## _062614 ## Source details **Canonical URL:** [_062614](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2014/_062614.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2014/_062614.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2014/_062614.pdf.json) --- ### INTRODUCTION — Report scope and purpose - The IMF’s Third Pilot External Sector Report (ESR) presents a multilaterally consistent assessment of the largest economies’ external sector positions and policies for 2013 and the first half of 2014. - Integrates bilateral and multilateral surveillance to assess exchange rates, current accounts, reserves, capital flows, and external balance sheets. - The 2014 Pilot ESR: - Gives an overview of developments in key external-sector dimensions. - Provides evaluation and assessment of external sector positions of individual economies, including what needs to be done to close external gaps (Box 1). - Emphasizes fresh assessments of recent positions while placing them in perspective of developments and trends of the last few years. - Discusses implications for future external positions and flags related risks. - Companion paper: “2014 Pilot External Sector Report—Individual Economy Assessments” covers the 29 economies in greater detail. ### Key concepts - Current account imbalances: any current account balance different from zero (surpluses or deficits). - Current account gaps, or excess imbalances: difference between actual current account imbalances and those assessed by staff to be consistent with fundamentals and desirable policies. - External sector position: overall assessment from external indicators—current account balances (and counterpart capital and financial account balance), international investment positions and exchange rates. (Note: for an external sector position weaker (stronger) than expected, the exchange rate is stronger (weaker).) ### Conjuncture — The global setting - Global environment characteristics: - Sub-par levels of output and growth. - Appropriately accommodative monetary policies in major reserve-currency economies. - Growth and output: - Global growth strengthened in the second half of 2013, with much of the contribution coming from advanced economies. - Global output remained below potential, with negative output gaps in nearly all economies; the global output gap widened in 2013. - Monetary policy and financial conditions: - U.S. and U.K.: stronger growth prospects permitted the first steps towards normalization of monetary policy. - Japan and the euro area: supportive monetary conditions expected to persist. - Beginning of exit from unconventional monetary policies in major advanced economies changed the external environment for emerging economies, tightening financial conditions amid slowing output growth rates. - Global financial conditions remain clearly on the easy side and volatility indicators are currently low, but markets may remain prone to selloff episodes. - Emerging Markets (EMs) remain vulnerable to potential financial shocks, including from a re-pricing of credit risks or a resurgence in EM sovereign risk premia. ### World Economic Outlook projection (Table 1) - World Output (Percent change): 2011: 3.9; 2012: 3.2; 2013: 3.0; 2014: 3.6 - Advanced Economies (Percent change): 2011: 1.7; 2012: 1.4; 2013: 1.3; 2014: 2.2 - Emerging Market and Developing Economies (Percent change): 2011: 6.3; 2012: 5.0; 2013: 4.7; 2014: 4.9 - Output Gap (percent): - World: 2011: -1.6; 2012: -1.8; 2013: -2.1; 2014: -1.9 - Advanced Economies: 2011: -2.7; 2012: -2.7; 2013: -2.8; 2014: -2.2 - Commodity Prices (U.S. dollars): - Oil: 2011: 31.6; 2012: 1.0; 2013: -0.9; 2014: 0.1 - Nonfuel*: 2011: 17.9; 2012: -10.0; 2013: -1.2; 2014: -3.5 - London Interbank Offered Rate** (Six-month for U.S. and Japan; Three-month for euro area): - On U.S. Dollar Deposits: 2011: 0.5; 2012: 0.7; 2013: 0.4; 2014: 0.4 - On Euro Deposits: 2011: 1.4; 2012: 0.6; 2013: 0.2; 2014: 0.3 - On Japanese Yen Deposits: 2011: 0.3; 2012: 0.3; 2013: 0.2; 2014: 0.2 - Financial Indicators*** (Period averages; 2014 values are average through June 16, 2014): - U.S. 10 Year Bond Yield (percent): 2011: 2.8; 2012: 1.8; 2013: 2.3; 2014: 2.7 - VIX Index (percent): 2011: 24.1; 2012: 17.8; 2013: 14.2; 2014: 13.9 - EMBI Global Spread (basis points): 2011: 342; 2012: 342; 2013: 318; 2014: 329 ### Current account and exchange rate developments in 2013–14 - Global current account imbalances: - Continued gradual narrowing in 2013, but not uniform across economies. - From peaks around 2006–07, imbalances contracted sharply in the global crisis, widened in 2010, and subsequently narrowed more modestly. - Largest contributors to narrowing: the U.S. (sustained increase in private saving rate and rising energy production) and euro area deficit economies (demand compression and relative price adjustments). - Among surplus economies: China’s current account narrowed due to strong investment growth, sluggish external demand, and real appreciation; Japan’s surplus fell to near-balance due to demographic trends and adverse shocks. - Current account surpluses of oil exporters were more volatile, mirroring oil prices. - Changing global configuration: - Significance of the three largest economies in global current accounts has receded; imbalances migrated to a larger number of smaller economies. - Surpluses widened for euro area surplus economies (Germany, the Netherlands) and in Korea. - Deficits now predominantly among “other deficit economies” including EMs (India, Indonesia, Brazil, Turkey, South Africa) and AEs (U.K., Canada, Australia). - Widening deficits among some EMs traced to expansionary post-crisis policies only partially reversed as output rose above potential in 2010–12. - 2013 cyclically-adjusted movements: - Narrowing of estimated cyclically-adjusted deficits: India, Poland, Spain; to a lesser extent Australia. - Cyclically-adjusted surpluses narrowed: Malaysia, Russia. - Widening imbalances: growing deficits in Turkey and Brazil; rising surplus in Korea. - Among largest economies: China’s surplus and U.S. deficit both narrowed modestly; Japan’s surplus steady at about 1 percent of GDP in cyclically-adjusted terms; euro area surplus expanded due to further narrowing of deficits in euro area deficit economies. - Drivers of current account movements in 2013: - Movements more related to shifts in countries’ own domestic demand than external demand, with fiscal policies contributing. - Across ESR economies, rising (falling) cyclically-adjusted fiscal balances generally associated with increases (decreases) in cyclically-adjusted current accounts in 2013. - Relationship reinforced when fiscal positions measured relative to a world average position. - Exchange rates and current accounts: - Relationship in 2013 is complex amid substantial currency volatility. - Trade responds with lags; some REER movements may not persist long enough to see expenditure-switching and production-switching effects. - Largest currency movements in 2013 were depreciations of EM currencies after May, but these occurred in the context of prior and subsequent real appreciations and inflation differentials. - Some currency movements may have been responses to trade and trade balance developments. ### Currency volatility and real exchange rate (REER) movements - Only a few economies experienced very sizable REER shifts that were sustained in recent years. - Largest REER movements (May 2014 vs. 2012 average): - Japan: -25 percent (depreciation) - South Africa: -15 percent (depreciation) - Canada: -9 percent (depreciation) - Korea: +13 percent (appreciation) - Among largest economies, movements were smaller as of May 2014: - U.S. REER: little changed - Euro area REER: appreciated from its trough in mid-2012 - China REER: 6 percent stronger than its 2012 average - 2013 REER movements generally consistent with narrowing excess imbalances if sustained and accompanied by appropriate domestic demand shifts: - Appreciations in some surplus economies: China, Korea - Depreciations in some deficit economies: Canada, South Africa, Turkey, U.S. - Structural factors reducing exchange rate responsiveness of trade: - Increased outsourcing of production beyond domestic borders - Rise of global supply chains - Exporters’ local currency pricing strategies ### Japan’s external position (Box 2) - Context: - Yen experienced a 20 percent real depreciation from 2012 to mid-2013, reversing a 20 percent real appreciation during 2008–2012. - Last year’s ESR found the yen moderately undervalued after that depreciation; current assessment (one year later) finds the real exchange rate and current account broadly consistent with medium-term fundamentals. - Assessment subject to high uncertainty due to structural changes and policy shifts. - Trade and current account developments: - Japan’s goods trade balance has been in deficit for three years. - Rapid yen depreciation over October 2012–May 2013 has so far failed to arrest the decline in the trade balance; current account has remained on a declining trend since 2007. - Structural drags and lower responsiveness to exchange rate: - Rising share of offshore production—exceeding 20 percent of overall manufacturing output. - Japan’s upstream position in the global supply chain. - Likely permanently lower supply of domestic nuclear power implying portion of elevated energy imports will persist. - Surged imports of consumer electronics and IT devices structurally increasing the import share in domestic final demand. - Transitory factors weighing on current account: - Cyclically weak demand for capital goods (a large portion of exports) - Low pass-through from yen depreciation to local currency prices in export markets - A fraction of the elevated energy imports - Rush demand for consumer goods ahead of the consumption tax increase in spring - Staff assessment of medium-term outcome: - Once temporary factors unwind, staff assess the trade balance will remain in deficit and the underlying current account balance will rise to at most 2 percent of GDP. - The implied gap between the underlying current account and the CA norm is centered on zero. - Uncertainty and bands: - Bands around the implied current account gap of zero range from -1½ to 1½ percent of GDP. - This range translates into exchange rate bands of -15 percent undervaluation to +15 percent overvaluation, based on a relatively low sensitivity of the trade balance (as a share of GDP) to the exchange rate. - Policy caveat: - Assessment assumes full implementation of all three arrows of Abenomics; effects on the external balance are uncertain as policies aim simultaneously to accelerate growth, lift inflation, and lower public debt. ### External financing: shifting capital flows and asset repricing - 2013 aggregated capital flows did not show a major swing, but experienced unsettled financing within the year—particularly turbulence following the May 2013 tapering announcement. - May 2013 tapering announcement and rise in U.S. bond yields provoked financial market turbulence especially in EMs, where sovereign spreads rose. - Within-year dynamics: - Gross inflows to EMs dipped in 2013 Q2 before recovering moderately by end-2013 (though not to pre-tapering levels). - Retrenchment driven by a marked decline in portfolio inflows. - FDI remained fairly resilient. - Other investment (primarily banking-related) inflows initially moderated then bounced back to a level higher than pre-tapering. - Geographical differentiation: - Asian markets (excluding China) saw large declines in net debt-creating flows in the post-tapering period. - Capital inflows to China rose markedly in 2013 after a lull in 2012. - Investor differentiation across EMs: - Retrenchment pressures most severe in EMs with large external financing needs, high inflation, and other vulnerabilities. - Examples of economies with weak or moderately weak external positions in the 2013 ESR: South Africa (weak), Turkey (weak), Brazil (moderately weak), Indonesia (moderately weak). - Some of these economies tightened policies and reaffirmed structural reforms, reversing rises in sovereign CDS spreads. - Policy responses to turbulence: - Monetary tightening, CFM measures, FX intervention, and some fiscal tightening used across EMs. - Country examples: - Indonesia: government and central bank measures including fiscal measures after May 2013. - India: fiscal consolidation measures since the tapering announcement; introduced a U.S. dollar-rupee swap window (operated Sep–Nov 2013). - Brazil: substantial policy rate increases and easing CFMs, including reducing the tax rate to zero on fixed income and short FX derivative positions. - Indonesia: relaxed regulations on banks’ short-term foreign borrowing and shortened the minimum holding period for central bank bills. - Implications for EM external positions: - Tightening of external financing conditions tends to slow EM domestic demand, pushing current accounts upward. - May induce EM currency depreciation and expenditure switching with some lag, boosting current accounts. - To date, the tightening has been modest and conditions remain easy by historical standards; real depreciations generally have not been significant. ### Reserve accumulation and foreign exchange market intervention - Aggregate reserve accumulation in 2013 broadly in line with previous years. - Growth of EM total reserve holdings—mostly reflecting accumulation by China—resumed speed after a slowdown in 2012. - Among advanced economies, accumulation of reserve assets continued but at a slower pace than in 2012, reflecting virtually no intervention in Switzerland in 2013 after record accumulation in 2012. - Variation across 2013 driven by shifts in global capital market conditions: - May 2013 tapering triggered capital outflows and currency depreciations in many EMs; intervention in FX markets, alongside monetary and macroprudential measures, was used as a response. - Real depreciations and reserve decumulation after May 2013 often reversed trends from late 2012/early 2013. - Country-level reserve changes: - Reserves declines after May 2013 especially pronounced in Indonesia, Malaysia, Thailand, and Russia (Indonesia’s reserves mostly recovered by May 2014). - China, Korea, and Mexico increased reserves holdings in 2013. - China’s reserve assets increased by about US$126 billion during the first quarter of 2014, amid a slight depreciation of the renminbi. - Aggregate statistics and indices referenced: - REER series indexed Jan. 2010 = 100. - U.S. 10-year bond yields and EMBI series indexed Jan 01, 2013 = 100. - Gross international reserves reported in billions of U.S. dollars, at end-quarter, 2005Q1–2014Q1. ### Assessment approach (staff methodology and framing) - Staff assessments are multidimensional and normative: current accounts, real exchange rates, external balance sheets, and official reserves and related policies. - Aim to identify deviations (“gaps”) from what would be appropriate based on fundamentals and desirable policy settings, allowing for temporary influences. - Analytical inputs: - EBA model estimates of current account and exchange rate gaps are a starting point but do not determine assessments. - Other inputs: Fund’s reserves adequacy metric and analysis of external balance sheets. - Assessment sequence: starts with current accounts and real exchange rates, then external balance sheets, and finally reserves positions and related policies. ### Overview of 2013 current account assessments - In 2013 most economies ran current account balances that went in the direction—surplus or deficit—appropriate to their circumstances; staff-assessed gaps reported as ranges reflecting uncertainty. - Aggregated outcome for ESR economies in 2013: - Sums of actual surpluses and of actual deficits are almost twice as large as the sums of the staff-assessed norms. - The aggregate excesses were each about 0.7 percent of the GDP of ESR economies, slightly down from the previous ESR assessments for 2012 (a bit more than ¾ percent). - Composition of global gaps in 2013: - Contributions to the excess surplus side concentrated in a few economies, especially China and Germany. - Contributions to the excess global deficit more diffuse; the largest contribution remains that of the U.S., but now less than a third of the total. - Recent shifts relative to previous ESR: - Sizable reductions in assessed current account gaps in Malaysia, Spain and Sweden. - Larger assessed gaps for Korea, Turkey and Belgium. - A new gap emerged in Russia as the current account surplus fell below its norm. ### Major-economy highlights (2013) - United States: - Midpoint of the negative gap range for 2013 is a bit less than one percent of U.S. output, reflecting narrowing of the deficit. - China: - Surplus, though much reduced, is above its staff-assessed norm level for 2013 by some 1 to 3 percent of GDP. - Japan: - Assessment subject to special uncertainties; no clear gap identified for 2013. - Euro area (aggregate): - Current account surplus assessed to be only slightly too high, masking sizable intra-euro-area gaps: - Above norms: Germany and the Netherlands. - Below norms: Belgium, France and Spain (despite notable improvement in Spain in 2013), and slightly below the norm in Italy. ### REER gaps and correspondence with current account gaps - REER gap pattern broadly parallels current account gaps, reflecting joint assessments. - Considering midpoints of the gap ranges for 2013: - Largest REER gaps on the too-strong side: Turkey and South Africa. - Largest REER gaps on the weak side: Germany, Singapore and Korea (although Korea’s REER recently strengthened). - As of May 2014: - No ESR economies had REERs that differed greatly from 2013 averages overall, but notable moves included REERs some 6 to 7 percent stronger for Korea and the U.K.; and some 5 percent weaker for Canada, Indonesia and Japan. If maintained, such movements could lead to changes in staff assessments. ### Use of the External Balance Assessment (EBA) methodology - ESR draws on EBA methodology (EBA version 2.0). - EBA features: - Panel regressions to derive current account and exchange rate values consistent with fundamentals (demographics, level of development). - Inclusion of policies: fiscal, monetary, public health expenditure, capital controls and FX intervention. - Staff assessments of desirable policy settings provide views on policy gaps; EBA estimates contributions of domestic policy gaps and foreign (spillover) policy gaps and a regression residual. - Separate exercise (CGER’s “ES” method) assesses external sustainability of NIIP positions and current accounts when NIIP stabilization is dominant concern. - Output and interpretation: - EBA produces estimated “Total Gaps” as sums of policy-gap contributions and regression residual. - EBA estimates are multilaterally-consistent starting points but not adopted mechanically; staff judgment incorporated. - Current account and exchange rate gaps reported as ranges to recognize uncertainty. - Multilateral consistency ensured—current account gaps “add up”. ### Assessment of external balance sheets and NIIP concerns - Consider NIIP level and trajectory from a sustainability perspective, and size and structure of external balance sheet. - No unique threshold for unacceptable NIIP; concerns rise when NIIP unusually negative and/or projected on a weak trajectory. - Indicative thresholds cited: - EC’s -35 percent of GDP. - -50 percent of GDP suggested in Catão and Milesi-Ferretti (2013) in context of reducing probability of external crisis. - Empirical analysis emphasizes composition of external balance sheet and current account balance. - Among net debtor economies: - Spain: position remains the weakest among the 29 ESR economies; a slight current account surplus needs to rise further. - Euro area: Ireland’s deeply negative position turned a corner in 2013; Greece and Portugal set to turn a corner in 2014. - Turkey: net debtor position more moderate, but expected NIIP decline prompts call to narrow current account deficit. - Poland and Australia: projected current account deficits smaller; NIIP trajectories broadly stable or rising. - Australia and Turkey benefited from sizable valuation gains in 2013. - Among net creditor economies: - Financial/trade centers with large NIIP ratios (e.g., Singapore) have higher assessment uncertainty. - Saudi Arabia: large net creditor position and current account surplus assessed broadly appropriate for an oil-based economy. - Russia: modestly positive NIIP and current account judged somewhat too low in intertemporal terms. - Largest absolute NIIPs: Japan, China and Germany (together more than half of net creditor side); Germany’s NIIP projected to rise; Japan slightly falling; China slightly rising. ### FX intervention policies since 2012: objectives and patterns - FX interventions aimed mainly at dampening sharp movements in exchange rates, countering excessive short-term volatility and preventing disorderly conditions. - Exchange rates tended to move in directions consistent with narrowing REER gaps in 2013 and early 2014, but FX interventions were not always supportive of such narrowing. - Country-specific examples: - China and Korea: FX purchases—or non-spot market interventions—deployed amid remaining real exchange rate undervaluations. - Korea: Bank of Korea increased its FX forward position by US$12 billion in 2013—although alongside a sizable appreciation. - China: reserve accumulation accelerated in response to sizable capital inflows during 2013; reserve assets increased by about US$126 billion during Q1 2014 amid slight renminbi depreciation. - Brazil and, to a lesser extent, Indonesia: conducted FX sales—or equivalent non-spot operations—during 2013, amid still overvalued currencies; Brazil’s interventions followed sizable depreciation and were undertaken in response to short-term volatility after May 2013. - Mexico and Turkey: strengthened FX liquidity buffers for precautionary motives. - Non-spot (off balance sheet) FX positions have become sizable in some countries, adding to (Korea) or subtracting from (Brazil) central banks’ net FX positions. ### Reserve adequacy and accumulation - Reserves levels remain adequate, or above adequate, for most emerging market economies despite some declines in 2013. - In some cases (Brazil, China, India, Russia, and Thailand), reserves are above the range suggested by the Fund’s ARA metric. - ARA metric may overstate reserve needs in economies with restrictions on capital outflows (for example, China); applying a reduced weight on broad money could substantially raise the ratio of reserves to the metric. - Only South Africa remains with reserves below the suggested range; Mexico and Turkey—at the lower end—would benefit from larger buffers given country-specific features not fully captured by the metric. - FX liquidity buffers of Mexico and Poland continue to be bolstered by availability of the FCL. ### Diagnosis of external imbalances and policy implications - Aggregate global imbalances smaller than pre-crisis, but remaining excess imbalances reflect distortions and carry risks. - Imbalances are interconnected; addressing excess imbalances may reduce adverse spillovers and systemic risks. - Cyclical factors generally make relatively small contributions to current account imbalances; policy gaps and other distortions play a much larger role. - Policies to reduce excess imbalances should reverse distortions (for example, excessively loose fiscal policy or policies that distort private saving rates). Policy actions needed even when gaps reflect private-sector distortions. - General policy contours: - Deficit economies: fiscal consolidation, steps to moderate excesses in private demand, and structural reforms to facilitate adjustment. - Surplus economies: policies to support stronger domestic demand, and in some cases adjustments in capital account and reserves intervention policies. ### Fiscal policy, the global fiscal gap, and external balances - Staff identify an aggregate or global fiscal policy gap of some -2¼ percent of GDP, reflecting combined differences between underlying fiscal positions in 2013 and appropriate medium- and longer-term fiscal objectives. - This global fiscal gap has declined from -3 percent in 2012 and 3½ percent in 2011. - Global fiscal gap affects economies’ current accounts: for an economy with no gap in its own fiscal policy, the EBA model estimates that this global fiscal gap distorts its current account balance upward by about ¾ percent of GDP (and this may be an understatement). - For an economy with its own fiscal policy gap of about -2 percent of GDP (the same size as the global fiscal gap), the opposing effects on its current account would fully offset each other. - Future correction of negative fiscal policy gaps in the largest advanced economies would affect current accounts and possibly growth elsewhere; outcomes depend on timing and accompanying developments. - If fiscal consolidations accompanied and offset by a parallel rise in private demand in the same economies, current accounts and growth might show little change. - Most desirable outcome: rising domestic demand in economies with excess current account surpluses—ideally spurred by policies addressing underlying distortions, including structural reforms. ### Country and regional highlights; policy guidance - Negative fiscal policy gaps particularly sizable in Japan and Spain, followed by the U.K., France, and the U.S.; further progress on fiscal consolidation in these larger economies will shift the global fiscal policy gap. - Too-rapid consolidation by economies representing a sizable share of world output could undermine the uneven global recovery if demand in surplus economies does not pick up. - Large fiscal expansion in external surplus economies is not the recommended general answer; staff call for medium-term fiscal expansions only in Germany and the Netherlands (by somewhat less than 1 and 2 percent of GDP, respectively). - Implementation of reform plans in China would be of global significance and would help rebalancing. - Fiscal policy should plan ahead: staff projections of structural fiscal balances 5 years ahead have declined by some ½ percent of GDP since the previous ESR, though they still imply some further consolidation over the medium term. - In some cases (including Japan and the U.S.), developing concrete and credible medium-term fiscal consolidation plans is important. ### Euro area: external positions and rebalancing - Euro area current account estimated to reach 2.3 percent of GDP in 2013, up from a balanced position in 2011 and a deficit of 1.5 percent in 2008. - External positions within the euro area differ greatly and adjustments among member states have been asymmetric: - Large surplus countries (Germany, Netherlands) reached high surplus levels in 2013, though Germany’s surplus with the rest of the euro area narrowed significantly. - Deficit countries (Spain, Ireland, Portugal) saw deficits shrink substantially; Greece saw import declines and mild export growth. - Part of adjustment is cyclical; structural components (lower potential output and medium-term expected growth) also contributed. - Further rebalancing relies on near-term policy support and advancing structural reforms: - Accommodative monetary conditions support domestic demand and facilitate relative price adjustments. - Boosting investment in surplus countries will improve potential growth with positive spillovers. - Further structural reforms in product and labor markets and progress on area-wide initiatives (banking union, financial market development, completing the Single Market) can help reduce external financing constraints and facilitate lending and investment. ### Policy needs for surplus economies (China, emerging Asia, Korea) - Excess surplus imbalances of China and emerging Asia have declined, but remaining gaps indicate policy needs; Korea’s surplus gap is rising. - General areas for action: - Strengthen social safety nets (weaker safety nets tend to distort saving rates upward). - Implement financial reforms, including appropriately-paced liberalization of capital account restrictions in China and other emerging Asia. - Increase exchange rate flexibility in some economies; avoid one-sided reserve accumulation over long periods given adequacy of reserves. - China-specific: - High investment since the global financial crisis has diminished the current account surplus, but need to rebalance domestic demand toward consumption expenditure. - Footnote: Successful implementation of China’s announced reform blueprint includes strengthening social safety net, moving to a more market-based exchange rate, further opening the capital account, financial market liberalization, and opening the service sector to more competition. ### Policy agenda for economies with excess deficit imbalances (mainly EMs, some smaller AEs) - Broad and pressing agenda: - Fiscal consolidation in varying degrees is needed in most cases. - Some EM deficit economies (Brazil, South Africa and Turkey) have too-low private saving rates; structural reforms would help correct distortions that depress saving. - Structural reforms to remove supply bottlenecks are relevant. - Expected gradual tightening of monetary policy in reserve currency economies will affect real exchange rates and current account imbalances, but underlying excess deficits still need adjustment. - Causes and corrective policies: - For many EMs, deficits widened amid surging domestic demand reflecting excessive private sector response to easy global financing conditions or procyclical fiscal policies. - Correcting too-weak current accounts will need moderation of domestic demand and a degree of real exchange rate depreciation. - Relevant policies include macroprudential tools to avoid excesses in credit, asset prices and domestic demand; and fiscal consolidation. - Where domestic demand moderation is successful, domestic monetary policy can be less restrictive, facilitating desirable real exchange rate adjustment in those with flexible exchange rates. ### Trade policy - Continue to avoid trade restrictions and take care in trade negotiations to avoid fragmenting the multilateral trade system. - Bali agreement in December 2013 renewed commitment to the WTO but focused on a relatively narrow set of issues (notably trade facilitation); substantial issues remain to conclude the Doha Round. - Interim trade negotiations (TPP, TTIP, TISA) have potential to bolster global trade and address non-tariff barriers, but risk fragmentation if not pursued openly and complemented by renewed multilateral efforts. ### Outlook for external imbalances and related risks - Cyclical conditions: - Estimated cyclical contributions do not themselves tell a clear story of future current account developments. - Staff estimates of output gaps suggest only a small part of cross-country variation in current accounts reflects differences in countries’ relative positions in the business cycle. - In 2013 cyclical contributions estimated roughly ¾ to 1 percent of GDP upward for the U.S., Italy, Netherlands, and Spain, and roughly the same amount downward for Germany, Australia, and most EMs (and more for Turkey and Singapore). - Aggregate picture: some cyclical effects dampen imbalances while others widen them; in aggregate terms the dampening effect currently dominates. - Future implications depend on how output gaps are closed and uncertainty over output gap size. - Structural drivers and short-term prospects: - Drivers of underlying current accounts generally not expected to shift quickly; current constellation unlikely to change greatly in near term, though policies will influence outcomes. - Further fiscal consolidation in advanced economies with deficits likely to be gradual. - In China, implementation of reform “blueprint” would support further narrowing of China’s gap relative to its own GDP; however, considering strong expected growth, its gap in absolute terms may continue to grow. - Impact of monetary policy normalization: - Gradual and asynchronous normalization of advanced economies’ monetary policy and firming growth will shape global pattern of current accounts and exchange rates. - 2014 Spillover Report analyzes monetary exit scenarios; estimated net consequences for current account imbalances are not large and would not greatly alter present cross-country pattern. - Normative external assessments allow for exchange rates and current accounts to fluctuate with business cycle changes and appropriate monetary policy changes. ### Risks, capital flows, and systemic considerations - Direct risks clearest for economies with excess deficits. - Disorderly external adjustment in some deficit economies remains a risk, particularly under tightening external financial conditions, deteriorating policy/institutional environments, or idiosyncratic shocks. - Country-level risks can have spillovers and potentially become systemic. - Evolution of EM capital markets reduced likelihood and fallout from sudden stops due to: - Accumulated FX buffers, lowered FX market restrictions, improved institutional frameworks, more manageable debt levels, and reduced “original sin”. - Offsetting vulnerabilities: - Increased integration with global financial markets makes EM local currency assets more exposed to fluctuations in global risk appetite and liquidity. - Economies with high gross financing needs—whether from excess current account deficits or high amortization rates—are more likely to be squeezed during tightening or sell-off episodes. - Changing global configuration: - Rotation of excess imbalances in recent years diminishes some risks but raises others (e.g., widening deficits in EMs face higher risks). - Global assessments must consider flow imbalances and gaps as well as stock positions and composition details. ### Annex Figures (selected descriptions) - Figure A1. Actual REER: Monthly and Yearly Average, 2010–2014 (Index Jan. 2012=100). Country numeric identifiers listed (e.g., 111, United States; 924, China). - Figure A2. Gross Assets and Liabilities, 2012 (Percent of GDP). Country order and components listed (e.g., Hong Kong SAR; Singapore; Direct investment; Reserve assets). - Figure A4. Actual Output Gaps, 2013 (Percent of Potential Output). Horizontal axis values: -7 -6 -5 -4 -3 -2 -1 0 1 2 3. - Figure A5–A7, A9–A10: Series and country order descriptions for staff-assessed current account gaps, REER gaps, patterns of current account balances and capital flows, cumulative weekly flows to EMs, and policy contributions to CA gaps; axis tick values and country order preserved in descriptions. _2014 PILOT EXTERNAL SECTOR REPORT — excerpts (May 2014 comparisons; Box 2: Japan)._ ### INTRODUCTION __________________________________________________________________________________ 6 ### INTRODUCTION ### Report scope and purpose - The IMF’s Third Pilot External Sector Report (ESR) presents a multilaterally consistent assessment of the largest economies’ external sector positions and policies for 2013 and the first half of 2014. - The report integrates analysis from the Fund’s bilateral and multilateral surveillance to provide a consistent assessment of exchange rates, current accounts, reserves, capital flows, and external balance sheets. - The 2014 Pilot ESR: - Gives an overview of developments in key external-sector dimensions. - Provides an evaluation and assessment of external sector positions of individual economies, including what needs to be done to close external gaps (Box 1). - Emphasizes fresh assessments of recent positions while placing them in the perspective of developments and trends of the last few years. - Discusses implications for future external positions and flags related risks. - A companion paper, “2014 Pilot External Sector Report—Individual Economy Assessments,” discusses in greater detail the external sector position of each of the 29 economies covered. ### Key concepts (Box 1) - Current account imbalances: any current account balance different from zero (surpluses or deficits). Such imbalances may be appropriate or inappropriate. - Current account gaps, or excess imbalances: the difference between actual current account imbalances and those assessed by staff to be consistent with fundamentals and desirable policies; these reflect distortions and other factors. - External sector position: the overall assessment from external indicators used in the Report—current account balances (and the counterpart capital and financial account balance), international investment positions and exchange rates. (Note: for an external sector position weaker (stronger) than expected, the exchange rate is stronger (weaker).) ### Conjuncture — The global setting - Global environment characteristics: - Sub-par levels of output and growth. - Appropriately accommodative monetary policies in major reserve-currency economies. - Growth and output: - Global growth strengthened in the second half of 2013, with much of the contribution coming from advanced economies. - Global output remained below potential, with negative output gaps in nearly all economies; the global output gap widened in 2013. - Monetary policy and financial conditions: - U.S. and U.K.: stronger growth prospects permitted the first steps towards normalization of monetary policy. - Japan and the euro area: supportive monetary conditions expected to persist. - Beginning of exit from unconventional monetary policies in major advanced economies changed the external environment for emerging economies, tightening financial conditions amid slowing output growth rates. - Global financial conditions remain clearly on the easy side and volatility indicators are currently low, but markets may remain prone to selloff episodes. - Emerging Markets (EMs) remain vulnerable to potential financial shocks, including from a re-pricing of credit risks or a resurgence in EM sovereign risk premia. ### World Economic Outlook projection (Table 1) - World Output (Percent change): 2011: 3.9; 2012: 3.2; 2013: 3.0; 2014: 3.6 - Advanced Economies (Percent change): 2011: 1.7; 2012: 1.4; 2013: 1.3; 2014: 2.2 - Emerging Market and Developing Economies (Percent change): 2011: 6.3; 2012: 5.0; 2013: 4.7; 2014: 4.9 - Output Gap (percent): - World: 2011: -1.6; 2012: -1.8; 2013: -2.1; 2014: -1.9 - Advanced Economies: 2011: -2.7; 2012: -2.7; 2013: -2.8; 2014: -2.2 - Commodity Prices (U.S. dollars): - Oil: 2011: 31.6; 2012: 1.0; 2013: -0.9; 2014: 0.1 - Nonfuel*: 2011: 17.9; 2012: -10.0; 2013: -1.2; 2014: -3.5 - London Interbank Offered Rate** (Six-month for U.S. and Japan; Three-month for euro area): - On U.S. Dollar Deposits: 2011: 0.5; 2012: 0.7; 2013: 0.4; 2014: 0.4 - On Euro Deposits: 2011: 1.4; 2012: 0.6; 2013: 0.2; 2014: 0.3 - On Japanese Yen Deposits: 2011: 0.3; 2012: 0.3; 2013: 0.2; 2014: 0.2 - Financial Indicators*** (Period averages; 2014 values are average through June 16, 2014): - U.S. 10 Year Bond Yield (percent): 2011: 2.8; 2012: 1.8; 2013: 2.3; 2014: 2.7 - VIX Index (percent): 2011: 24.1; 2012: 17.8; 2013: 14.2; 2014: 13.9 - EMBI Global Spread (basis points): 2011: 342; 2012: 342; 2013: 318; 2014: 329 ### Current account and exchange rate developments in 2013–14 - Global current account imbalances: - Continued gradual narrowing in 2013, but not uniform across economies. - From peaks around 2006–07, imbalances contracted sharply in the global crisis, widened in 2010, and subsequently narrowed more modestly. - Largest contributors to narrowing: the U.S. (sustained increase in private saving rate and rising energy production) and euro area deficit economies (demand compression and relative price adjustments). - Among surplus economies: China’s current account narrowed due to strong investment growth, sluggish external demand, and real appreciation; Japan’s surplus fell to near-balance due to demographic trends and adverse shocks. - Current account surpluses of oil exporters were more volatile, mirroring oil prices. - Changing global configuration: - The significance of the three largest economies in global current accounts has receded; imbalances migrated to a larger number of smaller economies. - Surpluses widened for euro area surplus economies (Germany, the Netherlands) and in Korea. - Deficits are now predominantly among “other deficit economies” including EMs (India, Indonesia, Brazil, Turkey, South Africa) and AEs (U.K., Canada, Australia). - Widening deficits among some EMs traced to expansionary post-crisis policies that were only partially reversed or reversed too slowly as output rose above potential in 2010–12. - 2013 cyclically-adjusted movements (Figure 2 highlights): - Narrowing of estimated cyclically-adjusted deficits: India, Poland, Spain; to a lesser extent Australia. - Cyclically-adjusted surpluses narrowed: Malaysia, Russia. - Widening imbalances: growing deficits in Turkey and Brazil; rising surplus in Korea. - Among largest economies: China’s surplus and U.S. deficit both narrowed modestly; Japan’s surplus steady at about 1 percent of GDP in cyclically-adjusted terms; euro area surplus expanded due to further narrowing of deficits in euro area deficit economies. - Drivers of current account movements in 2013: - Movements appear more related to shifts in countries’ own domestic demand than external demand, with fiscal policies contributing. - Across ESR economies, rising (falling) cyclically-adjusted fiscal balances generally associated with increases (decreases) in cyclically-adjusted current accounts in 2013. - The relationship is reinforced when fiscal positions are measured relative to a world average position. - Exchange rates and current accounts: - The relationship in 2013 is complex and difficult to disentangle amid substantial currency volatility. - Trade responds with lags; some REER movements may not persist long enough to see expenditure-switching and production-switching effects. - Largest currency movements in 2013 were depreciations of EM currencies after May, but these occurred in the context of prior and subsequent real appreciations and inflation differentials. - Some currency movements may have been responses to trade and trade balance developments (adverse developments triggering depreciation; positive developments bringing appreciation). *Source: 2014 Pilot External Sector Report, Third Pilot ESR, International Monetary Fund* ### 11. Notwithstanding a number of episodes of marked currency volatility, in the last ### 11. Notwithstanding a number of episodes of marked currency volatility, in the last ### Currency volatility and real exchange rate movements - Only a few economies experienced very sizable real exchange rate (REER) shifts that were sustained in recent years. - Largest REER movements (May 2014 vs. 2012 average): - Japan: -25 percent (depreciation) - South Africa: -15 percent (depreciation) - Canada: -9 percent (depreciation) - Korea: +13 percent (appreciation) - Among largest economies, movements were smaller as of May 2014: - U.S. REER: little changed - Euro area REER: appreciated from its trough in mid-2012 - China REER: 6 percent stronger than its 2012 average - Overall 2013 REER movements were generally in directions consistent with narrowing excess imbalances if sustained and accompanied by appropriate domestic demand shifts: - Appreciations in some surplus economies: China, Korea - Depreciations in some deficit economies: Canada, South Africa, Turkey, U.S. - Structural factors reducing exchange rate responsiveness of trade: - Increased outsourcing of production beyond domestic borders - Rise of global supply chains - Exporters’ local currency pricing strategies ### Japan’s external position (Box 2) - Context: - Yen experienced a 20 percent real depreciation from 2012 to mid-2013, reversing a 20 percent real appreciation during 2008–2012. - Last year’s ESR found the yen moderately undervalued after that depreciation; current assessment (one year later) finds the real exchange rate and current account broadly consistent with medium-term fundamentals. - The assessment is subject to a high degree of uncertainty due to underlying structural changes and policy shifts. - Trade and current account developments: - Japan’s goods trade balance has been in deficit for three years. - The rapid yen depreciation over October 2012–May 2013 has so far failed to arrest the decline in the trade balance; current account has remained on a declining trend since 2007. - Structural drags on trade balance and lower responsiveness to exchange rate: - Rising share of offshore production—exceeding 20 percent of overall manufacturing output. - Japan’s upstream position in the global supply chain. - Likely permanently lower supply of domestic nuclear power implying a portion of elevated energy imports will persist. - Surged imports of consumer electronics and IT devices structurally increasing the import share in domestic final demand. - Transitory factors weighing on current account: - Cyclically weak demand for capital goods (a large portion of exports) - Low pass-through from yen depreciation to local currency prices in export markets - A fraction of the elevated energy imports - Rush demand for consumer goods ahead of the consumption tax increase in spring - Staff assessment of medium-term outcome: - Once temporary factors unwind, staff assess the trade balance will remain in deficit and the underlying current account balance will rise to at most 2 percent of GDP. - The implied gap between the underlying current account and the CA norm is centered on zero. - Uncertainty and bands: - Bands around the implied current account gap of zero range from -1½ to 1½ percent of GDP. - This range translates into exchange rate bands of -15 percent undervaluation to +15 percent overvaluation, based on a relatively low sensitivity of the trade balance (as a share of GDP) to the exchange rate. - Policy caveat: - Assessment assumes full implementation of all three arrows of Abenomics; effects on the external balance are uncertain as policies aim simultaneously to accelerate growth, lift inflation, and lower public debt. ### External financing: shifting capital flows and asset repricing - 2013 aggregated capital flows did not show a major swing, but experienced unsettled financing within the year—particularly turbulence following the May 2013 announcement on tapering of U.S. monetary stimulus. - May 2013 tapering announcement and rise in U.S. bond yields provoked financial market turbulence especially in EMs, where sovereign spreads rose. - Within-year dynamics: - Gross inflows to EMs dipped in 2013 Q2 before recovering moderately by end-2013 (though not to pre-tapering levels). - Retrenchment driven by a marked decline in portfolio inflows. - FDI remained fairly resilient. - Other investment (primarily banking-related) inflows initially moderated then bounced back to a level higher than pre-tapering. - Geographical differentiation: - Asian markets (excluding China) saw large declines in net debt-creating flows in the post-tapering period. - Capital inflows to China rose markedly in 2013 after a lull in 2012. - Investor differentiation across EMs: - Retrenchment pressures most severe in EMs with large external financing needs, high inflation, and other vulnerabilities. - Examples of economies with weak or moderately weak external positions in the 2013 ESR: South Africa (weak), Turkey (weak), Brazil (moderately weak), Indonesia (moderately weak). - Some of these economies tightened macroeconomic policies and reaffirmed structural reforms, reversing rises in sovereign CDS spreads. - Policy responses to turbulence: - Monetary tightening, CFM measures, FX intervention, and some fiscal tightening were used across EMs. - Country examples: - Indonesia: government and central bank measures including fiscal measures after May 2013. - India: fiscal consolidation measures since the tapering announcement. - Specific CFM and related actions: - Brazil: substantial policy rate increases accompanied by easing CFMs, including reducing the tax rate to zero on fixed income and short FX derivative positions. - Indonesia: relaxed regulations on banks’ short-term foreign borrowing and shortened the minimum holding period for central bank bills. - India: introduced a U.S. dollar-rupee swap window to attract foreign currency deposits from non-resident Indians (swap arrangement operated between September and November 2013). - Implications for EM external positions: - Tightening of external financing conditions tends to slow EM domestic demand, pushing current accounts upward. - May induce EM currency depreciation and expenditure switching with some lag, boosting current accounts. - To date, the tightening has been modest and conditions remain easy by historical standards; real depreciations generally have not been significant. - Not seen as a basis for a generalized, major rise in EM current accounts in 2014, though individual countries could be affected if financial shocks interact with idiosyncratic vulnerabilities. ### Reserve accumulation and foreign exchange market intervention - Aggregate reserve accumulation in 2013 was broadly in line with previous years. - Growth of EM total reserve holdings—mostly reflecting accumulation by China—resumed speed after a slowdown in 2012. - Among advanced economies, accumulation of reserve assets continued but at a slower pace than in 2012, reflecting virtually no intervention in Switzerland in 2013 after record accumulation in 2012. - Variation across 2013 driven by shifts in global capital market conditions: - May 2013 tapering triggered capital outflows and currency depreciations in many EMs; intervention in FX markets, alongside monetary and macroprudential measures, was used as a response (though some EMs relied on exchange rate flexibility). - Real depreciations and reserve decumulation after May 2013 often reversed trends from late 2012/early 2013. - Country-level reserve changes: - Reserves declines after May 2013 were especially pronounced in Indonesia, Malaysia, Thailand, and Russia (Indonesia’s reserves mostly recovered by May 2014). - China, Korea, and Mexico increased reserves holdings in 2013. - In China, reserve accumulation accelerated during 2013 after a slower pace in 2012; in Q1 2014 reserve accumulation remained strong while the renminbi depreciated somewhat against the U.S. dollar. - Aggregate statistics and indices referenced: - REER series indexed Jan. 2010 = 100. - U.S. 10-year bond yields and EMBI series indexed Jan 01, 2013 = 100. - Gross international reserves reported in billions of U.S. dollars, at end-quarter, 2005Q1–2014Q1. ### Assessment approach (staff methodology and framing) - Staff assessments are multidimensional and normative, analyzing appropriateness of current accounts, real exchange rates, external balance sheets, and official reserves and related policies. - Aim is to identify deviations (“gaps”) from what would be appropriate based on fundamentals and desirable policy settings, allowing for appropriate temporary influences—rather than to predict future movements. - Temporary fluctuations due to shocks and appropriate policy responses are allowed for in assessments. - Analytical inputs: - EBA model estimates of current account and exchange rate gaps are a starting point but do not determine assessments. - Other key inputs: Fund’s reserves adequacy metric and analysis of external balance sheets. - Assessment sequence: starts with current accounts and real exchange rates, then focuses on external balance sheets, and finally on reserves positions and related policies. *Source: 2014 PILOT EXTERNAL SECTOR REPORT — excerpts (May 2014 comparisons; Box 2: Japan).* ### 24. In 2013 most economies ran current account balances that went in the direction— ### 24. In 2013 most economies ran current account balances that went in the direction— ### Overview of 2013 current account assessments - In 2013 most economies ran current account balances that went in the direction—surplus or deficit—appropriate to their circumstances. Assessments do not call for balanced or near-balanced current accounts; they call for a wide dispersion of current accounts (Figure 9). - Staff-assessed current account gaps for 2013 are reported as ranges reflecting recognized uncertainties (Figure 10). - Aggregated outcome for ESR economies in 2013: - Sums of actual surpluses and of actual deficits are almost twice as large as the sums of the staff-assessed norms. - The aggregate excesses were each about 0.7 percent of the GDP of ESR economies, slightly down from the previous ESR assessments for 2012 (a bit more than ¾ percent). - Composition of global gaps in 2013: - Contributions to the excess surplus side are concentrated in a few economies, especially China and Germany. - Contributions to the excess global deficit are more diffuse; the largest contribution remains that of the U.S., but this is now less than a third of the total. - Recent shifts relative to the previous ESR round: - Sizable reductions in assessed current account gaps in Malaysia, Spain and Sweden. - Larger assessed gaps for Korea, Turkey and Belgium. - A new gap emerged in Russia as the current account surplus fell below its norm. ### Major-economy highlights (2013) - United States: - With the continued narrowing of the deficit—owing to ongoing fiscal consolidation and the boom in the energy sector—the midpoint of the negative gap range for 2013 is a bit less than one percent of U.S. output. - China: - The surplus, though much reduced from the past, is above its staff-assessed norm level for 2013, by some 1 to 3 percent of GDP. - Japan: - The assessment is subject to special uncertainties; no clear gap is identified for 2013 (see Box 2 on Japan). - Euro area (aggregate): - The current account surplus is assessed to be only slightly too high, but this masks sizable intra-euro-area gaps: - Above norms: Germany and the Netherlands. - Below norms: Belgium, France and Spain (despite notable improvement in Spain in 2013), and slightly below the norm in Italy. ### Real effective exchange rates (REER) and correspondence with current account gaps - The pattern of REER gaps broadly parallels the pattern of current account (CA) gaps, reflecting the joint and consistent nature of assessments (Figure 11). - Considering midpoints of the gap ranges for 2013: - Largest REER gaps on the too-strong (appreciated) side: Turkey and South Africa. - Largest REER gaps on the weak side: Germany, Singapore and Korea (although the REER of Korea recently has strengthened). - As of May 2014: - No ESR economies had REERs that differed greatly from 2013 averages overall, but notable moves included REERs some 6 to 7 percent stronger for Korea and the U.K.; and some 5 percent weaker for Canada, Indonesia and Japan. If maintained, such movements could lead to changes in staff assessments. ### Use of the External Balance Assessment (EBA) methodology (Box 3) - ESR draws on EBA methodology, in particular EBA version 2.0 introduced in the 2013 Pilot External Sector Report. - EBA analyzes current accounts and exchange rates based on fundamental economic characteristics and policies, including policy distortions. - EBA methodology features: - Panel regressions to derive current account and exchange rate values consistent with an economy’s “fundamental” characteristics (demographic factors, level of economic development). - Inclusion of policies: fiscal, monetary, public health expenditure (influences household saving), capital controls and foreign exchange intervention. - Staff assessments of desirable policy settings provide views on policy gaps; EBA estimates contributions of domestic policy gaps and foreign (spillover) policy gaps and a regression residual. - A separate exercise (CGER’s “ES” method) assesses external sustainability of NIIP positions and current accounts; used when NIIP stabilization is a dominant concern. - Output and interpretation: - EBA produces estimated “Total Gaps” for current accounts and real exchange rates as sums of policy-gap contributions and a regression residual. - EBA estimates are multilaterally-consistent starting points but are not adopted mechanically; staff assessments incorporate judgment and other information. - Where regression residuals are large, judgment is needed whether residuals reflect distortions not captured by the model or missed fundamentals. - Current account regression-based approaches generally more accurate than real exchange rate regressions, but exchange rate approaches may be preferable when current account analysis faces special difficulties. - ESR reports current account and exchange rate gaps as ranges to recognize uncertainty. - An essential feature: multilateral consistency—current account gaps “add up” so assessments of too-strong balances are matched by too-weak balances. ### Assessment of the external balance sheet and NIIP concerns - Assessments consider NIIP level and trajectory from a sustainability perspective, and the size and structure of the external balance sheet (Figures 15 & 16). - No unique threshold defines an unacceptable NIIP, but concerns rise when NIIP is unusually negative and/or projected on a weak trajectory. - Indicative thresholds cited in discussion: - EC’s -35 percent of GDP (European Commission, 2011). - -50 percent of GDP suggested in Catão and Milesi-Ferretti (2013) in context of reducing probability of external crisis. - Empirical analysis emphasizes composition of external balance sheet and current account balance, not only NIIP level. - Among net debtor economies: - Spain: position remains the weakest among the 29 ESR economies; a slight current account surplus needs to rise further to improve NIIP at an adequate pace. - Euro area: Ireland’s deeply negative position turned a corner in 2013; Greece and Portugal set to turn a corner in 2014 after substantial current account adjustments and improved growth outlook. - Turkey: net debtor position is more moderate, but expected NIIP decline prompts staff call to narrow substantial current account deficit. - Poland and Australia: projected current account deficits are smaller; NIIP trajectories broadly stable or rising; concerns muted by balance-sheet structure. - Australia and Turkey benefited from sizable valuation gains in 2013, related in part to currency depreciation. - Among net creditor economies: - Financial/trade centers with large NIIP ratios (e.g., Singapore) have higher assessment uncertainty. - Singapore: high current account surplus assessed to be stronger than appropriate; NIIP to GDP ratio projected to rise over medium term. - Hong Kong SAR and Switzerland: no clear current account gaps; NIIPs projected to decline (Hong Kong SAR) and rise slightly (Switzerland). - Saudi Arabia: large net creditor position and current account surplus assessed broadly appropriate for an oil-based economy saving part of non-renewable resource revenue for intergenerational purposes. - Russia: modestly positive NIIP and current account judged somewhat too low in light of intertemporal considerations. - Largest absolute NIIPs: Japan, China and Germany (together represent more than half of the net creditor side of the global balance sheet). - Germany’s NIIP projected to rise over the medium term; sizable current account surplus assessed to be stronger than appropriate. - Japan and China positions projected to be broadly stable in relation to their GDP—slightly falling for Japan and slightly rising for China. *Source: 2014 PILOT EXTERNAL SECTOR REPORT, INTERNATIONAL MONETARY FUND* ### 34. In general, FX intervention policies since 2012 appear to have been aimed mainly at ### _062614 - 34. In general, FX intervention policies since 2012 appear to have been aimed mainly at ### FX intervention policies since 2012: objectives and patterns - FX interventions were aimed mainly at dampening sharp movements in exchange rates against a backdrop of volatile capital flows, countering excessive short-term exchange rate volatility and preventing disorderly conditions. - Exchange rates tended to move in directions consistent with narrowing REER gaps in 2013 and early 2014, but FX intervention policies were not always supportive of such narrowing. - Country-specific intervention examples: - China and Korea: FX purchases—or non-spot market interventions—were deployed in the context of remaining real exchange rate undervaluations. - Korea: the Bank of Korea increased its FX forward position by US$12 billion in 2013—although alongside a sizable appreciation. - China: amid strong reserve buffers, China allowed real exchange appreciation in line with previous trends while reserve accumulation accelerated in response to sizable capital inflows during 2013. - China’s reserve assets increased by about US$126 billion during the first quarter of 2014, amid a slight depreciation of the renminbi. - Brazil and, to a lesser extent, Indonesia: conducted FX sales—or equivalent non-spot operations—during 2013, amid still overvalued currencies; Brazil’s FX interventions followed sizable depreciation and were undertaken in response to short-term volatility after May 2013. - Mexico and Turkey: strengthened FX liquidity buffers for precautionary motives, in line with staff recommendations. - Non-spot (off balance sheet) FX positions have become sizable in some countries, adding to (Korea) or subtracting from (Brazil) central banks’ net FX positions. ### Reserve adequacy and accumulation - Reserves levels remain adequate, or above adequate levels, for most emerging market economies despite some declines in 2013. - In some cases (Brazil, China, India, Russia, and Thailand), reserves are above the range suggested by the Fund’s current metric for assessing reserve adequacy (ARA). - The ARA metric may overstate reserve needs in economies with restrictions on capital outflows (for example, China), because such restrictions reduce the risk of large capital flight; applying a reduced weight on broad money in such cases could substantially raise the ratio of reserves to the metric. - Only South Africa remains with reserves below the suggested range; Mexico and Turkey—at the lower end of the range—would also benefit from having larger buffers given country-specific features not fully captured by the current adequacy metric. - The FX liquidity buffers of Mexico and Poland continue to be bolstered by the availability of the FCL. ### Diagnosis of external imbalances and policy implications - Aggregate global imbalances are smaller than in the pre-crisis period, but remaining excess imbalances still reflect distortions and carry risks that need to be addressed for welfare and stability reasons. - Imbalances are interconnected; addressing excess imbalances may reduce adverse spillovers and systemic risks. Benefits of adjustment are greatest when both excess-deficit and excess-surplus economies act to reduce their respective imbalances, facilitating a mutually supportive and balanced adjustment process. - Cyclical factors (including commodity prices) generally make relatively small contributions to current account imbalances; policy gaps and other distortions play a much larger role. - Policies to reduce excess imbalances should reverse distortions (for example, excessively loose fiscal policy or policies that distort private saving rates). Even when gaps reflect private-sector distortions (demand or credit booms), policy actions are needed to prevent or counter those excesses and facilitate adjustment. - General policy contours: - Deficit economies: fiscal consolidation, steps to moderate excesses in private demand, and structural reforms to facilitate adjustment. - Surplus economies: policies to support stronger domestic demand, and in some cases adjustments in capital account and reserves intervention policies. ### Fiscal policy, the global fiscal gap, and external balances - Staff identify an aggregate or global fiscal policy gap of some -2¼ percent of GDP, reflecting combined differences between underlying fiscal positions in 2013 and appropriate medium- and longer-term fiscal objectives. - This global fiscal gap has declined from -3 percent in 2012 (April 2014 Fiscal Monitor) and 3½ percent in 2011. - The global fiscal gap affects economies’ current accounts: for an economy with no gap in its own fiscal policy, the EBA model estimates that this global fiscal gap distorts its current account balance upward by about ¾ percent of GDP (and this may be an understatement). - For an economy with its own fiscal policy gap of about -2 percent of GDP (the same size as the global fiscal gap), the opposing effects on its current account would fully offset each other, potentially hiding the impact of its own fiscal shortfall while the global gap persists. - Future correction of negative fiscal policy gaps in the largest advanced economies would affect current accounts and possibly growth elsewhere; outcomes depend on timing and accompanying developments. - If fiscal consolidations are accompanied and offset by a parallel rise in private demand in the same economies, current accounts and growth might show little change. - The most desirable outcome is rising domestic demand in economies with excess current account surpluses—ideally spurred by policies addressing underlying distortions, including structural reforms to remove constraints on domestic demand. ### Country and regional highlights; policy guidance - Among ESR economies, negative fiscal policy gaps are particularly sizable in Japan and Spain, followed by the U.K., France, and the U.S.; further progress on fiscal consolidation in these larger economies will shift the global fiscal policy gap. - Too-rapid consolidation by economies representing a sizable share of world output could undermine the uneven global recovery if demand in surplus economies does not pick up. - Large fiscal expansion in external surplus economies is not the recommended general answer; staff assessments call for medium-term fiscal expansions only in Germany and the Netherlands (by somewhat less than 1 and 2 percent of GDP, respectively). - Implementation of reform plans in China would be of global significance given China’s size, and would help rebalancing. - Fiscal policy should plan ahead: staff projections of structural fiscal balances 5 years ahead (from the World Economic Outlook, based on current policies) have declined by some ½ percent of GDP since the previous ESR, notwithstanding recent consolidation, though they still imply some further consolidation over the medium term. - In some cases (including Japan and the U.S.), developing concrete and credible medium-term fiscal consolidation plans is important to ensure sustainability of public debt and stable future growth. ### Euro area: external positions and rebalancing - The euro area current account is estimated to reach 2.3 percent of GDP in 2013, up from a balanced position in 2011 and a deficit of 1.5 percent in 2008, mostly due to rising exports to the rest of the world; the current account is forecast to be sustained at the current level. - External positions within the euro area differ greatly and adjustments among member states have been asymmetric: - Large surplus countries (e.g., Germany and Netherlands) reached high surplus levels in 2013, though Germany’s surplus with the rest of the euro area narrowed significantly. - Deficit countries (e.g., Spain, Ireland, Portugal) saw deficits shrink substantially, sometimes due to recovering exports outpacing import growth; other cases (e.g., Greece) saw import declines and mild export growth. - Part of the adjustment is cyclical (weak domestic demand compressing imports), but structural components (lower potential output and medium-term expected growth) also contributed. - Further rebalancing relies on near-term policy support and advancing structural reforms: - Accommodative monetary conditions would support domestic demand and facilitate relative price adjustments, which are slowed by the current low inflation environment. - Boosting investment in surplus countries will improve potential growth with positive spillovers to the euro area. - Further structural reforms in product and labor markets (with country-specific priorities) are necessary to raise productivity and support resource reallocation. - Continued progress on area-wide policy initiatives—banking union, financial market development, and completing the Single Market—can help reduce external financing constraints, ensure more risk sharing, and facilitate lending and investment. *2014 PILOT EXTERNAL SECTOR REPORT, INTERNATIONAL MONETARY FUND* ### 46. While the excess surplus imbalances of China and emerging Asia have declined over ### _062614 - 46. While the excess surplus imbalances of China and emerging Asia have declined over ### Policy needs for surplus economies (China, emerging Asia, Korea) - Excess surplus imbalances of China and emerging Asia have declined over the years, but remaining gaps indicate a range of policy needs; Korea’s surplus gap is rising. - General areas for policy action: - Strengthen social safety nets (weaker safety nets tend to distort saving rates upward). - Implement financial reforms, including appropriately-paced liberalization of capital account restrictions in China and other emerging Asia. - Increase exchange rate flexibility in some economies; avoid one-sided reserve accumulation over long periods given adequacy of reserves. - China-specific points: - High investment since the global financial crisis has diminished the current account surplus, but there is a need to rebalance domestic demand toward consumption expenditure. - Footnote 19: “Successful implementation of China’s announced reform blueprint will move the economy to a more balanced and sustainable growth path. Reforms include strengthening the social safety net, moving to a more market-based exchange rate, further opening the capital account, financial market liberalization, and opening the service sector to more competition—which, as implemented, will also rebalance China's domestic economy away from investment and toward consumption.” ### Policy agenda for economies with excess deficit imbalances (mainly EMs, some smaller AEs) - The policy agenda is broad and pressing for deficit economies. - Key elements: - Fiscal consolidation in varying degrees is needed in most cases. - Some EM deficit economies (Brazil, South Africa and Turkey) have too-low private saving rates; structural reforms would help correct distortions that depress saving. - Structural reforms to remove supply bottlenecks are relevant in some economies. - Expected gradual tightening of monetary policy in reserve currency economies will affect real exchange rates and current account imbalances, but underlying excess deficit imbalances will still need adjustment. - On causes and corrective policies: - For many EMs, deficits have widened amid surging domestic demand that may reflect excessive private sector response to easy global financing conditions or procyclical fiscal policies (including failure to unwind policies initiated countercyclically). - Correcting too-weak current accounts will need both moderation of domestic demand and a degree of depreciation of the real exchange rate. - Relevant policies include macroprudential tools to avoid excesses in credit, asset prices and domestic demand; and fiscal consolidation. - Where domestic demand moderation is successful, domestic monetary policy can be less restrictive, facilitating desirable real exchange rate adjustment in those with flexible exchange rates. ### Trade policy - Continue to avoid trade restrictions and take care in trade negotiations to avoid fragmenting the multilateral trade system. - Bali agreement in December 2013 renewed commitment to the WTO but focused on a relatively narrow set of issues (notably trade facilitation); substantial issues remain to conclude the Doha Round. - Interim trade negotiation efforts have focused on preferential and plurilateral agreements (TPP, TTIP, TISA). - These agreements have potential to bolster global trade, improve trade conditions, and foster deeper integration by addressing non-tariff barriers and regulatory coherence. - There is a risk of fragmentation of the global trading system if such agreements are not pursued in an open and transparent manner and are not actively complemented by renewed multilateral trade efforts. ### Outlook for external imbalances and related risks - ESR assessments provide insight on outlook for external imbalances, gaps, and risks. - Role of cyclical conditions: - Estimated cyclical contributions do not themselves tell a clear story of future current account developments. - Current staff estimates of output gaps suggest only a small part of cross-country variation in current accounts reflects differences in countries’ relative positions in the business cycle (Figure A9). - Cyclical contributions are non-negligible for some ESR economies. - For some large economies (China and Japan) net cyclical impacts now appear slight. - In 2013 cyclical contributions are estimated to have been roughly ¾ to 1 percent of GDP upward for the U.S., Italy, Netherlands, and Spain, and roughly the same amount downward for Germany, Australia, and most EMs (and more for Turkey and Singapore). - Aggregate picture: some cyclical effects dampen imbalances while others widen them; in aggregated terms the dampening effect currently dominates (see Figure 20). - Future implications depend on how output gaps are closed (by own-demand shifts, and on synchronicity) and uncertainty over output gap size; estimated cyclical effects are only suggestive of future current account developments. - Since staff assessments are of underlying current accounts, future unwinding of cyclical effects would not itself mean changes in excess imbalances (gaps). - Structural drivers and short-term prospects: - Drivers of underlying current accounts generally are not expected to shift quickly; current constellation unlikely to change greatly in the near term, though policies will influence outcomes. - Further fiscal consolidation in advanced economies with deficits likely to be gradual. - In Germany, government plans for modest expansion of public investment will not greatly change the external position. - In China, implementation of the reform “blueprint” would tend to support further narrowing of China’s gap relative to its own GDP; however, considering China’s strong expected growth, its gap in absolute terms may continue to grow. - Impact of monetary policy normalization: - Global pattern of current accounts and exchange rates will be shaped by gradual and asynchronous normalization of advanced economies’ monetary policy and by firming growth motivating that tightening. - The 2014 Spillover Report analyzes monetary exit scenarios; in general estimated net consequences for current account imbalances are not large and would not greatly alter the present cross-country pattern. - Normative external assessments allow for exchange rates and current accounts to fluctuate with business cycle changes and appropriate monetary policy changes. ### Risks, capital flows, and systemic considerations - Direct risks are clearest for economies with excess deficits. - Disorderly external adjustment in some deficit economies remains a risk, particularly under tightening external financial conditions, deteriorating policy/institutional environments, or idiosyncratic shocks. - Country-level risks can have spillovers and potentially become systemic (e.g., if a group of EMs with excess deficits were simultaneously affected by negative shocks). - Disorderly external adjustment is undesirable even if it might reduce excess external imbalances; the objective is to correct gaps to promote welfare and stability. - Evolution of EM capital markets has reduced likelihood and potential fallout from sudden stops due to: - Accumulated FX buffers (though perhaps more than necessary), lowered FX market restrictions, improved institutional frameworks, more manageable debt levels, and reduced “original sin” in balance sheet composition (April 2014 GFSR). - Offsetting vulnerabilities: - Increased integration with global financial markets makes EM local currency assets more exposed to fluctuations in global risk appetite and liquidity. - Economies with high gross financing needs—whether from excess current account deficits or high amortization rates—are more likely to be squeezed during tightening or sell-off episodes. - Changing global configuration of imbalances: - The global size and configuration of current account imbalances has evolved since the global financial crisis, including rotation of excess imbalances in recent years. - The new pattern diminishes some risks (e.g., direct risks for the U.S. may be lower) but raises others (e.g., widening deficits in EMs face higher risks). - The nature and spillovers of deficit-related risks depend on where excess deficits are located (large reserve-currency economy versus diffuse EMs with varying financial interconnections). - Global macroeconomic and financial risk assessments must consider flow imbalances and gaps as well as stock positions (external balance sheets and composition details); attention to these and systemic global financial issues is essential. *International Monetary Fund, 2014 PILOT EXTERNAL SECTOR REPORT (excerpt)* ### Annex Figures ### Annex Figures ### Figure A1. Actual REER: Monthly and Yearly Average, 2010–2014 (Index Jan. 2012=100) - Series shown: INS REER, Jan 2012=100; GDS REER, Jan 2012=100; Yearly average of the INS monthly data. - Time frequency: Monthly points from 2010m1 through 2014m5; yearly averages also plotted. - Y-axis tick values displayed: 70 75 80 85 90 95 100 105 110 115 120. - Country labels with numeric identifiers as shown: - 111, United States - 136, Italy - 158, Japan - 112, United Kingdom - 138, Netherlands - 163, Euro area - 124, Belgium - 144, Sweden - 184, Spain - 132, France - 146, Switzerland - 186, Turkey - 134, Germany - 156, Canada - 193, Australia - 199, South Africa - 534, India - 578, Thailand - 223, Brazil - 536, Indonesia - 922, Russia - 273, Mexico - 542, Korea - 924, China - 456, Saudi Arabia - 548, Malaysia - 964, Poland - 532, Hong Kong SAR - 576, Singapore ### Figure A2. Gross Assets and Liabilities, 2012 (Percent of GDP) - Bar chart range on horizontal axis (NIIP/GDP scale): -1200 -1000 -800 -600 -400 -200 0 200 400 600 800 1000 1200 1400. - Countries/entities listed (order shown on chart): Hong Kong SAR; Singapore; Switzerland; Saudi Arabia; Japan; Belgium; Netherlands; Germany; China; Russia; Malaysia; Korea; South Africa; Sweden; Euro Area; United Kingdom; India; Canada; France; Thailand; United States; Italy; Brazil; Mexico; Indonesia; Turkey; Australia; Poland; Spain. - Asset/liability components illustrated: Direct investment; Equity & investment fund shares; Debt securities; Other investment; Reserve assets; Financial derivatives. - Two series indicated: Gross Assets and Gross Liabilities. ### Figure A3. NIIP: Creditor and Debtor Countries, 2012 (Percent of world GDP) - Vertical axis tick values: 0 2 4 6 8 10 12 14 16 18 20. - Labels on chart include: Creditors and Debtors grouping; country list includes France; Other; Australia; Brazil; Switzerland; Hong Kong; Germany; Japan; Other; United States; China; Spain; Saudi Arabia; Singapore; Norway; Italy; Mexico; Turkey. ### Figure A4. Actual Output Gaps, 2013 (Percent of Potential Output) - Horizontal axis values shown: -7 -6 -5 -4 -3 -2 -1 0 1 2 3. - Countries listed (left to right order shown): Spain; Netherlands; Italy; USA; Euro Area; UK; France; World Avergae; Japan; China; Belgium; Hong Kong SAR; Poland; Canada; Switzerland; Mexico; Sweden; Korea; South Africa; India; Germany; Australia; Thailand; Malaysia; Brazil; Russia; Indonesia; Turkey; Singapore. - Source: WEO. ### Figure A5. Staff Assessed Current Account Gaps and EBA Regression Estimated CA gaps (2013) (Percent of GDP) - Vertical axis tick values: -6 -4 -2 0 2 4 6 8 10. - Countries listed (order shown): Singapore; Germany; Korea; Malaysia; Netherlands; China; Sweden; Euro Area; Thailand; Mexico; Poland; India; Japan; Switzerland; Hong Kong SAR; Italy; United States; Indonesia; Australia; United Kingdom; Canada; Brazil; Russia; France; Spain; South Africa; Belgium; Turkey. - Series/legend: EBA (CA regression) and ESR staff assessment. - Source: IMF staff calculations. ### Figure A6. Staff Assessed REER Gaps and EBA Regression Estimated REER gaps (2013 year average) (Percent) - Vertical axis tick values: -6 -4 -2 0 2 4 6 8 10. - Countries listed (order shown): Singapore; Germany; Korea; Malaysia; Netherlands; China; Sweden; Euro Area; Thailand; Mexico; Poland; India; Japan; Switzerland; Hong Kong SAR; Italy; United States; Indonesia; Australia; United Kingdom; Canada; Brazil; Russia; France; Spain; South Africa; Belgium; Turkey. - Series/legend: EBA (from REER regression); EBA (as implied by CA regression); ESR staff assessment. - Source: IMF staff calculations. ### Figure A7. Pattern of Current Account Balances and Capital Flows, 2006–13 (Percent of each economy's or region's GDP) - Time span: 2008 through 2013 plotted (annual markers shown by year). - Vertical axis tick values: -9 -6 -3 0 3 6 9 12. - Country/region panels shown: Euro Area; United States; Japan; Emerging Europe; Emerging Latin America; China; Emerging Asia excl China; Other Emerging Markets; Other Advanced Economies; Oil Exporters. - Series/legend: Current Account; Capital & Financial Account; Change in Reserves. - Source: IMF World Economic Outlook Database. - Note: Country groupings are broader than the 29 economies covered by the ESR. ### Figure A8. Cumulative Weekly Equity and Bond Flows to Emerging Markets, 2007-14 (In billions of U.S. dollars) - Time axis labeled from 1-Jan-2007 through 1-May-2014 with quarterly tick markers (1-Jan, 1-May, 1-Sep each year). - Vertical axis range examples for equities: -20 -10 0 10 20 30 40 50 60 70 80. - Vertical axis range examples for bonds: -10 0 10 20 30 40 50. - Regions shown: Emerging Asia excl. China; Emerging Europe; Latin America. - Two panels: Equities and Bonds. - Sources: Haver Analytics and EPFR. Updated to June 16, 2014. ### Figure A9. Actual and EBA Estimated Cyclically Adjusted Current Accounts (2013) (Percent of GDP) - Horizontal axis tick labels shown as percentages: -6% -4% -2% 0% 2% 4% 6%. - Countries listed (order shown): Germany; Korea; Malaysia; Netherlands; China; Sweden; Euro Area; Thailand; Mexico; Poland; India; Japan; Switzerland; Italy; United States; Indonesia; Australia; United Kingdom; Canada; Brazil; Russia; France; Spain; South Africa; Belgium; Turkey. - Series/legend: Actual and EBA Estimated Cyclically Adjusted (as estimated by EBA model, based on output gap and commodity price cycle estimates). - Note: Staff assessments of underlying current account balances may take account of other temporary influences. - Source: IMF Staff Estimates. ### Figure A10. Individual Economies: Contribution of Policies to Current Account Gaps (2013) (Percent of GDP, based on midpoint of staff estimates) - Horizontal axis tick labels shown as percentages: -6% -4% -2% 0% 2% 4% 6%. - Countries listed (order shown): Germany; Korea; Malaysia; Netherlands; China; Sweden; Euro Area; Thailand; Mexico; Poland; India; Japan; Switzerland; Italy; United States; Indonesia; Australia; United Kingdom; Canada; Brazil; Russia; France; Spain; South Africa; Belgium; Turkey. - Policy contribution categories stacked (legend items shown): Social Protection; Cap Controls & Intervention; Fiscal (global); Credit; Fiscal (domestic); Unidentified policies & other; Total. - Explanatory notes included on chart: - Source: IMF staff calculations from EBA, incorporates desk judgment. - Policy contributions are estimates from EBA (see IMF Working Paper 13/272) of how much deviations from desirable policies contribute to the gap between the cyclically adjusted current account and that consistent with medium-term fundamentals and desirable policies. - Estimated contributions of individual policies may not coincide with staff's view in some cases. - Deviations are measured for each economy relative to a global benchmark. - For fiscal policy, the gaps are shown separately as a domestic policy contribution and a global fiscal contribution which illustrates how medium-term fiscal consolidation in the large advanced economies impacts the current accounts of others. - The global fiscal policy gap is around -2¼ percent of GDP which has an effect on current account gaps of around ¾ percent of GDP. - “Unidentified policies and other” are not solely from EBA but represent all the other factors that affect the current account gap, including uncertainty over the size of the gap. *Sources: INS, GDS and IMF staff calculations.* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2014/_062614.pdf_