13.1 (1998), 7.1 (1999), 4.1 (2000)
  - Australia: –3.1 (1997), –5.0 (1998), –5.4 (1999), –5.0 (2000)
  - Singapore: 15.8 (1997), 20.9 (1998), 18.0 (1999), 17.7 (2000)
  - China: 3.3 (1997), 2.4 (1998), 1.7 (1999), 1.1 (2000)
  - Brazil: –4.1 (1997), –4.5 (1998), –3.0 (1999), –2.6 (2000)
  - India: –1.4 (1997), –1.7 (1998), –1.9 (1999), –2.2 (2000)
  - Thailand: –1.9 (1997), 12.2 (1998), 8.8 (1999), 5.5 (2000)
  - Russia: –1.3 (1997), 0.3 (1998), 8.4 (1999), 8.2 (2000)
  - Euro area (memorandum): 1.7 (1997), 1.4 (1998), 1.5 (1999), 1.6 (2000)
- Financial market reactions to Brazil’s devaluation:
  - Advanced economies: little impact on currency, equity, or other financial markets.
  - Emerging markets: bond spreads initially rose but fell back within a few days in most cases; Asia and transition countries saw muted, short-lived reactions.
  - Possible explanations: prior deleveraging after August 1998 Russian crisis and LTCM near-collapse; risk of Brazilian devaluation may have been partially discounted.
- ECB and interest rate developments:
  - ECB preannounced a narrow corridor between deposit and emergency lending rates at euro introduction; repo rate left unchanged at 3 percent through first quarter of 1999 and reduced to 2!/2 percent at April Governing Council meeting (reduction about !/4 of 1 percentage point more than assumed in baseline projections).
  - U.S. Federal Reserve had lowered target federal funds rate to 4#/4 percent and discount rate to 4!/2 percent in late November (policy interest rates in United States held unchanged since that move).

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### Financial markets, contagion, and Brazil’s market effects (selected chapter material)
- Brazil: band adjustment and float
  - Band adjusted on January 13 from 1.12–1.22 per U.S. dollar to 1.20–1.32 per U.S. dollar; immediate depreciation around 7!/2percent.
  - January 15 float led to further 16 percent depreciation.
  - After revised program and IMF approval, real firmed to around R$1.73 per U.S. dollar; total depreciation since January float about 40 percent.
- Interest rates and equity:
  - Brazil central bank raised prime lending rate for banks to 41 percent from 29 percent; overnight interbank (Selic) rate raised by 9 percentage points to 39 percent; on March 4 Selic increased from 39 percent to 45 percent; by early April Selic lowered to 39!/2percent.
  - Equity market initially weakened ~15 percent in early January; subsequently rallied by more than 50 percent (around 30 percent in dollar terms) after devaluation episode.
  - Bovespa index rebounded sharply, gaining more than 50 percent in dollar terms from its early March low.
- Regional contagion (selected impacts):
  - Latin America: short-term rates increased by up to 500 basis points in Argentina and Mexico in days after January 13; Argentinean, Mexican, and Venezuelan bond spreads widened ~200–300 basis points; equity prices dropped >10 percent in Argentina, >5 percent in Chile, Colombia, and Venezuela; currencies of Colombia, Ecuador, Mexico, and Peru depreciated but by no more than 5 percent versus the dollar.
  - Asia: stock prices fell by up to 8 percent in week after Brazil’s devaluation; sovereign spreads widened by up to 80 basis points in several countries; by end-January short-term rates resumed downward course and exchange rates near early-January levels.
  - Central and Eastern Europe: Polish zloty depreciated almost 5 percent against the euro in mid-January; equity prices fell 10–15 percent in Hungary and Poland then subsequently rebounded.
  - Russia: by early April ruble had lost around 80 percent of its value since August 1998 crisis; international reserves at a three-year low.
- Why some emerging markets were relatively unaffected:
  - China, India, and Africa generally weathered recent crises reasonably well due to limited trade links with crisis countries and relatively low reliance on private capital inflows.
  - China ran current account surpluses and maintained a de facto renminbi peg while supporting regional stability; India had exports ≈ 8 percent of GDP with only about 13 percent of exports to rest of Asia, reserves ≈ 6!/2 months of imports, and net private inflows averaging 1.5 percent of GDP in 1992–96; Africa benefited from structural reforms and a shift to longer-term official or guaranteed debt.

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### Commodity exporters — price declines, impacts, and adjustments (selected chapter material)
- 1998 commodity price declines:
  - Petroleum: 32 percent decline in average price in 1998 (largest drop since 1986).
  - Nonfuel commodities: 16 percent fall in price index in 1998 (largest decline since 1975).
- Drivers: weakened demand from Asian crisis countries and Japan; secular supply increases and technology improvements.
- Outlook: commodity prices expected to remain weak in 1999; slow recovery thereafter.
- Impacts on incomes and fiscal balances:
  - Oil-exporting African countries: ~30 percent decline in world oil prices in 1998 estimated to have reduced real income in oil-exporting African countries by an estimated 13 percent and worsened fiscal balances by about 6 to 7 percent of GDP.
  - Region as a whole: decline in export prices led to an estimated 2!/2percent decline in real income.
- Country examples and quantified impacts (selected entries from Table 2.12 and country notes):
  - Saudi Arabia: decline in value of oil exports in 1998 estimated about $20 billion, contributing to fiscal deficit of 10 percent of GDP projected to remain at this level in 1999.
  - Islamic Republic of Iran: external current account expected to deteriorate by 5 percent of GDP in 1998/99; financing gap about $2.8 billion in 1998/99 and about $1.6 billion projected for 1999/2000.
  - Algeria: external current account shifted into a deficit of 2 percent of GDP in 1998; international reserves could fall from $7 billion to $4 billion or less.
  - Nigeria: fiscal package for 1999 designed to reduce overall deficit to 8.4 percent of GDP.
  - Venezuela: oil revenues declined 30 percent, turning 1997 current account surplus of 6.8 percent of GDP into 1998 deficit of 1.6 percent of GDP.
- First-round sensitivity (selected Table 2.12 format):
  - Example entries (First-round impact of $1 per barrel decline in oil prices; impact of decline from 1997 to 1998 assuming no policy responses):
    - Algeria: –1.2; –1.0 | –7.8; –6.0
    - Iran, Islamic Rep. of: –0.9; –0.5 | –5.1; –3.0
    - Kuwait: –2.7; –2.7 | –16.2; –16.2
    - Oman: –2.2; –1.9 | –13.2; –11.4
    - Saudi Arabia: –2.1; –1.7 | –12.6; –10.2
    - United Arab Emirates: –1.6; –1.3 | –9.3; –7.9

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### U.S. saving-investment imbalance and scenarios (selected chapter material)
- Private sector saving-investment balance in the United States had deteriorated to a deficit of 5 percent of GDP (private net saving deficit).
- Factors behind household saving decline include buoyant equity markets, rising household net wealth, strong macroeconomic environment, low interest rates, and increased access to credit.
- Balance-sheet composition differs from late-1980s comparators: 1994–98 rise in U.S. net worth mainly from stock market wealth.
- Hard-landing illustrative scenario assumptions:
  - Household saving rate rises partly reflecting a 30 percent correction in U.S. equity prices.
  - Market corrections around 15 percent in other industrial countries.
  - International investors reduce holdings of dollar assets, resulting in a depreciation of the dollar of around 10 percent.
- Alternative scenario simulation results (percent deviation from baseline; shocks starting in 2000; selected entries):
  - World real GDP: –1.2, –0.8, –0.6, –0.3, –0.2 (First Year through Fifth Year).
  - United States real GDP: –1.9, –1.5, –0.8, –0.3, –0.5.
  - United States domestic demand: –3.3, –3.5, –3.1, –2.5, –2.3.
  - United States net private saving: 1.8, 2.3, 2.3, 2.1, 2.1.
  - United States current account (billions of U.S. dollars): 79.0, 173.0, 235.0, 280.0, 282.0.
  - Japan real GDP: –1.1, –0.8, –0.5, 0.1, 0.7.
  - Euro area real GDP: –1.2, –0.6, –0.4, –0.2, 0.1.
  - Developing countries real GDP: –0.8, –1.0, –1.2, –1.3, –1.2.

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### Measuring household saving in the United States (Box 2.2)
- Two measures:
  - NIPA personal saving rate (percent of personal disposable income).
  - FOFA personal saving rate (household acquisition of financial assets plus net investment in tangible assets less net increase in liabilities).
- Measurement issues:
  - Capital gains on equities excluded from NIPA income; taxes on capital gains included in tax payments; rising equity prices lower measured personal disposable income and measured NIPA saving rate.
  - FOFA includes durables purchases as saving; NIPA treats durables purchases as consumption.
  - Both measures exclude capital gains on equities; FOFA historically higher but trended down.
- Historical revisions to NIPA personal saving rate (Previously Published / Revised / Bias; percent of disposable personal income):
  - 1982: 9.1 / 9.0 / –0.1
  - 1983: 7.0 / 6.7 / –0.3
  - 1984: 8.7 / 8.6 / –0.1
  - 1985: 7.2 / 6.9 / –0.3
  - 1986: 6.5 / 5.9 / –0.6
  - 1987: 5.3 / 5.0 / –0.3
  - 1988: 5.5 / 5.4 / –0.1
  - 1989: 5.1 / 5.0 / –0.1
  - 1990: 5.3 / 5.1 / –0.2
  - 1991: 6.0 / 5.6 / –0.4
  - 1992: 6.2 / 5.7 / –0.5
  - 1993: 5.1 / 4.4 / –0.7
  - 1994: 4.2 / 3.5 / –0.7
  - 1995: 4.8 / 3.4 / –1.4
  - 1996: 4.3 / 2.9 / –1.4
  - 1997: 3.9 / 2.1 / –1.8
- Implications for macro scenarios:
  - Soft landing possible if interest rates need not rise much and households align spending with incomes.
  - Risks to inflation could force tighter policy and risk a harder landing.
  - Box presents scenario results (see Alternative scenario simulation results above) for global and major-region impacts if U.S. saving preference rises and equity prices decline.

*Italic: Source — Excerpts from IMF World Economic Outlook chapter material and Boxes 1.1, 2.1, and 2.2 as provided in the content unit (_0599ch2pdf).*

### Box  1.1  of  the  December  1998Interim  Assessment,

### Box 1.1 of the December 1998 Interim Assessment

### Brazil: sequence of events and immediate market reactions
- Following the announcement of the international rescue package in November 1998, financial pressures initially abated but increased again in December as resistance in Congress to social security reforms became apparent.
- Market responses in December:
  - Spreads on Brazil’s external debt rose to about 1,000 basis points.
  - The state of Minas Gerais sought to renegotiate payment terms of its debt with the federal government (then totaling $15 billion).
  - Net outflow of capital intensified to reach $1.2 billion on January 12.
- Policy responses:
  - The authorities widened the real’s exchange rate band on January 13.
  - When outflows continued, the authorities allowed the currency to float on January 15.
  - The floating of the real and subsequent increases in official interest rates stemmed capital outflows; the currency broadly stabilized at about R$2 until the revised adjustment program in March, after which the currency appreciated to R$1.7–R$1.8.

### Determinants of the likely recovery path for Brazil
- Four factors bearing on adjustment and recovery:
  - Domestic imbalances that contributed to precrisis current account deficits.
  - The external environment at the time of the crisis.
  - Public and private sector internal and external debt.
  - Fragilities in the financial sector.
- Current account deficits in the crisis countries discussed:
  - Ranged from around 4 percent of GDP in Brazil to almost 8 percent of GDP in Thailand.
- Differences in saving-investment patterns:
  - Asian crisis countries: high investment and exceptionally high saving rates.
  - Mexico: buoyant private consumption and low private saving.
  - Brazil: growing fiscal imbalance appears to be at the root of the external current account deficit.
- Implications for timing and shape of recovery:
  - Fiscal imbalances can, in principle, be addressed quickly but implementation delays are common and failure to act can lead to prolonged high interest rates and costly confidence restoration.
  - Private-sector imbalances may respond quickly to policy and market signals (example: Mexico’s high interest rates and peso depreciation led to rapid retrenchment in domestic demand and reduction in the current account deficit).
  - Asian countries face additional hurdles from financial sector problems that prolong recessions.
- External environment:
  - Mexico’s rapid recovery aided by strong external demand in the United States: exports to the United States represent about 25 percent of Mexican GDP and 85 percent of its total exports.
  - Asia’s deeper recessions partly reflected contraction in intraregional trade, including trade with Japan.
  - For Brazil, baseline forecasts incorporate some slowing of intraregional trade, but this is less important because the economy is more closed than those in Asia.

### Debt structure, interest rates, and budgetary impacts in Brazil
- Brazil’s large public debt:
  - Two-thirds of public debt indexed to the overnight interbank rate (Selic).
  - Increase in Selic from 30 percent to about 40 percent following the change in currency regime is estimated to have added about 1!/4percent of GDP to the budget deficit through March (not taking into account effects of higher inflation).
- Exchange rate effects on public debt:
  - Depreciation of the real increases the stock of external and dollar-indexed domestic debt in domestic currency terms.
  - If the real remains in a trading range of R$1.7 to R$1.8 against the U.S. dollar, public debt would increase by 6 percent to 7 percent of GDP relative to pre-float levels, adding significantly to budget outlays.
- Mitigating factors:
  - Successful stabilization is expected to result in declines in real interest rates and a partial reversal of the initial exchange rate depreciation, easing the debt-service burden on domestic and dollar-denominated debt.

### Financial sector fragilities and implications for recovery
- Banking sector condition comparisons:
  - Mexico: fragilities emerged but authorities stepped in to prevent deposit runs and clean up balance sheets, helping to prevent shutdown of domestic lending and the payments system.
  - Asian crisis countries: deeper, more structural banking problems due to borrowing in foreign currencies without hedging, directed lending, investment in low-return projects, and balance-sheet currency exposure; required bank restructuring and corporate insolvency processes that are time-consuming.
  - Brazil: less likely to face long delays from banking-sector restructuring because of recent reforms; banking sector and supporting institutions have undergone considerable reform; level of financial intermediation is much lower (legacy of high-inflation experience), reducing the banking sector’s role relative to Asian economies.
- Risk factors for Brazil’s recovery:
  - Pace of recovery depends crucially on the speed at which the government addresses the fiscal deficit, inflation expectations, and restoration of confidence to allow interest rates to be brought down.
  - IMF staff projection cited: a contraction of about 3#/4 percent in 1999; some private forecasters consider larger output declines more likely.

### Regional spillovers in Latin America
- Expected adverse effects of the Brazilian crisis on the rest of Latin America via:
  - Reduced Brazilian demand and activity.
  - Competitiveness effects of the real’s depreciation.
  - Tighter external financing constraints.
- Regional trade linkages:
  - Regional trade links among Latin American countries are generally less important than intraregional links in east Asia and Japan, reducing potential for large negative trade-based spillovers.
  - Argentina, Paraguay, and Uruguay (MERCOSUR partners) have the highest trade exposures to Brazil and are likely to be most affected.
  - Chile, Colombia, Ecuador, and Venezuela: direct trade links with Brazil are less important, but falling commodity prices have adversely affected external and fiscal balances and growth prospects.
  - Mexico: relatively unimportant economic links with Brazil, hence less affected.
- Financial spillovers:
  - Brazilian crisis has had only limited and short-lived direct effects on interest rates, equity prices, and exchange rates in other Latin American countries.
  - Crisis appears to have been a significant setback to normalization of financing conditions for emerging market economies, confronting these countries with the prospect of continued low levels of private capital inflows.

### Russia: aftermath of the August 1998 crisis and macroeconomic deterioration
- Key outcomes in late 1998:
  - Over the last five months of 1998, consumer prices rose by more than 75 percent.
  - The ruble depreciated by more than 70 percent against the U.S. dollar.
  - For 1998 as a whole:
    - Real GDP fell by about 5 percent.
    - Real investment declined by close to 10 percent.
    - Foreign direct investment fell to $1.2 billion from $6.2 billion in 1997.
  - Federal government revenues fell to below 10 percent of GDP in 1998.
  - Federal government deficit amounted to 6 percent of GDP in 1998.
- Root causes of the August 1998 crisis:
  - Persistent fiscal imbalances and structural weaknesses in enterprise and banking sectors.
  - Limited progress on underlying fiscal and structural problems despite stabilization programs from 1995.
  - Rapidly falling borrowing costs in domestic and international markets reduced incentives to correct fiscal imbalances.
  - Decline in oil and other commodity prices reduced tax revenues and prospective privatization receipts: oil and gas export revenues down by around 20 percent or $3.5 billion in the first seven months of 1998 (compared with the same period a year earlier), contributing to a swing of the external current account balance into deficit during this period.
- Policy and market consequences after August 1998:
  - De facto devaluation, payment moratorium on private sector external obligations, and unilateral restructuring of government domestic currency debt.
  - Ruble depreciated by around 70 percent against the U.S. dollar in a couple of weeks; monthly consumer price inflation accelerated to almost 40 percent in September from virtual price stability in the first half of the year.
  - Temporary moderation to 4!/2percent monthly inflation in October owing to administrative restrictions and slowed central bank liquidity creation; pressures reemerged from November with renewed central bank support to budget and banks.
  - Devaluation and unilateral restructuring had major implications:
    - Trading in the treasury bill market suspended (very limited operations resumed in early 1999).
    - Equity market lost most of its value and turnover declined sharply.
    - Banks suffered extensive losses and many had large net foreign currency liabilities.
    - Central bank assessment in October 1998: banks accounting for about one-third of total banking assets and deposits had no prospect of recovery; substantial public financial support needed for other banks, including some large banks for systemic reasons.
- Fiscal, structural, and monetary policy setbacks:
  - Since August, fiscal policy stance was loosened; implementation of revenue measures and expenditure cuts introduced in July 1998 anticrisis plan stalled.
  - Decline in federal government cash revenue in the second half of 1998 financed primarily by central bank credit and further buildup of budgetary arrears.
  - Setbacks in structural reform: obligations on oil companies to supply nonpaying domestic refineries; bankruptcy procedures de facto suspended; tariffs for energy and other utilities administratively frozen or reduced; price controls imposed at regional and municipal levels.
  - Monetary and financial market issues not fully addressed: significant central bank credits to the federal budget and banking sector in late 1998 intensified foreign exchange market and inflationary pressures unleashed by the August devaluation.
  - Tightening of monetary policy in January–February 1999 (central bank did not extend credit to the government) contributed to stabilization of the exchange rate and a slowdown in inflation during that period.
  - Bank restructuring program announced in October 1998 has been slow; no firm action yet against major insolvent banks; risk of large-scale and ad hoc bailouts remains.
- External creditor relations:
  - Payment moratorium and domestic debt restructuring alienated investors; foreign commercial banks’ repayment claims on Russian banks from mid-August to mid-November suspended by the moratorium.
  - Bilateral negotiations with creditors were initiated; in September 1998 Russia opened negotiations with an international investor committee to revise August restructuring terms.
  - In the absence of a full agreement, authorities unilaterally introduced new payment terms in February 1999.
  - Government announcement at the end of 1998 that it would be unable to meet its 1999 payment obligations on Soviet-era debt to London Club and Paris Club creditors further reduced scope for restoring access to international financial markets.
- Prospects and risks:
  - Russia faces the prospect of protracted high inflation and prolonged recession unless determined and coherent efforts are made to address unresolved fiscal and structural issues and the crisis’s negative consequences.
  - Financial intermediation and future borrowing prospects have suffered severely due to banking-sector collapse, reduced activity in securities markets, and drying up of the interbank market; low precrisis financial intermediation limited some negative repercussions on economic activity.
  - IMF staff baseline scenario table (selected figures):
    - Real GDP: 1997 actual 0.8; 1998 preliminary –4.8; 1999 baseline scenario –7.0.
    - Consumer prices, annual average: 1997 14.7; 1998 27.8; 1999 baseline 101.5.
    - Consumer prices, 12-month year-end: 1997 11.0; 1998 84.5; 1999 baseline 50.0.
    - Federal government fiscal balance (including noncash revenue and expenditure for 1997–98): 1997 –7.0 percent of GDP; 1998 –6.0 percent of GDP.
    - Revenue: 1997 12.0 percent of GDP; 1998 9.9 percent of GDP.
    - Expenditure: 1997 19.0 percent of GDP; 1998 15.9 percent of GDP.
    - Total exports, f.o.b.: 1997 $88.7 billion; 1998 $73.3 billion; 1999 baseline $74.0 billion.
    - Total imports, f.o.b.: 1997 $74.8 billion; 1998 $60.4 billion; 1999 baseline $47.5 billion.
    - Foreign direct investment: 1997 $6.2 billion; 1998 $1.2 billion; 1999 baseline $0.8 billion.
    - Stock of external government debt: 1997 $123.5 billion; 1998 $149.0 billion.
    - Exchange rate, rubles per U.S. dollar: 1997 5.8; 1998 9.7.
    - GDP in billions of U.S. dollars: 1997 $446.0; 1998 $329.0.

### Lessons on inflation control after devaluation (comparative experience)
- The box highlights lessons from Italy and the United Kingdom after the ERM crisis in 1992 and from Mexico after 1994–95 and Korea after 1997:
  - In Mexico, Korea, and Brazil the initial devaluation was much larger than in Italy and the United Kingdom after ERM; within five weeks post-crisis, the peso, won, and real depreciated over 50 percent relative to the dollar, while the Italian lira and pound sterling fell less than 20 percent.
  - Different recoveries reflect:
    - State of the domestic economy.
    - Credibility of policy response based on past experience.
    - Progress toward resolving underlying causes: macroeconomic imbalances, structural weaknesses, and financial fragilities such as large external debt-service requirements relative to reserves.
  - In the United Kingdom and Italy, weak precrisis demand limited price pass-through from devaluations; 12-month inflation rates declined during the following year.
  - U.K. official interest rates were reduced after abandoning the ERM constraint, helping rebound in economic activity; easing was possible because authorities correctly perceived limited inflationary pressures from devaluation.

*Source: Box 1.1 of the December 1998 Interim Assessment (pp. 8–9).*

### Box 2.1.Exchange Rate Crashes and Inflation: Lessons forBrazil

### Box 2.1.Exchange Rate Crashes and Inflation: Lessons for Brazil

### Overview
- Focus: lessons about containing inflation in the aftermath of a currency devaluation.
- Related discussion: see Box 2.3, “The Role of Monetary Policy in Responding to Currency Crises,” in the October 1998 World Economic Outlook, pp. 40–43.
- Further analysis: see Chapters II and III, and references therein, for a more extensive analysis of these crises.

### Data, timing, and measurement
- Exchange and interest rates are measured in weeks around the crisis; price levels are measured in months around the crisis.
- Week or month zero is, respectively, the week or month prior to the devaluation.
- Crises dates:
  - United Kingdom: September 1992
  - Italy: September 1992
  - Mexico: December 1994
  - Korea: December 1997
  - Brazil: January 1999
- Indexing and units:
  - Exchange rates and price levels are indexed to 100 for week zero and month zero, respectively.
  - Interest rates are in percent.

### Key implications for containing post-devaluation inflation
- The box emphasizes lessons for containing inflation after a currency devaluation, highlighting the role of monetary policy and trade-offs involved in monetary tightening to stabilize the exchange rate.
- For a more extensive treatment of the advantages and disadvantages of using monetary tightening to stabilize the exchange rate, refer to the cited Box 2.3 in the October 1998 World Economic Outlook.

*Source: _0599ch2pdf - Box 2.1.Exchange Rate Crashes and Inflation: Lessons forBrazil*

### Box 2.1 (concluded)

### Box 2.1 (concluded)

### Exchange rate crises: comparative experiences and implications for Brazil
- In the United Kingdom and Italy the exchange market crises reflected market sentiment that maintaining ERM pegs was incompatible with cyclical requirements; Italy faced higher interest rates as the lira depreciated amid stronger demand, backward-looking wage indexation, and wider fiscal imbalances.
- Korea and Mexico faced larger output losses because credibility was lost, initial currency depreciations were large, and external financing needs were immediate; official interest rates were raised substantially in both countries.
  - Korea: after about three months adjustment, inflation declined significantly, the external current account reversed sharply, depreciation was largely contained, and interest rates began to fall; traditionally low pass-through from exchange rate to inflation may have helped.
  - Mexico: annualized monthly inflation rates peaked at over 150 percent; a premature attempt to lower interest rates set off further depreciation, necessitating subsequently higher rates.
- For Brazil, long-run inflation experience matters for expectations and credibility:
  - Over 1970–98, inflation averaged under 10 percent in the United Kingdom, Italy, and Korea; over 30 percent in Mexico; and over 180 percent in Brazil. Differences in long-run inflation tended to be reflected in exchange rate changes.
  - Given Brazil’s historical hyperinflation and indexation mechanisms (wage indexation is not now permitted), reemergence of widespread indexation would risk renewed inflation inertia and make disinflation more difficult and costly.

### Immediate inflationary implications of Brazil’s depreciation
- The large depreciation of the real since mid-January suggests a significant direct impact on Brazil’s price level similar to Mexico and, to a lesser degree, Korea.
- The initial jump in the overall price level is roughly estimated to be just over 5 percent (given the 60 percent initial rise in the price of foreign exchange and the 9 percent ratio of imports to GDP).
- This implies annualized monthly inflation could easily rise to the middle double digits in the near term, even with only moderate spillover to prices of domestically produced goods and services.
- If the initial jump is extrapolated into expectations of sustained inflation and continued depreciation, an inflation spiral could ensue—underscoring the crucial importance of early establishment of a credible monetary policy to contain inflation expectations.

### Policy framework and near-term policy tradeoffs for Brazil
- Authorities announced intention in early February 1999 to introduce an inflation-targeting framework as the nominal anchor, with a goal of annualized monthly inflation in the middle single digits by the end of the year.
- While inflation targeting is being put in place, the central bank is committed to keeping the growth of net domestic assets within rates consistent with the target path of inflation and projected paths of real GDP and the overall balance of payments.
- To make the new framework credible:
  - Strong fiscal support will be required.
  - High nominal interest rates are likely unavoidable for a period, particularly to ensure refinancing of public sector debt; otherwise liquidity injections could fuel an inflation spiral.
- Initial weeks after floating the real: nominal interest rates seemed not high enough in view of cancellation or reduction of some government debt auctions; after announcing inflation targeting and further increases in short-term rates, refinancing difficulties eased.
- Although nominal rates will be relatively high near term, real interest rates will have increased by less because inflation expectations rose.
- Relatively tight monetary conditions need not be prolonged if the new monetary framework’s credibility is rapidly established and strong fiscal adjustment is implemented; if the private sector views the price-level increase as a one-time adjustment, nominal interest rates should begin to fall as the exchange rate stabilizes.
- Higher nominal interest rates will raise debt-servicing costs, but these will be less in real terms and represent a transitional problem preferable to an inflation spiral with substantial adverse effects on resource allocation, growth, and income distribution.

### Brazil’s structural and cyclical conditions affecting pass-through
- The weakness of activity prior to the devaluation and Brazil’s relatively low import share will both support efforts to resist buildup of inflationary pressures.
- The pass-through from exchange rate depreciation to inflation depends in part on the level of economic activity and prior inflation; findings indicate main determinants include output position relative to trend, extent of initial overvaluation, and initial rate of inflation.
- In Brazil, as in the United Kingdom and to some extent Italy, the economy had slowed prior to the devaluation; tight financial conditions in the year leading up to the crisis had caused inflation in Brazil to turn negative in late 1998.

### Selected macroeconomic characteristics (percent average for 1970–98 unless otherwise indicated)
- Inflation: United Kingdom 8.0; Italy 9.6; Korea 9.6; Mexico 33.0; Brazil 180.1
- Exchange rate depreciation (relative to the U.S. dollar): United Kingdom 1.3; Italy 3.7; Korea 5.5; Mexico 26.6; Brazil 164.8
- Import share of GDP: United Kingdom 26.5; Italy 20.4; Korea 33.1; Mexico 16.5; Brazil 8.6
- GDP growth: United Kingdom 2.3; Italy 2.6; Korea 7.6; Mexico 4.1; Brazil 4.4
- Current account balance to GDP: United Kingdom –0.5; Italy –0.1; Korea –1.1; Mexico –2.9; Brazil –2.4
- Fiscal balance to GDP (consolidated general government; Italy average computed for 1977–98 and Brazil for 1980–98): United Kingdom –2.8; Italy –9.2; Korea –0.5; Mexico –5.9; Brazil –4.2

### Broader lessons and related scenario for Russia (illustrative elements)
- Russia can draw encouragement from other crisis recoveries (e.g., Bulgaria) where disciplined fiscal stances and accelerated structural reforms reduced inflation and restored growth.
- A scenario to return inflation in Russia to the moderate range (low double digits) by next year would include:
  - Strong fiscal adjustment that limits the need for central bank credit to the budget and further accumulation of budget arrears.
  - A program that boosts revenue and cuts noninterest expenditure as a share of GDP, combined with debt rescheduling, to contain overall 1999 financing requirements.
  - International financial support to cover part of financing needs and reduce residual monetary financing.
  - Reinvigorated structural reform effort to restore sustainable growth.
- Priority structural measures for Russia:
  1. Tackle the economy-wide nonpayment problem by establishing hard budget constraints, beginning with the government and the energy sector.
  2. Reduce the claims of ailing large enterprises on scarce resources by encouraging industrial restructuring and the exit of nonviable enterprises.
  3. Foster development of small and medium-sized private enterprises and stimulate foreign participation and investment, including via revitalized privatization.
  4. Strengthen the legal system, including property rights.
- Without early progress on these reforms—especially correction of government revenue and payment arrears—sustained recovery in Russia is unlikely.

*Source: _0599ch2pdf - Box 2.1 (concluded)_*

### 1.3 percent of GDP, which is the estimated outcome of

### _0599ch2pdf - 1.3 percent of GDP, which is the estimated outcome of

### Underlying current account balances: key estimates and implications
- The implication, on net, of three adjustments together is that the underlying current account deficit of the United States is about 3.3 percent of GDP, which is 0.6 percent of GDP larger than the actual deficit in 1998.
- Japan’s underlying surplus is estimated to be only 0.2 percent of GDP below the 3.2 percent surplus recorded in 1998; the severity of its current recession, closing of output gaps abroad, and exchange rate effects that have not yet occurred are cited as factors that would tend to increase Japan’s underlying surplus.
- For the euro area, the estimated underlying balance is equal to its actual balance in 1998 and not significantly different from the balance projected for 2004.
- The estimated underlying current account deficits for Australia and New Zealand are smaller than the actual deficits in 1998, largely reflecting the impact of lagged exchange rate effects; the text notes that standard trade elasticities may overstate the effects of recent depreciations if those depreciations reflect weakened terms of trade from depressed commodity prices.
- These estimates suggest that, even after adjusting for business cycle asymmetries, the Asian crisis, and lagged exchange rate effects, underlying current account positions of a number of advanced economies are of a magnitude that could result in growing stocks of external liabilities or assets in relation to GDP.
- The WEO baseline projections confirm a tendency toward growing imbalances over the next five years (Figure 2.4 referenced).

### Interpretation of sustainability and roles of exchange rates, saving, and demographics
- Estimates of underlying current account balances do not take into account possible future changes in exchange rates or in domestic saving and investment.
- The current pattern of deficits and surpluses could be reversed over time by a depreciation of the U.S. dollar relative to the euro and the yen, with accompanying adjustments in relative growth rates of domestic demand.
- Reduction in current account imbalances could be accompanied—or triggered—by changes in domestic saving and investment rates because the balance of domestic saving over investment must be identical to the external balance.
- Thus today’s current account imbalances could be consistent with a sustainable long-run path provided that changes in domestic saving and investment are expected in the future.
- Demographic factors, including the more rapidly aging populations of Japan and most of Europe, imply that saving rates in these regions will eventually decline relative to the United States, which will tend to reduce current account imbalances slowly over time.
- The text cautions that, in practice, external imbalances are often corrected through abrupt shifts in saving and investment associated with cyclical fluctuations and changes in financial conditions.
- The implications of the current saving-investment imbalance in the United States are noted as discussed at the end of the chapter.

### Trade developments and regional balances
- The east Asian crisis and declines in commodity prices led to substantial shifts in trade balances in 1996–98; the crisis in Brazil will contribute to adjustments in 1999 (Figure 2.2 referenced).
- In the Asian-5 economies, the surplus in merchandise trade has stabilized as the reduction in imports has come to an end (Figure 2.3 referenced). The Asian-5 economies are Korea, Indonesia, Malaysia, the Philippines, and Thailand.
- Table 2.6 (Selected Economies: Current Account Positions, Percent of GDP) lists many country-level current account numbers. Examples preserved exactly as presented:
  - United States: –1.9 (1997), –2.7 (1998), –3.5 (1999), –3.3 (2000)
  - Japan: 2.2 (1997), 3.2 (1998), 3.6 (1999), 3.4 (2000)
  - Korea: –1.8 (1997), 13.1 (1998), 7.1 (1999), 4.1 (2000)
  - Australia: –3.1 (1997), –5.0 (1998), –5.4 (1999), –5.0 (2000)
  - Singapore: 15.8 (1997), 20.9 (1998), 18.0 (1999), 17.7 (2000)
  - China: 3.3 (1997), 2.4 (1998), 1.7 (1999), 1.1 (2000)
  - Brazil: –4.1 (1997), –4.5 (1998), –3.0 (1999), –2.6 (2000)
  - India: –1.4 (1997), –1.7 (1998), –1.9 (1999), –2.2 (2000)
  - Thailand: –1.9 (1997), 12.2 (1998), 8.8 (1999), 5.5 (2000)
  - Russia: –1.3 (1997), 0.3 (1998), 8.4 (1999), 8.2 (2000)
- Memorandum entries include Euro area: 1.7 (1997), 1.4 (1998), 1.5 (1999), 1.6 (2000).

### Financial markets: Brazil’s devaluation and global spillovers
- The fallout in global financial markets from the crisis in Brazil has been much less intense and widespread than that observed following the crises in Mexico, Asia, and Russia.
- In the advanced economies, there has been little impact on currency, equity, or other financial markets.
- In emerging market economies, bond spreads initially rose but fell back in most cases within a few days of Brazil’s devaluation, albeit still to relatively high levels.
- In Asia and the transition countries of central and eastern Europe, exchange and equity market reactions have been muted and short-lived.
- Possible explanations for limited spillovers include that investors may already have deleveraged much of their exposure to emerging markets following the August 1998 Russian crisis and the near-bankruptcy of Long-Term Capital Management, and that the risk of a Brazilian devaluation may already have been discounted to a large extent.

### European Central Bank, euro introduction, and interest rate developments
- On January 4, 1999 European financial markets opened with the introduction of the euro; the transition went smoothly with minor payment and liquidity difficulties quickly resolved.
- The European Central Bank (ECB) preannounced a narrow corridor between its deposit and emergency lending rates to help banks manage liquidity during the transition period.
- On January 22, the ECB widened the interest rate band by raising its lending rate and lowering its deposit rate to encourage market participants to manage liquidity more effectively.
- The ECB’s main policy interest rate, the repo rate, was left unchanged at 3 percent through the first quarter of 1999, and was reduced to 2!/2 percent at the April meeting of the Governing Council. The reduction was about !/4 of 1 percentage point more than assumed in the baseline projections.
- Elsewhere among industrial countries, policy interest rates have been held unchanged in the United States since the Federal Reserve lowered the target federal funds rate to 4#/4 percent and the discount rate to 4!/2 percent in late November.
- In a number of other countries, central banks have acted to lower short-term interest rates. In mid-February, the Bank of Japan lowered the target overnight call rate from 0.25 percent (where it had been set in September 1998) to [text ends at this point].

*Italic source attribution: IMF chapter excerpt from _0599ch2pdf - 1.3 percent of GDP, which is the estimated outcome of (extracted content).*

### 0.15 percent and indicated that it would seek to reduce

### _0599ch2pdf - 0.15 percent and indicated that it would seek to reduce

### Monetary policy and short-term interest rates
- Japan: overnight call rate fell virtually to zero by early March; Bank of Japan eased policy after earlier tightening signaled by increases in longer-term interest rates and yen appreciation.
- United Kingdom: Bank of England lowered its repo rate in a series of steps reaching 5!/4percent in April, 2!/4percentage points below the peak between June and October 1998.
- Since the beginning of 1999, short-term interest rates were cut in Canada, Denmark, Norway, Sweden, and Switzerland.
- Brazil: central bank raised prime lending rate for banks to 41 percent from 29 percent; overnight interbank (Selic) rate raised by 9 percentage points to 39 percent; on March 4 Selic increased from 39 percent to 45 percent; by early April Selic lowered to 39!/2percent.

### Long-term interest rates and corporate spreads
- United States: long-term interest rates rose by about 60 basis points between end-1998 and early April (on top of earlier rises from 30-year lows in early October 1998); yields peaked but tended to ease toward end of period on signs of strong growth and little inflation.
- Euro area core countries: long-term rates rose by about 15 basis points between end-1998 and early April; intra-area yield spreads widened somewhat.
- Japan: long-term rates fell by about 40 basis points between end-1998 and early April; bond yields rose from unprecedented lows of around 0.7 percent in October 1998 to close to 2.4 percent in early February, then fell back to about 1.6 percent as monetary policy eased.
- Corporate yield spreads continued to narrow as financial conditions improved but remained above early 1998 levels, indicating continuing heightened aversion to risk.

### Equity markets
- United States: price indices reached new record highs in early April, more than 5 percent above end-1998 levels.
- Many industrial country equity markets recovered to or above pre-August–October 1998 dip levels; Japanese market recovered significantly since mid-1998 but had not uniformly surpassed earlier highs.

### Foreign exchange developments
- U.S. dollar: appreciated in terms of most other major international currencies since end-1998, reflecting relatively buoyant U.S. growth and widening interest differentials.
- Euro: initially strengthened against the dollar in its first few days, then depreciated to a level in early April that was 8percent below its initial value in terms of the dollar and 5 percent lower in effective terms.
- Yen: reached ¥109 per dollar in mid-January (about 25 percent above its August trough), fell back to around ¥115 per dollar in late January/early February, then fell further to about ¥120 per dollar after Bank of Japan eased policy; effective value about 2 percent lower than at the beginning of the year.
- Pound sterling: moderately depreciated against the U.S. dollar between end-1998 and early April, but appreciated by about 3 percent in effective terms over the period.

### Brazil: devaluation, policy response, and market effects
- Exchange rate band adjustment on January 13: from 1.12–1.22 per U.S. dollar to 1.20–1.32 per U.S. dollar; immediate depreciation around 7!/2percent to the weaker end.
- January 15: currency allowed to float and depreciated a further 16 percent.
- Equity market: initially weakened by around 15 percent in early January; subsequently rallied by more than 50 percent (around 30 percent in dollar terms) after devaluation episode.
- International bond spreads: secondary market spreads widened; net capital outflows continued after initial devaluation.
- By middle of February: currency and equity market broadly stabilized but remained volatile.
- After revised economic program and IMF approval: real firmed to around R$1.73 per U.S. dollar, reducing depreciation since January float to around 40 percent.
- Inflation pass-through: recent data indicated only a moderate pass-through of currency depreciation to prices.
- Bovespa equity index: rebounded sharply, gaining more than 50 percent in dollar terms from its early March low.

### Contagion and effects across Latin America, Asia, and Eastern Europe
- Latin America (immediate aftermath of Brazil’s devaluation):
  - Short-term interest rates increased by up to 500 basis points in Argentina and Mexico in days after January 13.
  - Spreads on Argentinean, Mexican, and Venezuelan international bonds widened by around 200–300 basis points.
  - Equity prices dropped by more than 10 percent in Argentina, and by more than 5 percent in Chile, Colombia, and Venezuela.
  - Currencies of Colombia, Ecuador, Mexico, and Peru depreciated but by no more than 5 percent versus the dollar in the period.
  - Markets generally stabilized by second half of January; by early April markets in Chile and Mexico had returned close to year-earlier levels.
- Asia:
  - Following Brazil’s devaluation, stock prices fell by up to 8 percent in the week after, short-term interest rates rose, and currencies depreciated moderately in many economies.
  - Sovereign bond spreads widened by up to 80 basis points in several countries—less than in prior volatility episodes.
  - By end-January, short-term rates resumed downward course and exchange rates were near early-January levels in most countries; by early April stock prices had rebounded but not to pre-1997 crisis levels.
  - Indonesia: rupiah weakened throughout January due to social unrest, political concerns, and uncertainties about financial/corporate restructuring.
- Central and Eastern Europe:
  - Polish zloty depreciated almost 5 percent against the euro in mid-January; equity prices fell 10–15 percent in Hungary and Poland during same period; subsequently rebounded.
  - Hungary issued a ten-year euro-denominated Eurobond at a spread of only 87 basis points above the German Bund rate at end-January.
  - February currency weakness in Czech Republic and Poland reflected domestic developments including sizable cuts in official interest rates and rising current account deficits; currencies stabilized in March and early April.
- Russia and other transition countries:
  - Domestic treasury bill market reopened mid-January after five-month shutdown; market activity low due to yield limit and nonparticipation by foreign investors.
  - By early April, ruble had lost around 80 percent of its value since August 1998 crisis; international reserves at a three-year low.
  - Market value of Russia’s external debt reflected anticipated negotiations on rescheduling Soviet-era debt and concerns about servicing Russia-era Eurobonds.
  - Kazakhstan, Moldova, and Ukraine had no access to foreign markets since Russian crisis; Kazakh currency depreciated sharply in early April after announcement of refraining from intervention.

### Why some emerging markets were relatively unaffected
- China, India, and Africa generally weathered recent financial crises reasonably well; notable exception: several African countries hit hard by falling commodity prices.
- Factors for resilience:
  - Limited trade links with crisis countries and relatively low reliance on private capital inflows (Table 2.8).
  - China recorded current account surpluses; India and many African countries did not exhibit large current account deficits typical of crisis countries.
  - China maintained de facto peg of renminbi to the dollar and supported Asian stability; implemented policy stimulus including interest rate reductions and increased public investment since mid-1998.
  - India: exports ≈ 8 percent of GDP; only about 13 percent of exports directed to rest of Asia (excluding Japan); net inflows of private capital during 1992–96 averaged 1.5 percent of GDP (compared with 8.8 percent in Thailand, 10.5 percent in Malaysia, 4.8 percent in Indonesia); foreign exchange reserves remained at equivalent of 6!/2 months of imports; Resurgent India Bonds issue of $4.2 billion to nonresident Indians in late 1998 helped cushion impact.
  - Africa: structural reforms, improved fiscal control, and a shift in debt structure toward longer-term official or government-guaranteed debt reduced vulnerability to swings in interest rates and short-term capital flows; reduced government spending ratio from 30 percent in 1992 to 28 percent in 1998; average fiscal deficit in region fell to 3#/4percent in 1998 from nearly 6 percent in 1992.

### Commodity prices and impacts on commodity exporters
- 1998 commodity price declines:
  - Petroleum: 32 percent decline in average price in 1998 (largest drop since 1986).
  - Nonfuel commodities: 16 percent fall in price index in 1998 (largest decline since 1975).
- Key drivers: weakened demand from Asian crisis countries and Japan; output decline in Japan (e.g., petroleum consumption fell by 3 percent in Japan and by 15 percent in Korea); sharp curtailment of infrastructure investment reduced demand for copper, aluminum, and other commodities.
- Econometric assessment: decline in activity in Asian crisis countries and Japan in 1997–98 can account for most of decline in oil and nonfuel commodity prices in those years.
- Secular factors also contributing to trend declines: gradual increase in global supplies, less robust demand growth in advanced countries, advances in technology lowering production costs, increased privatization and market liberalization encouraging investment and adoption of new technology.
- Outlook: overall weakness of commodity prices expected to continue in 1999 because of further unfavorable demand conditions, large supplies, and rising inventories; demand from Asia expected to stay subdued as Asian crisis countries begin to recover and Japan remains weak.
- Impact on Africa:
  - Approximately 30 percent decline in world oil prices in 1998 estimated to have reduced real income in oil-exporting African countries by an estimated 13 percent and worsened fiscal balances by about 6 to 7 percent of GDP.
  - For the region as a whole, decline in export prices led to an estimated 2!/2percent decline in real income; reduction absorbed in part by fall in real consumption and part by reduction in saving, with negative effects on domestic demand and investment.

*Italic: Source — IMF staff analysis from _0599ch2pdf (chapter content).*

### 1998. On the other hand, the production cutbacks an-

### How Are Commodity Exporters Adjusting to the Crisis?

### Commodity price developments and outlook
- Production cutbacks announced in March 1999 have recently supported the level of global oil prices, although there remains uncertainty on their longer-term effectiveness.
- Prices for food and agricultural commodities are expected to reflect, in addition to weak demand outside Europe and the United States, some commodity-specific factors:
  - Wheat prices are forecast to remain broadly unchanged in 1999 because EU and U.S. food aid to Russia is expected to sustain demand and because supply conditions are expected to stabilize following the large supply response to the high prices of 1995 and 1996.
  - Sugar prices are likely to fall further owing to large stocks and a steady flow of exports from Brazil.
- Beyond 1999, commodity prices are forecast to recover, depending on the strength of the global business cycle upturn, but the recovery is expected to be slow; a full rebound from current low levels should not be anticipated, even after the east Asian crisis and the recession in Japan have ended, owing to the secular increase in supplies.
- Prices of oil and nonfuel commodities have declined further in 1998, in both nominal (U.S. dollar) and real terms (Figure 2.14). The declines in the prices of petroleum and nonfuel commodities, including metals, in 1997–98 are related to the slowdown in world industrial production (Figure 2.15).

### Terms of trade, real income effects, and distributional impacts
- The changes in commodity prices have resulted in sharp terms of trade changes and a redistribution of world income from oil-exporting countries, in particular, to countries that are net commodity importers (most industrial countries).
- Table 2.11: Impact on terms of trade and on real income (as reported)
  - Percent change in terms of trade:
    - Oil exporters: 144.6, 30.4, 39.9, –48.8, –1.0, –18.0 (for years 1974, 1979, 1980, 1986, 1997, 1998 respectively)
    - Nonfuel primary commodity exporters: . . . . . . . . . –3.8, –0.5, –3.2 (for 1997, 1998 entries shown)
    - Net primary commodity importers: –11.7, –3.4, –7.5, 8.9, –0.3, 1.8 (for 1974, 1979, 1980, 1986, 1997, 1998 respectively)
  - Change in real income (percent of GDP):
    - Oil exporters: 65.3, 15.9, 24.1, –15.0, –0.8, –6.3 (for 1974, 1979, 1980, 1986, 1997, 1998 respectively)
    - Nonfuel primary commodity exporters: . . . . . . . . . –0.5— –0.5
    - Net primary commodity importers: –2.1, –0.6, –1.6, 1.3, –0.1, 0.3 (for 1974, 1979, 1980, 1986, 1997, 1998 respectively)
  - Note: Change in the nominal trade balance owing to changes in export and import prices, as percent of GDP.
- In 1998:
  - Oil exporters clearly suffered a large loss in their terms of trade, which led to a strong negative real income effect.
  - Primary commodity exporters experienced moderate deterioration in terms of trade because reductions in their export prices were largely offset by the decline in oil prices; the impact on their real income was moderate.
  - Net importers of oil and primary commodities clearly gained from the changes in commodity prices.

### Country-specific impacts and adjustments
- General:
  - With current account and fiscal positions of a significant number of countries, in the Middle East and sub-Saharan Africa in particular, heavily dependent upon commodity price developments, the price declines since 1997 have had a major impact.
  - The export revenue shortfall has often been met by drawing down official reserves and increased external borrowing, though access to international borrowing has been constrained by financial market conditions. Protracted low commodity prices will force substantial fiscal adjustments; such adjustments were, at the time of writing, only in a preliminary stage.
  - Countries that have relied on reserves and external borrowing need to begin to reduce domestic absorption given low projected commodity prices in 1999 and slow recovery thereafter.

- Saudi Arabia:
  - The decline in the value of oil exports in 1998 is estimated to be about $20 billion, contributing to a fiscal deficit of 10 percent of GDP, which is projected to remain at this level in 1999 (Table 2.12).
  - Some decline in oil revenues has been offset through borrowing and a drawdown of official assets; the oil price decline prompted the government to implement fiscal adjustment measures.

- Islamic Republic of Iran:
  - External current account is expected to deteriorate by 5 percent of GDP in 1998/99.
  - The government financed deterioration through reserves and external borrowing, but a financing gap of about $2.8 billion remains in 1998/99, and a gap of about $1.6 billion is projected for 1999/2000.
  - Authorities intend to tighten fiscal policies and target a balanced budget in 1999/2000, down from a deficit of 3.5 percent of GDP in 1998/99.
  - Authorities allowed a 24 percent depreciation of the market-based exchange rate since March 1998 and intend to permit further downward flexibility.

- Algeria:
  - Fall in oil revenues partially offset by increased sales of gas, but the external current account shifted into a deficit of 2 percent of GDP in 1998.
  - With minimal adjustment in domestic absorption to date, international reserves could fall from $7 billion to $4 billion or less, about 4 months of import cover.

- Nigeria (sub-Saharan Africa):
  - Decline in oil revenues aggravated by an expansionary 1998 budget and increased expenditures (including a large boost in civil service pay).
  - Authorities introduced adjustment measures: cutting nonessential capital spending, raising domestic petroleum prices, restarting privatization, unifying the exchange rate at market-based levels, and halving the pay increase.
  - The fiscal package adopted for 1999, supported by an IMF staff-monitored program, is designed to offset a further projected decline in oil revenues and to reduce the overall deficit to 8.4 percent of GDP.

- Venezuela (Latin America):
  - Oil revenues declined 30 percent, transforming a current account surplus of 6.8 percent of GDP in 1997 into a 1.6 percent deficit in 1998.
  - The deficit was largely financed by drawing down reserves due to tight external finance; low oil prices forced budget revisions and public spending cuts.

- Ecuador and Mexico:
  - More diversified and less dependent on oil than Venezuela, but the fall in oil prices contributed to deterioration of external and fiscal balances; authorities reduced oil sector operations because of lack of funds.

- Chile and Peru (metals exporters):
  - Chile: Decline in copper prices resulted in widening of the trade deficit; monetary tightening reduced import growth and helped restore reserves; modest growth in export volume expected for 1999 as major new copper mines come on line.
  - Peru: More diversified exporter; decline in export prices largely offset by increased receipts from agricultural and fish exports.
  - Zambia (Africa): Severe impact from drop in metals prices; main exports are copper and cobalt.

- Advanced economies with significant commodity exports:
  - Canada:
    - Generates about one-third of export earnings from natural resources.
    - Price declines (lumber, petroleum, metals) contributed to strong downward pressure on the currency and a swing in the current account from a surplus of 1/2 of 1 percent of GDP in 1996 to a deficit of 2 percent of GDP in 1998.
  - Norway:
    - Almost 30 percent drop in value of oil and gas exports led to weakening of the currency in 1998 and a deterioration in the current account from a surplus of about 5 percent of GDP in 1997 to a 1 percent deficit in 1998.
    - Fall in oil and gas export revenues reflected lower oil prices and reduced export volumes due to supply-reduction efforts; authorities indicated oil production and investment in oil projects are being scaled down.
  - Australia:
    - Strong marketing efforts and redirection of exports outside Asia left value of commodity exports broadly unchanged; robust domestic demand and weak noncommodity export revenues led to widening current account deficit from 3 percent of GDP in 1997 to 5 percent of GDP in 1998.
  - United Kingdom:
    - Relatively low contribution of net oil exports (estimated at around 1/2 of 1 percent of GDP between 1995 and 1997) contained the impact of oil price drop; oil prices ceased to be a key determinant of movements in the exchange rate.

### Fiscal and reserve responses; need for absorption reduction
- Many commodity exporters met export revenue shortfalls by drawing down official reserves and increasing external borrowing, but these are short-term solutions.
- A protracted period of low commodity prices will force substantial fiscal adjustments; countries that have relied on reserves and borrowing need to begin reducing domestic absorption.

### Quantified impacts on oil-exporting emerging market economies (Table 2.12)
- Table 2.12 reports:
  - First-round impact of $1 per barrel decline in oil prices (percent of GDP) and impact of decline from 1997 to 1998 (assuming no policy responses; average world oil price declined from $19.3 a barrel in 1997 to $13.1 a barrel in 1998).
  - Entries (Net export earnings; Budgetary receipts):
    - Algeria: –1.2; –1.0 | –7.8; –6.0
    - Bahrain: –0.3; –0.1 | –1.8; –0.6
    - Iran, Islamic Rep. of: –0.9; –0.5 | –5.1; –3.0
    - Kuwait: –2.7; –2.7 | –16.2; –16.2
    - Oman: –2.2; –1.9 | –13.2; –11.4
    - Saudi Arabia: –2.1; –1.7 | –12.6; –10.2
    - United Arab Emirates: –1.6; –1.3 | –9.3; –7.9

### Implications of the U.S. saving-investment imbalance (connection to commodity effects and global outlook)
- The private sector saving-investment balance in the United States had deteriorated to a deficit of 5 percent of GDP, and was projected to remain in this neighborhood in the medium term (Figure 2.16).
- National saving increased in 1993–98 owing to a 5 percent of GDP improvement in the public sector balance, but a private net saving deficit of this magnitude is unprecedented in the U.S. postwar data and suggests a potential risk of correction through a drop in demand.
- Historical parallels: Japan, Finland, Sweden, and the United Kingdom experienced declines in net private saving in the 1980s, with corrections followed by sharp increases in net saving rates and significant recessions.
- Factors behind the U.S. household saving decline:
  - Recent drop in U.S. household saving rate (fell below zero in October and December 1998) reflects buoyant equity markets, impact on household net wealth, strong macroeconomic environment, rising employment and incomes, low interest rates, falling commodity prices, and availability of low-cost consumer goods through imports.
  - Longer-term trend decline in household saving since the early 1980s facilitated by financial deregulation and increased access to credit; shrinking federal budget deficit since 1993 may have boosted expectations of future after-tax income and encouraged higher current spending.
- Balance-sheet composition differences versus past crises:
  - In the late 1980s comparator countries, increases in household net assets mainly from housing prices (home equity accounted for between 65 percent and 90 percent of net wealth gains).
  - In the United States (1994–98), much of the rise in net worth reflects stock market wealth (Figure 2.17), implying consumption may be less sensitive to equity corrections than to housing corrections, though a larger equity decline could still meaningfully reduce spending.
- Household liabilities:
  - Consumer debt as a percent of household income has risen steadily since 1984 (Figure 2.18); debt-service payments show no clear trend but are at the previous peak reached in 1989–90, indicating vulnerability to interest rate increases or job loss.
- Private investment:
  - Rapid growth in private investment in the United States contributed to the decline in private net saving; the ratio of private investment to GDP (current prices) rose from 12 1/4 percent to over 16 percent in 1992–98.
  - Measured in real terms, the ratio of investment to GDP is now above the historical average, but scant signs of overcapacity or overbuilding make it difficult to argue that an adjustment would originate from a fall in investment.
- Corporate balance sheets:
  - Nonfinancial firms have taken on more debt but debt-to-equity ratios have not risen significantly; increased complexity of financial instruments and off-balance-sheet operations increases uncertainty about vulnerability to spending drops or interest rate rises.
- Policy context and implications:
  - In past episodes, monetary accommodation helped sustain declines in net private saving, later followed by monetary tightening that precipitated asset price corrections and recessions.
  - In the United States in the late 1990s:
    - Fiscal consolidation had strengthened national saving and dampened demand; expected fiscal surpluses offered room for countercyclical policy if activity weakens.
    - Low inflation provided a different monetary policy environment compared with past episodes.

*Source: Excerpt from the IMF chapter provided in the content unit.*

### Box 2.2.Measuring Household Saving in the United States

### Box 2.2.Measuring Household Saving in the United States

### Measures of U.S. household saving
- Two commonly used measures:
  - NIPA (National Income and Product Accounts) personal saving rate (percent of personal disposable income).
  - FOFA (Flow of Funds Accounts) personal saving rate, based on household acquisition of financial assets plus net investment in tangible assets less net increase in liabilities.
- Charted behavior (percent of personal disposable income) shows both measures trending downward since the 1980s.
- Source: Haver Analytics database.

### Key measurement issues and contributing factors to low measured personal saving
- Capital gains on equities are excluded from NIPA income, but taxes on capital gains are included in tax payments; this lowers personal disposable income and hence the NIPA household saving rate.
- With rising equity prices, households shifted saving away from interest-bearing assets toward equities, which lowers measured personal disposable income.
- Both NIPA and FOFA exclude capital gains on equities from saving measures; therefore increases in household net wealth from equity value rises are not captured by either measure.
- Result: the sharp rise in household wealth has allowed consumer spending to outpace disposable income, driving down both the NIPA and FOFA measures of saving.
- Household survey-based saving estimates exist but suffer from problematic quality and sampling error.

### Differences between NIPA and FOFA saving measures
- FOFA includes the purchase of durables as part of household saving; NIPA treats the purchase of durables as pure consumption and records only depreciation (services from durables) as consumption over time.
- FOFA includes acquisition of net financial assets but does not include changes in valuation of these assets; thus capital gains on equity are excluded in both measures.
- As a consequence of methodology differences, FOFA saving rate has been higher historically but has trended down since the 1980s—declining from about 14 percent in 1990 to about 6 percent in 1998.
- NIPA saving rate has fallen from about 9 percent in 1982 to about 0.5 percent in 1998, including two months of negative saving in late 1998.

### Revisions to the NIPA personal saving rate
- Table: Previously Published / Revised / Bias (Percent of disposable personal income)
  - 1982: 9.1 / 9.0 / –0.1
  - 1983: 7.0 / 6.7 / –0.3
  - 1984: 8.7 / 8.6 / –0.1
  - 1985: 7.2 / 6.9 / –0.3
  - 1986: 6.5 / 5.9 / –0.6
  - 1987: 5.3 / 5.0 / –0.3
  - 1988: 5.5 / 5.4 / –0.1
  - 1989: 5.1 / 5.0 / –0.1
  - 1990: 5.3 / 5.1 / –0.2
  - 1991: 6.0 / 5.6 / –0.4
  - 1992: 6.2 / 5.7 / –0.5
  - 1993: 5.1 / 4.4 / –0.7
  - 1994: 4.2 / 3.5 / –0.7
  - 1995: 4.8 / 3.4 / –1.4
  - 1996: 4.3 / 2.9 / –1.4
  - 1997: 3.9 / 2.1 / –1.8
- Source: U.S. Department of Commerce, Survey of Current Business, August 1998, p. 30.

### Implications for macroeconomic scenarios (soft landing vs. hard landing)
- Soft landing possibility: interest rates may not need to be raised — or at least not as much as in the late 1980s in comparator countries — allowing the U.S. economy to cool gradually as households align spending with incomes.
- Risks to inflation that could force tighter policy (and risk a harder landing):
  - Reversal of recent moderation in employment cost increases.
  - Slowing productivity increases typical near the top of the cycle.
  - Diminishing or reversal of temporary factors restraining price increases (for example, falling commodity prices).
- Hard-landing illustrative scenario assumptions:
  - Household saving rate rises, reflecting in part a 30 percent correction in U.S. equity prices.
  - Market corrections of around 15 percent in other industrial countries.
  - International investors reduce holdings of dollar-denominated assets, resulting in a depreciation of the dollar of around 10 percent.
- Rationale: wealth effects assumed greater in the United States than in other countries.

### Alternative scenario: simulation results (percent deviation from baseline unless otherwise noted; shocks starting in 2000)
- World
  - Real GDP: –1.2, –0.8, –0.6, –0.3, –0.2 (First Year through Fifth Year)
- Industrial economies — United States
  - Real GDP: –1.9, –1.5, –0.8, –0.3, –0.5
  - Domestic demand: –3.3, –3.5, –3.1, –2.5, –2.3
  - Net private saving: 1.8, 2.3, 2.3, 2.1, 2.1
  - Current account (billions of U.S. dollars): 79.0, 173.0, 235.0, 280.0, 282.0
  - Effective exchange rate: –10.3, –6.8, –3.1, 0.9, 5.5
- Japan
  - Real GDP: –1.1, –0.8, –0.5, 0.1, 0.7
  - Domestic demand: 0.4, 1.1, 1.6, 2.0, 2.2
  - Net private saving: –0.4, –1.2, –1.8, –2.3, –2.4
  - Current account (billions of U.S. dollars): –3.0, –44.0, –74.0, –92.0, –90.0
  - Effective exchange rate: 15.8, 12.1, 8.2, 4.5, 0.8
- Euro area
  - Real GDP: –1.2, –0.6, –0.4, –0.2, 0.1
  - Domestic demand: 0.7, 1.3, 1.4, 1.4, 1.3
  - Net private saving: –0.1, –0.9, –1.4, –1.8, –1.9
  - Current account (billions of U.S. dollars): –8.0, –40.0, –72.0, –100.0, –111.0
  - Effective exchange rate: 10.8, 8.8, 6.5, 4.2, 2.2
- Developing countries
  - Real GDP: –0.8, –1.0, –1.2, –1.3, –1.2
- Notes:
  - Baseline taken from the World Economic Outlook database, with shocks starting in 2000. The scenario models an increase in U.S. consumers’ preference for saving and declines in equity prices, especially in the United States.
  - Current account values are in billions of U.S. dollars.

*Italic: Source — U.S. Department of Commerce, Bureau of Economic Analysis; Survey of Current Business; Haver Analytics database; World Economic Outlook material as presented in the source content.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-flagship-issues/external/pubs/ft/weo/1999/01/_0599ch2pdf.pdf_