## INTRODUCTION ## Source details **Canonical URL:** [INTRODUCTION](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2015/_062615.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2015/_062615.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2015/_062615.pdf.json) --- ### Scope and structure of the report - Fourth annual External Sector Report (ESR) covering staff assessments of external positions of 29 economies. - Comprises two papers: - Individual Economy Assessments: full, multi-dimensional assessments of external positions. - Overview paper: synthesizes part of their content, emphasizing cross-country patterns, globally relevant issues and policy issues that need consideration beyond the country level. - Overview paper sections: - Context: evolution of global pattern of current account balances and main findings of the previous ESR. - Quantitative assessments: current account and real exchange rate outcomes for calendar 2014 and reserve adequacy at end-2014. - Key recent developments: commodity price movements, economic and monetary policy divergence, and exchange rates, and potential significance for external positions in 2015 and beyond. - Conclusions: policy implications and risks. ### Historical evolution of imbalances and prior ESR findings - 2006-08: global sum of (absolute) imbalances peaked at more than 5 percent of world GDP; dominated by the U.S. deficit and surpluses of China and oil exporting economies; notable surpluses in some euro area economies (Germany and the Netherlands). - By 2010-11: global sum of imbalances down by about a third from peak; large reductions of the U.S. and China imbalances (each contracted by more than one half from 2006-08 levels) and a less concentrated composition. - After 2010: global sum of imbalances broadly stable with modest narrowing in 2013; compositional shifts: Japan surplus nearly disappeared; euro area excluding Germany and the Netherlands moved to a small surplus; U.S. deficit narrowed; Korea surplus widened; U.K. and some EM deficits widened; India’s deficit narrowed sharply after 2012; Poland’s deficit narrowed; surplus of oil exporters narrowed in 2013 and further in 2014. - Previous ESR summarized findings: - Aggregate actual current account (CA) imbalances for 2013 exceeded the sum of staff-assessed norms. - Among the largest four economies (U.S., euro area, China, Japan) excesses were not great relative to their own GDP but globally significant due to size. - Excesses remain large for many other economies; recent progress mainly among some deficit economies, offset by widening of other deficits and stalled progress on reducing excessive surpluses. ### Key ESR concepts - Current account imbalances: any CA balance different from zero; may be appropriate or inappropriate. - Current account gaps (excess imbalances): difference between actual imbalances and staff-assessed norms consistent with fundamentals and desirable policies. - Multilateral consistency: too-high current accounts of some economies are necessarily matched by too-low current accounts of others. - REER gaps: correspond to underlying CA gaps; adjustment involves change in expenditure and REER; not related to expected future exchange rates; may occur in any economy including those with floating exchange rates. - External sector position: overall assessment from external indicators used in the Report—current account balances, international investment positions and exchange rates. - External Balance Assessment (EBA) methodology: quantitative methods developed to inform assessments; Annex 1 summarizes EBA methods and enhancements. ### Developments since the last ESR relevant for 2015 - Significant developments: - Large movements in commodity prices (notably oil) primarily in late 2014 and early 2015. - Economic and monetary policy divergence across major economies. - Exchange rate movements of major currencies. - These developments had limited impact on 2014 year outcomes but are likely to have appreciable effects on external positions in 2015. ### Assessments of 2014 current accounts and real exchange rates - Broad correspondence between actual current account imbalances and staff-assessed norms in 2014, at least in direction; many imbalances differ from norms and gaps are presented as ranges reflecting uncertainty. - Cross-country shifts from 2013 to 2014: - U.K.: negative current account gap widened. - Malaysia: positive current account gap widened; REER gap widened. - Brazil: REER gap widened. - Turkey and Russia: REER gaps narrowed amid depreciations and shifts in norms. - Among the four largest economies: - China: current account gap remained moderate, centered on +2 percent of GDP. - U.S.: midpoint of current account gap remained a small negative. - Japan: midpoint of the gap moved upward to a small positive. - Euro area heterogeneity: - Substantial positive current account gap for Germany and positive gap for the Netherlands. - France, Italy, and Spain assessed to have current accounts weaker than desirable despite notable increases in recent years. - Systemic perspective among 29 economies: - Absolute sums of the gaps for economies with positive current account gaps and those with negative gaps are balanced, each about 0.6 percent of world GDP—essentially unchanged from 2013. - Bulk of assessed gaps concentrated in a small number of economies: - Excess surplus side concentrated in China (reflecting size), Germany, followed by Korea. - Excess deficit side more diffuse; largest contributions from the U.S., followed by the U.K., Brazil and France. - Sources of current account gaps: - Fiscal policy gaps: many economies judged to have fiscal balances below recommended levels; a negative fiscal policy gap lowers an economy’s own CA but raises its CA via other economies’ negative fiscal gaps. Example: a fiscal policy gap of minus 2 percent of GDP yields offsetting domestic and foreign fiscal gap contributions to its current account; for an economy with no fiscal gap, net contribution of fiscal gaps would be upward, by almost 1 percent of GDP, coming entirely from other economies’ policies. - Insufficient social safety nets: judged to push up private saving rates and current accounts. - Capital controls and official purchases of foreign currency: may act to raise current accounts; deceleration of such purchases in 2014 was notable (including in China where net purchases decelerated and turned to sales recently). - More generally, any condition that distorts a country’s saving or investment rate will contribute to a current account gap. ### Staff assessments, national external balance sheets, and reserve adequacy - Staff assessments incorporate national (external) balance sheets and adequacy of international reserves. - External sustainability and weak net international investment positions informed current account gap assessments (example cited: Spain; Figure A6 referenced). - Reserve adequacy end-2014: - Calculations broadly similar to end-2013. - A few EMs saw a decline in reserves in 2014, including Malaysia, Russia, Saudi Arabia—partly due to weakness in capital flows and in exports arising from lower oil and gas prices in latter 2014. - For most EMs, reserves remained adequate. - China’s reserves at end-2014: - 149 percent of the unadjusted metric and 238 percent of the metric adjusted for capital flow management measures (CFMs). - Under either metric, staff assessment: further accumulation unnecessary from a reserves adequacy perspective. - Some countries warrant strengthening reserve buffers as financial conditions permit: Malaysia, South Africa, Turkey. - FCL arrangement in Poland complements international reserves, but some additional reserve accumulation is desirable. - Adjustment note: adjustment to Turkey’s reserve adequacy metric for Reserve Option Mechanism-related reserve holdings would reduce the ARA metric to 72 percent. - Adjusted metric considers lower precautionary needs where CFMs may lower risk of capital flight by residents; applicable ESR countries include China, India, Thailand, and South Africa. ### Global financial conditions, capital flows, and reserve accumulation (Box 2) - Global financial conditions in 2014: - Overall remained accommodative; financing terms evolved and diverged over 2014. - U.S. T-10 yield, after rising steeply in 2013, declined gradually throughout 2014. - Risk spreads turned upward after mid-2014 for EMs and more broadly. - Among EMs, sovereign spreads widened most for those affected by the drop in commodity export prices and by geopolitical tensions. - External financing conditions nevertheless remained easy for most EMs from a historical perspective. - Capital flows to EMs: - Slowed after mid-2014, though not uniformly. - For China, flows declined throughout 2014. - About a third of the drop in H2 2014 reflected collapse of flows to Russia. - India experienced stable gross inflows, in part due to a strengthening policy framework. - Commodity price effects on flows and reserves: - Sharp fall in oil prices shaped patterns and scale of capital flows: lower import prices mean temporarily higher current accounts and lower demand for gross external financing for many net oil importers. - Counterpart: reduced current account surpluses and foreign asset accumulation of a relatively small number of large oil exporters. - Reserve accumulation generally slowed and in some cases reversed. - Declines in reserves reflect valuation changes (euro and yen depreciation vis-à-vis the U.S. dollar) and lower accumulation. - Notable declines: China (including estimated foreign exchange sales in early 2015), some oil exporters (Russia, Saudi Arabia), and to a lesser extent Malaysia. - Exception: Switzerland experienced rising reserve holdings starting in late 2014 due to strong capital inflows and appreciation pressure under an exchange rate floor; central bank removed that floor in mid-January 2015 with limited intervention after end-January. - Last observation for reserve series corresponds to March 2015 (IMF International Financial Statistics). ### Key developments since 2014 and implications for external positions — overview - ESR focuses on 2014 outcomes; this section takes preliminary stock of select recent developments that began in 2014 but were too late to affect 2014 outcomes. Impacts are uncertain and full 2015 assessments are not yet possible. A. Lower prices of oil and other commodities - Oil price decline and projections: - Late 2014 plunge in oil price and declines in some other commodity prices will differentially affect global pattern of current accounts. - WEO projections: 2015 average price, in U.S. dollars, will be about 40 percent below its 2014 average. - Prices of natural gas and other fuels also dropped. - Exposure and short-run impacts: - Exports of oil and natural gas important to several ESR economies, notably Saudi Arabia and Russia, and to a lesser degree Canada and Malaysia. - Most ESR economies are net importers of oil and natural gas and will receive an income windfall from the oil price drop, degree varies. - Direct, static valuation effect on the oil trade balance exceeds 1 percent of GDP for many ESR economies, and in some cases is far larger. - In practice, impacts on current accounts generally smaller than the initial valuation effect and likely to decline over time because: - Oil price projected to recover about half of its decline gradually over the next several years (Spring 2015 WEO). - Exchange rate responses to the terms of trade shock will dampen the effect on the current account. - Oil-related income gains (or losses) will spur expenditure changes that partly offset initial impact. - Box 3: roughly 40 percent estimated drop of the price of oil from 2014 to 2015 will mean a transfer of income from oil exporters to oil importers worth about 1 percent of world GDP. - Income loss for oil exporters highly concentrated: five countries account for more than half of all oil exports and 10 countries account for 75 percent. - Among net importers of oil, little correspondence between size of their oil trade deficits and their current accounts; economies importing more oil tend to have stronger non-oil current accounts. - Long-run effects of oil price changes on current accounts may be small or absent as domestic demand and REER adjustments offset direct impact. B. Economic and monetary policy divergence and exchange rates - Divergence of growth, inflation, and monetary policy among major economies matters for REERs and current accounts. - Late 2014: cyclical recoveries of the U.S. and U.K. proceeding faster than euro area and Japan. - Significant monetary policy easing in Japan in late 2014 and in the euro area in January 2015. - Monetary easing spread in early 2015 among emerging markets and smaller advanced economies. - Exchange rate movements Aug. 2014–early 2015: - Easing announcements prompted currency depreciations; labeling as “competitive easing” is misplaced. - Between Aug. 2014 and early March 2015 large bilateral exchange rate movements occurred; U.S. dollar appreciated against nearly all flexible currencies. - Weakest currencies in that period included the euro, the yen, and currencies of oil and gas exporters with flexible exchange rates (e.g., Russia, Colombia, Norway). - Depreciations against the dollar were small for several Asian economies with flexible exchange rates and heavy oil import reliance (e.g., India, Korea, Thailand). - Timing and triggers: - Uniform U.S. dollar appreciation initially. - Late Oct. 2014: QQE announcement in Japan followed by substantial yen depreciation. - Late Nov. 2014: OPEC meeting and abrupt expectations drop in medium-term oil prices led to sharp depreciations for oil and gas exporters. - Early 2015: ECB QE announcement and implementation associated with substantial euro depreciation; currencies integrated with euro moved with it. - Since mid-March 2015 currency movements less pronounced; the dollar weakened and the euro strengthened somewhat; largest movement was strong recovery of the ruble. - REER and bilateral changes: - Figure 12 reports changes in REER and bilateral exchange rates against the U.S. dollar for Aug. 2014 to May 2015 (difference in log values*100; + indicates appreciation). - Country list includes Singapore, Germany, Malaysia, Korea, China, Sweden, Netherlands, India, Japan, Mexico, Poland, Hong Kong SAR, Thailand, Belgium, Switzerland, United States, Italy, Australia, Indonesia, Canada, Russia, Spain, France, Brazil, United Kingdom, South Africa, Saudi Arabia, Turkey, Euro Area. ### Recent currency movements: characterization, drivers, and implications - Episode distinguished by size and abruptness of bilateral exchange rate shifts among major economies. - Current REER levels of the U.S., Japan, and the euro area not unprecedented; China’s REER appreciation is notable and abrupt and builds on a larger appreciation since 2005. - Among EMs, REER movements since mid-2014 generally not remarkable relative to recent years, with Russia an exception (much of its very large REER depreciation has been reversed). - Contrasts with 2013 “taper” episode when EMs generally depreciated against all reserve currencies rather than depreciating against the dollar but appreciating against others. - Cross-country REER movements strongly related to exposure to commodity prices (particularly oil and natural gas) and to revisions in economic outlook (see Spring 2015 WEO). Implications for external positions—three angles: - Commodity-terms-of-trade gains paired with real appreciations: current account likely to rise initially before full adjustment to new real income and relative prices; may be no long-term implication for current account. - Exchange rate movements from domestic demand-driven cyclical divergences: actual current accounts will fluctuate over the cycle; if cyclical divergences are temporary, underlying current accounts may not change but interim exchange rates may diverge from fundamentals and shift aggregate demand across economies. - Where external positions previously assessed too weak or too strong: a recent REER movement “in the right direction” does not necessarily correct the underlying external position; lasting correction requires expenditure adjustment and addressing longstanding drivers (e.g., too-low saving in Brazil or too-high saving in China). In absence of domestic demand adjustment, REER shifts may move economies away from full employment and may not be sustained. Baseline near-term outlook (2015 focus) - Staff projections highlight role of oil price drop in net impacts on current accounts. - Cross-country pattern of current account in 2015 projected broadly similar to 2014; except Saudi Arabia, changes in 2015 not large relative to existing wide variation. Holds for 2016 projections (not shown). - For most economies current account projected to rise in 2015 mainly from rise in oil trade balance driven by reduced oil import bills. - Notable exception: Russia, where current account surplus expected to rise significantly despite sizable decline in oil export revenue. - Current accounts expected to decline for several commodity exporters including Australia, Malaysia, and Saudi Arabia, and to a lesser extent Canada. - Lower current account projected for Switzerland, and to a lesser extent for the U.S., notwithstanding narrowing of their oil trade deficits—reflects REER appreciation effects and domestic demand growth in U.S. case. - Projected current account shifts in 2015 correlated with changes in oil trade balances, but have no general correspondence with 2014 current account gaps; closure of those gaps requires addressing longstanding drivers. Projections for largest economies (2015) - Euro area and Japan: - Projected current account rises slightly more than the narrowing of the oil trade deficit. - Upward effect of REER depreciation mostly offset by downward effect of domestic demand growth. - China: - Projected current account rises roughly in line with the oil trade balance. - Non-oil current account essentially flat, as REER appreciation effect offset by ongoing productivity gains and slower domestic demand growth. - United States: - Projected U.S. current account falls slightly as a small rise in the oil trade balance is more than offset by domestic demand growth and REER appreciation. - Note: U.S. oil deficit modest relative to GDP, so oil price drop means a relatively small gain for the U.S. Oil-dominated economies and current account dynamics - For oil-dominated economies a sustained oil price shock is a watershed: public sector primarily experiences income loss and public response will largely determine whether the external position weakens on a lasting basis. - Historically appropriate for these economies to run large external surpluses (resource exhaustibility, intergenerational considerations, precaution against oil price drops); a sustained lower oil price calls for downward expenditure adjustment, potentially gradual for those with sufficient buffers. - Box 4 highlights: - Five economies (Saudi Arabia, Kuwait, Qatar, UAE, Russia) account for more than half of all oil exports and about 90 percent of the combined surplus of all net exporters of oil. - GCC economies with fixed exchange rates run very large current account surpluses and have sizable buffers; external adjustment is largely fiscal and need not involve sizable REER adjustment. Near-term expenditure adjustment projected to be much less than loss of oil revenue, and current account surpluses have fallen sharply. - Russia has run current account surpluses (smaller as share of GDP), and in the context of flexible exchange rate, sanctions, and reduced external financing, has undergone a very large adjustment on the non-oil current account; despite loss of oil revenue, Russia’s current account is projected to rise in 2015. When large REER shifts translate into large current account movements (Box 5 insights) - Predicting current account responses to REER shifts requires structural, industry, and macro-context considerations; simple elasticity approaches can mislead if they ignore concurrent shocks. - Important factors: - Pricing behavior and pass-through of exchange rate changes to prices. - Lags in demand and supply responses and potential nonlinearity (zones of inaction). - Trade openness: larger export/import ratios increase responsiveness to exchange rate movements, but high gross exports with high import content can reduce net impact. - Global value-added chains complicate trade effects. - Macro context: drivers of REER change and concurrent developments (especially domestic demand) that directly affect import demand. - Illustrative cases of REER appreciation: 1. If associated with strong domestic demand growth, combined implications for current account can be large while implications for aggregate demand and GDP growth may be small. 2. If occurring when domestic demand growth is weak, predicted current account movement smaller but negative implications for aggregate demand and growth larger; countercyclical policy responses must be considered. - Bottom line: an REER shift alone does not yield a clear prediction of current account movement; much more needs consideration. ### Policy implications, risks, and recommended actions - Existing policy agenda to address excess external imbalances remains relevant; commodity prices and exchange rate changes alone will not overturn 2014 excess imbalances. - Broad policy contours: - Deficit economies: fiscal consolidation, steps to boost private saving and moderate excesses in private demand, and structural reforms to facilitate adjustment. - Surplus economies: policies to support stronger domestic demand. - Demand adjustments should be accompanied by REER changes to avoid deficit economies falling into recession or surplus economies overheating. - Avoid sustained, one-sided reserve accumulation where international reserves are adequate. - Policies should facilitate, not delay, real exchange rate adjustment accompanying demand adjustment. - Economies with current accounts below norms: gradual fiscal consolidation often part of agenda plus policies to raise saving or curb private demand excesses. - For economies with too-low private saving rates (including Brazil, South Africa and Turkey among others), reforms addressing distortions that depress saving would be useful. - Further fiscal consolidation over coming years remains desirable for some (e.g., Brazil, the U.K., and some larger euro area members, particularly France and Spain), with timing and pace dependent on growth and cyclical considerations; consolidation and demand adjustment should be complemented by relative price adjustment. - Euro area specifics: - Relative price adjustment should be facilitated by product and labor market reforms, boosting productivity and growth. - Easing of euro area monetary policy should facilitate relative price adjustment among members. - Strengthening bank balance sheets, and greater use of fiscal rule space to support structural reforms and public investment, are important. - United States: - U.S. current account deficit no longer assessed as excessive relative to U.S. size; assessed current account gap for 2014 ranges from -1¼ percent of GDP to zero, suggesting modest further narrowing could be desirable. - Considerable fiscal consolidation has contributed to narrowing the current account gap; some further consolidation over the medium term appropriate for fiscal sustainability. - In near term, if U.S. REER appreciation puts downward pressure on growth and inflation, monetary policy decisions will need to take this into account. Downsides, risks, and financial spillovers - Large nominal bilateral rate movements can pose costs beyond external positions: - Sectoral dislocation. - Balance sheet risks for entities heavily indebted in U.S. dollar. - 2015 Spillover Report: balance sheet risks, while generally much reduced, remain relevant for some economies and sectors. - QE and low interest rates can encourage excessive risk‑taking and large capital flows to EMs; exit from accommodative policy can disrupt markets, especially in EMs. - Policymakers, including in EMs, should be prepared to respond flexibly to disruptions using a range of tools. - Economies with largest current account deficits may be most vulnerable; risk of disorderly external adjustment remains—especially if external financing tightens and policy deteriorates or other shocks materialize. - Addressing excess deficits by removing underlying drivers and adjusting gradually is preferable to disorderly compression triggered by sudden tightening of external financing. Scenarios and vigilance - Pattern of imbalances depends on whether policies move in recommended directions and on financial market and private sector developments. - Spring 2015 WEO baseline: aggregate imbalances at global level do not change greatly absent further shocks; baseline assumes partial recovery of oil prices over medium term and constant real exchange rates. - Unlikely all real exchange rates remain constant; significant shifts must be evaluated in context of drivers and concurrent developments. - Policy agenda calls for steady effort to address sources of existing excess imbalances and for policymakers to be alert to new developments that may add to or create excess imbalances. ### Role and refinements of the External Balance Assessment (EBA) methodology - EBA analyzes current accounts and exchange rates based on fundamentals and policy settings via panel regressions; includes policy factors: fiscal, monetary, public health expenditure, capital controls and foreign exchange intervention. - EBA includes separate exercise focusing on external sustainability of NIIP positions and current account balances, used when NIIP stabilization is dominant concern. - Output: estimated “Total Gaps” for current accounts and REERs, summing contributions of policy gaps (domestic and foreign/ spillover) and a regression residual. - ESR staff assessments reflect EBA estimates plus other information and judgment; EBA estimates are starting points and not adopted mechanically. - Where regression residual is large, judgment required to determine whether it reflects distortions not captured or omitted fundamentals. - Current account regression‑based approach often considered more reliable than REER regression approaches. - EBA refinements and features: - Weakness of REER index approach: indices influenced by past averages and sustained distortions. - New supplementary tool: REER regression using “level” exchange rates rather than indices; supplements rather than replaces index‑based tool. - Treatment of demographic factors refined and sample estimation periods extended; EBA models re‑estimated using data through 2013 (previously through 2010). - Treatment of capital controls explored; de jure and de facto indicators imperfect; choice of index has little effect on overall pattern of EBA CA gap estimates. - ESR reports CA and REER gaps as ranges to reflect uncertainty; uncertainty high in financial center economies with large balance sheets and large unexplained regression residuals. - Multilateral consistency is essential: current account gaps “add up” so assessments of too‑strong balances are matched by too‑weak balances. - Overall: staff‑assessed gaps often differ from one or more EBA estimates but cross‑country correlation between assessments and EBA estimates remains, especially for current account assessments. *Source: INTRODUCTION and selected sections, 2015 External Sector Report, International Monetary Fund.* ### INTRODUCTION __________________________________________________________________________________ 5 ### INTRODUCTION ### Scope and structure of the report - This fourth annual External Sector Report (ESR) presents updated staff assessments of the external positions of 29 economies. - The report comprises two papers: - Individual Economy Assessments: full, multi-dimensional assessments of external positions. - Overview paper: synthesizes part of their content, emphasizing cross-country patterns, globally relevant issues and policy issues that need consideration beyond the country level. - Overview paper sections: - Context: evolution of global pattern of current account balances and main findings of the previous ESR. - Quantitative assessments: current account and real exchange rate outcomes for calendar 2014 and reserve adequacy at end-2014. - Key recent developments: commodity price movements, economic and monetary policy divergence, and exchange rates, and potential significance for external positions in 2015 and beyond. - Conclusions: policy implications and risks. ### Background: evolution of imbalances and findings of previous report - Key historical patterns: - 2006-08: global sum of (absolute) imbalances peaked at more than 5 percent of world GDP, dominated by the U.S. deficit and surpluses of China and oil exporting economies; notable surpluses in some euro area economies (Germany and the Netherlands). - By 2010-11: the global sum of imbalances had come down by about a third from its peak; large reductions of the U.S. and China imbalances (each contracted by more than one half from 2006-08 levels) led to a much less concentrated composition of imbalances. - After 2010: global sum of imbalances broadly stable with a modest narrowing in 2013; composition continued to change (Japan surplus nearly disappeared; combined current accounts of euro area excluding Germany and the Netherlands moved from deficit to a small surplus; U.S. deficit narrowed; Korea surplus widened; U.K. and some EM deficits widened; India’s deficit narrowed sharply after 2012; Poland’s deficit narrowed; surplus of oil exporters narrowed in 2013 and further in 2014). - Previous ESR findings summarized: - Aggregate actual current account (CA) imbalances for 2013 exceeded the sum of staff-assessed norms. - Among the largest four economies (U.S., euro area, China, Japan) excesses were not great relative to their own GDP but were globally significant due to size. - Excesses remain large for many other economies; recent progress was mainly among some deficit economies, offset by widening of other deficits and stalled progress on reducing excessive surpluses. ### Key ESR concepts (as summarized) - Current account imbalances: any CA balance different from zero; may be appropriate or inappropriate. - Current account gaps (excess imbalances): difference between actual imbalances and staff-assessed norms consistent with fundamentals and desirable policies. - Multilateral consistency: too-high current accounts of some economies are necessarily matched by too-low current accounts of others. - REER gaps: correspond to underlying CA gaps; adjustment involves change in expenditure and REER; not related to expected future exchange rates; may occur in any economy including those with floating exchange rates. - External sector position: overall assessment from external indicators used in the Report—current account balances, international investment positions and exchange rates. - External Balance Assessment (EBA) methodology: quantitative methods developed to inform assessments; Annex 1 summarizes EBA methods and enhancements. ### Developments since the last ESR relevant for 2015 - Significant developments since the last ESR include: - Large movements in commodity prices (notably oil) primarily in late 2014 and early 2015. - Economic and monetary policy divergence across major economies. - Exchange rate movements of major currencies. - These developments had limited impact on 2014 year outcomes but are likely to have appreciable effects on external positions in 2015. ### Assessments of 2014 current accounts and real exchange rates - General findings: - There is a broad correspondence between actual current account imbalances and staff-assessed norms in 2014, at least in terms of direction; an important part of the international pattern appears justified. - Imbalances often differ from staff-assessed norms; gaps typically presented as ranges reflecting uncertainty (see Annex 1 for gap-range widths). - Cross-country patterns and changes from 2013 to 2014: - Broad cross-country pattern of CA and REER gaps similar to 2013, though some economies’ positions changed. - Notable shifts in 2014: - U.K.: negative current account gap widened. - Malaysia: positive current account gap widened; REER gap widened. - Brazil: REER gap widened. - Turkey and Russia: REER gaps narrowed amid depreciations and shifts in norms. - Among the four largest economies (U.S., China, euro area, Japan) shifts in assessments were negligible relative to margins of uncertainty: - China: current account gap remained moderate, centered on +2 percent of GDP. - U.S.: midpoint of current account gap remained a small negative. - Japan: midpoint of the gap moved upward to a small positive. - Euro area heterogeneity: - Substantial positive current account gap for Germany and positive gap for the Netherlands. - France, Italy, and Spain assessed to have current accounts weaker than desirable despite notable increases in recent years. - Systemic perspective (distribution and importance of gaps among 29 economies): - Absolute sums of the gaps for economies with positive current account gaps and those with negative gaps are balanced, each about 0.6 percent of world GDP—essentially unchanged from 2013. - A small number of the 29 economies account for the bulk of assessed gaps: - Excess surplus side concentrated in China (reflecting size), Germany, followed by Korea. - Excess deficit side more diffuse; largest contributions from the U.S. (reflecting size despite small gap as share of U.S. GDP), followed by the U.K., Brazil and France. - Sources of current account gaps: - Fiscal policy gaps: many economies judged to have fiscal balances below recommended levels; a negative fiscal policy gap lowers an economy’s own CA but raises its CA via other economies’ negative fiscal gaps. Example: a fiscal policy gap of minus 2 percent of GDP yields offsetting domestic and foreign fiscal gap contributions to its current account; for an economy with no fiscal gap, net contribution of fiscal gaps would be upward, by almost 1 percent of GDP, coming entirely from other economies’ policies. - Insufficient social safety nets: judged to push up private saving rates and current accounts. - Capital controls and official purchases of foreign currency: may act to raise current accounts; deceleration of such purchases in 2014 was notable (including in China where net purchases decelerated and turned to sales recently). - More generally, any condition that distorts a country’s saving or investment rate will contribute to a current account gap (and to gaps in other economies to a lesser degree, relative to their sizes). *Source: INTRODUCTION, 2015 External Sector Report, International Monetary Fund* ### 15. Staff assessments of overall external positions take account also of national (external) ### 15. Staff assessments of overall external positions take account also of national (external) ### Staff assessments, national external balance sheets, and reserve adequacy - Staff assessments incorporate national (external) balance sheets and the adequacy of international reserves. - External sustainability considerations and the need to bolster the still-relatively weak net international investment position informed current account gap assessments (example cited: Spain; Figure A6 referenced). - Assessments are informed by the structure and size of an economy’s gross foreign assets and liabilities where relevant. - Reserve adequacy calculations: - Reserve adequacy calculations for end-2014 are broadly similar to those for end-2013 (Figure 6). - A few EMs saw a decline in reserves in 2014, including Malaysia, Russia, Saudi Arabia—partly due to weakness in capital flows and in exports arising from lower oil and gas prices in latter 2014. - For most EMs, reserves remained adequate. - China’s reserves: - At end-2014 were 149 percent of the unadjusted metric and 238 percent of the metric adjusted for capital flow management measures (CFMs). - Under either metric, the staff assessment is that further accumulation is unnecessary from a reserves adequacy perspective. - For some countries a strengthening of reserve buffers is warranted as financial conditions permit: Malaysia, South Africa, Turkey. - The FCL arrangement in Poland is an effective complement to international reserves, but some additional reserve accumulation is desirable to bolster insurance against external risks. - Adjustment note: An adjustment to Turkey’s reserve adequacy metric for Reserve Option Mechanism-related reserve holdings would reduce the ARA metric to 72 percent (see accompanying country assessment). - The adjusted metric considers that precautionary needs are lower where capital flow management measures (CFMs) may lower the risk of capital flight by residents; ESR countries where this adjusted metric could be considered are China, India, Thailand, and South Africa. ### Global financial conditions, capital flows, and reserve accumulation (Box 2) - Global financial conditions in 2014: - Overall remained accommodative, but financing terms evolved and diverged over 2014. - The U.S. T-10 yield, after rising steeply in 2013, declined gradually throughout 2014. - Risk spreads turned upward after mid-2014 for EMs and more broadly (e.g., U.S. high yield corporate bonds). - Among EMs, sovereign spreads widened most for those affected by the drop in commodity export prices and by geopolitical tensions (especially in late 2014). - External financing conditions nevertheless remained easy for most EMs from a historical perspective. - Capital flows to EMs: - Capital flows to EMs slowed after mid-2014, though not uniformly. - For China, flows declined throughout 2014. - Among other EMs, about a third of the drop in the second half of the year reflected the collapse of flows to Russia. - Country differentiation: India experienced stable gross inflows, in part due to a strengthening policy framework. - Commodity price effects on flows and reserves: - The sharp fall in oil prices shaped patterns and scale of capital flows: for many net oil importers with current account deficits, lower import prices mean temporarily higher current accounts and lower demand for gross external financing. - The counterpart has been reduced current account surpluses and foreign asset accumulation of a relatively small number of large oil exporters. - Reserve accumulation generally slowed and in some cases reversed (Figure 9). - Declines in reserves reflect valuation changes (euro and yen depreciation vis-à-vis the U.S. dollar) and lower accumulation. - Notable declines: China (including estimated foreign exchange sales in early 2015), some oil exporters (Russia, Saudi Arabia), and to a lesser extent Malaysia. - Exception: Switzerland experienced rising reserve holdings starting in late 2014 due to strong capital inflows and appreciation pressure under an exchange rate floor; the central bank removed that floor in mid-January 2015 with limited intervention after end-January. - Last observation for reserve series corresponds to March 2015 (IMF International Financial Statistics). ### Key developments since 2014 and implications for external positions — overview - The ESR annuals focus on outcomes of the most recent calendar year (the analysis of 2014 above), while this section takes preliminary stock of select recent developments (some began in 2014 but were too late to affect 2014 current account outcomes). - These impacts remain to be seen and are subject to much uncertainty; complete assessments of 2015 external positions are not yet possible. A. Lower prices of oil and other commodities - Oil price decline and projections: - The late 2014 plunge in the price of oil and declines in some other commodity prices will have differential impacts on the global pattern of current accounts. - WEO projections are that the 2015 average price, in U.S. dollars, will be about 40 percent below its 2014 average. - The prices of natural gas and other fuels also dropped. - Exposure and short-run impacts: - Exports of oil and natural gas are important to a number of ESR economies, notably Saudi Arabia and Russia, and to a lesser degree Canada and Malaysia. - Most ESR economies are net importers of oil and natural gas and will receive an income windfall from the oil price drop, although the degree varies importantly. - The direct, static valuation effect on the oil trade balance exceeds 1 percent of GDP for many ESR economies, and in some cases is far larger. - In practice, impacts on current accounts will generally be smaller than the initial valuation effect and are likely to decline over time because: - The oil price is projected to recover about half of its decline gradually over the next several years (Spring 2015 WEO). - Exchange rate responses to the terms of trade shock will tend to dampen the effect on the current account. - Oil-related income gains (or losses) will spur increases (or declines) in expenditure that partly offset the initial impact. - The size and speed of the offsetting effect depend on expectations of the duration of the oil price drop and on whether policies allow passthrough of the price drop to consumers in the private sector. - Where the public sector receives the oil-related income gain (loss), the impact on the current account will depend on the public sector’s decision to offset or not its own income gain (loss). - Box 3 highlights that the roughly 40 percent estimated drop of the price of oil from 2014 to 2015 will mean a transfer of income from oil exporters to oil importers worth about 1 percent of world GDP. - The associated income loss for oil exporters will be highly concentrated: five countries account for more than half of all oil exports and 10 countries account for 75 percent. - Among net importers of oil, there is little correspondence between the size of their oil trade deficits and their current accounts; economies which import more oil tend to have stronger non-oil current accounts. - Long-run effects of oil price changes on current accounts may be small or absent as domestic demand and real exchange rate adjustments offset the direct impact. B. Economic and monetary policy divergence and exchange rates - Divergence in growth, inflation, and monetary policy: - Divergence of growth and inflation among major economies and divergence in monetary policies and outlooks have significance for REERs and current accounts. - In late 2014, data and expectations indicated a widening divergence: cyclical recoveries of the U.S. and U.K. were proceeding faster than for the euro area and Japan. - Significant monetary policy easing occurred in Japan in late 2014 and in the euro area in January 2015. - Monetary policy easing steps became widespread in the first few months of 2015 among emerging markets and smaller advanced economies. - Exchange rate movements Aug. 2014–early 2015: - Widespread easing announcements prompted currency depreciations, though labeling this as “competitive easing” is misplaced—policymakers were responding to diminished inflation and growth prospects for their own economies. - Between August 2014 and early March 2015 there were large bilateral exchange rate movements, notably among largest economies and some oil exporters. - The U.S. dollar appreciated against nearly all currencies with flexible exchange rates, but depreciation patterns were not uniform. - Among the weakest currencies in this period: the euro and its nearest trading partners (e.g., Poland, Sweden), the yen, and currencies of oil and gas exporters with flexible exchange rates (e.g., Russia, Colombia, Norway). - Depreciations against the dollar were small for a number of Asian economies with flexible exchange rates and heavy oil import reliance (e.g., India, Korea, Thailand). - Timing and triggers of currency movements: - Initially there was fairly uniform U.S. dollar appreciation. - Late October 2014: announcement of QQE in Japan was followed by substantial yen depreciation in weeks. - Late November 2014: following an OPEC meeting, expectations of medium-term oil prices dropped abruptly and currencies of oil and gas exporters depreciated sharply. - Early 2015: ECB announcement and subsequent implementation of QE associated with substantial euro depreciation; currencies most integrated with the euro area moved along with the euro. - Since mid-March 2015, currency movements were less pronounced and without clear trends, although the dollar weakened and the euro strengthened somewhat; the largest movement was a strong recovery of the ruble. - REER and bilateral exchange rate changes: - Figure 12 reports changes in REER and bilateral exchange rates against the U.S. dollar for Aug. 2014 to May 2015 (difference in log values*100; + indicates appreciation). - Country list shown includes Singapore, Germany, Malaysia, Korea, China, Sweden, Netherlands, India, Japan, Mexico, Poland, Hong Kong SAR, Thailand, Belgium, Switzerland, United States, Italy, Australia, Indonesia, Canada, Russia, Spain, France, Brazil, United Kingdom, South Africa, Saudi Arabia, Turkey, Euro Area. *2015 EXTERNAL SECTOR REPORT, INTERNATIONAL MONETARY FUND.* ### 23. Recent currency movements are unusual in some respects, though not unprecedented. ### 23. Recent currency movements are unusual in some respects, though not unprecedented. ### Recent currency movements: characterization and drivers - The episode is distinguished by the size and abruptness of shifts in bilateral exchange rates among the major economies. - Current REER levels of the U.S., Japan, and the euro area are not unprecedented; China’s recent REER appreciation is notable and abrupt and builds on a much larger appreciation since 2005. - Among EMs, REER movements since mid-2014 generally have not been remarkable relative to those in the last several years, with Russia an exception (much of its very large REER depreciation has been reversed). - The recent episode contrasts with the 2013 “taper” episode, when EMs generally depreciated against all reserve currencies rather than depreciating against the dollar but appreciating against others. - Cross-country analysis shows REER movements were strongly related to exposure to commodity prices (particularly oil and natural gas) and to revisions in economic outlook (see Spring 2015 World Economic Outlook). ### Implications for external positions - Three angles for considering implications: - Commodity-terms-of-trade gains paired with real appreciations: current account likely to rise at first before full adjustment to new real income and relative prices; there may be no long-term implication for the current account. The picture is complicated by uncertainty over the persistence of the oil price drop. - Exchange rate movements arising from domestic demand-driven cyclical divergences: actual current accounts will fluctuate over the cycle due to both domestic demand weakness/strength and currency depreciation/appreciation. If cyclical divergences are temporary, underlying current accounts would not change over the business cycle, but interim exchange rates may diverge from fundamentals and aggregate demand and growth may shift across economies. The underlying issue is deficiency of domestic demand in cyclically-weaker economies. - Where external positions were previously assessed as too weak or too strong: a recent REER movement “in the right direction” does not necessarily correct the underlying external position; lasting correction requires adjustment of expenditure as well as relative prices and addressing longstanding drivers (e.g., too-low saving in Brazil or too-high saving in China). In the absence of domestic demand adjustment, REER shifts may move economies away from full employment; initial REER shifts may not be sustained. ### Baseline outlook for the near term (focus on 2015 projections) - Staff projections highlight the role of the oil price drop in net impacts on current accounts. - Cross-country pattern of current account in 2015 is projected to be broadly similar to 2014; with the exception of Saudi Arabia, changes in 2015 are not large relative to the existing wide range of variation. This holds also for 2016 projections (not shown). - For most economies, the current account is projected to rise in 2015; in most such cases the increase comes mainly or entirely from a rise in these countries’ oil trade balance, driven by reduced oil import bills. Notable exception: Russia, where the current account surplus is expected to rise significantly despite a sizable decline in oil export revenue. - Current accounts are expected to decline for a number of commodity exporters, including Australia, Malaysia, and Saudi Arabia, and to a lesser extent Canada. - A lower current account is projected for Switzerland, and to a lesser extent for the U.S., notwithstanding the narrowing of their oil trade deficits. This decline reflects effects of REER appreciation, as well as domestic demand growth in the U.S. case. - Overall, projected current account shifts in 2015 are correlated with changes in oil trade balances, but have no general correspondence with the current account gaps identified for 2014. Closure of those gaps will require adjustment addressing longstanding drivers. ### Projections for largest economies (2015) - Euro area and Japan: - Projected current account rises by slightly more than the narrowing of the oil trade deficit. - Upward effect of REER depreciation is mostly offset by downward effect of domestic demand growth. - China: - Projected current account rises roughly in line with the oil trade balance. - Non-oil current account essentially flat, as REER appreciation effect is offset by ongoing productivity gains and slower domestic demand growth. - United States: - Projected U.S. current account falls slightly, as a (relatively) small rise in the oil trade balance is more than offset by effects of domestic demand growth and REER appreciation. - Note: The U.S. oil deficit is modest relative to GDP, so the oil price drop means a relatively small gain for the U.S. ### Oil-dominated economies and current account dynamics - Recent shifts of commodity terms of trade and REERs are large enough to be macroeconomically significant for many economies, but implications for current accounts and underlying external positions are complex and uncertain. - For oil-dominated economies, a sustained oil price shock is a watershed: the public sector primarily experiences the income loss and public sector response will largely determine whether the external position weakens on a lasting basis. - It has generally been appropriate for these economies to run large external surpluses (resource exhaustibility, intergenerational considerations, and precaution against oil price drops); a sustained lower oil price calls for downward adjustment of expenditure, potentially proceeding gradually for those with sufficient buffers. - Different experiences among major oil exporters (Box 4): - Five economies (Saudi Arabia, Kuwait, Qatar, UAE, Russia) account for more than half of all oil exports and about 90 percent of the combined surplus of all net exporters of oil. - GCC economies with fixed exchange rates run very large current account surpluses and have sizable buffers; external adjustment is largely fiscal and need not involve sizable REER adjustment. Near-term expenditure adjustment is projected to be much less than loss of oil revenue, and current account surpluses have fallen sharply. - Russia has run current account surpluses (smaller as share of GDP), and in the context of a flexible exchange rate, sanctions, and reduced external financing, has undergone a very large adjustment on the non-oil current account; despite loss of oil revenue, Russia’s current account is projected to rise in 2015. ### When large REER shifts translate into large current account movements (Box 5 insights) - Predicting current account responses to REER shifts requires structural, industry, and macro-context considerations; a simple elasticity approach is partial and may mislead if it ignores concurrent shocks. - Important factors: - Pricing behavior and pass-through of exchange rate changes to prices. - Lags in demand and supply responses and potential nonlinearity (zones of inaction). - Trade openness: countries with larger ratios of exports and imports to GDP tend to be more responsive to exchange rate movements, but high gross exports may have high import content, reducing net impact. - Global value-added chains complicate effects on trade. - Macro context: what is driving the REER change and concurrent developments (especially domestic demand) that affect import demand directly. - Two illustrative cases of REER appreciation: 1. If associated with strong domestic demand growth, combined implications for the current account can be large while implications for aggregate demand and GDP growth may be small. 2. If occurring when domestic demand growth is weak, predicted current account movement will be smaller but negative implications for aggregate demand and growth will be larger; countercyclical policy responses must be considered. - Concurrent changes in terms of trade and productivity raise predicted impacts on current account and growth. - Bottom line: an REER shift alone does not yield a clear prediction of current account movement; much more needs consideration. ### Implications for policies and risks - The existing policy agenda to address excess external imbalances remains relevant; commodity prices and exchange rate changes alone will not overturn the broad pattern of excess imbalances assessed for 2014. - Broad contours of policy action: - For deficit economies: fiscal consolidation, steps to boost private saving and moderate excesses in private demand, and structural reforms to facilitate adjustment. - For surplus economies: policies to support stronger domestic demand. - Demand adjustments should be accompanied by REER changes to avoid deficit economies falling into recession or surplus economies overheating. - Avoid sustained, one-sided reserve accumulation where international reserves are adequate. - Policies should facilitate, not delay, real exchange rate adjustment accompanying demand adjustment. - Among ESR economies with current accounts below norms, gradual fiscal consolidation is often part of the agenda plus policies to raise saving or curb private demand excesses. - For economies with too-low private saving rates (including Brazil, South Africa and Turkey among others), reforms addressing distortions that depress saving would be useful. - Further fiscal consolidation over coming years remains desirable for some (e.g., Brazil, the U.K., and some larger euro area members, particularly France and Spain), with timing and pace dependent on growth and cyclical considerations. Consolidation and demand adjustment should be complemented by relative price adjustment. - Euro area specifics: - Lacking nominal exchange rate adjustment among members, relative price adjustment should be facilitated by product and labor market reforms, boosting productivity and growth. - Easing of euro area monetary policy should facilitate relative price adjustment among members. - Strengthening bank balance sheets, and greater use of fiscal rule space to support structural reforms and public investment, are important. - United States: - The U.S. current account deficit is no longer assessed as excessive relative to the size of the U.S. economy; assessed current account gap for 2014 ranges from -1¼ percent of GDP to zero, suggesting modest further narrowing could be desirable. - Considerable fiscal consolidation has contributed to narrowing the current account gap; some further consolidation over the medium term would be appropriate for fiscal sustainability. - In the near term, if recent U.S. REER appreciation puts downward pressure on growth and inflation, monetary policy decisions will need to take this into account. *Italic: Source — 2015 EXTERNAL SECTOR REPORT, INTERNATIONAL MONETARY FUND (Content unit: 23. Recent currency movements are unusual in some respects, though not unprecedented.)* ### 34. For the ESR economies with current accounts assessed to above norms, a range of ### 34. For the ESR economies with current accounts assessed to above norms, a range of policies would be appropriate ### Policies for economies with above‑norm current accounts - Within the euro area, increased public investment would be beneficial for Germany, boosting growth in addition to affecting the current account. - China and emerging Asia: although excess surplus imbalances have declined importantly over the years, remaining gaps point to policy needs; Korea also has a surplus gap. - 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. - China specifics: - High investment since the global financial crisis has brought down the current account surplus, but private saving remains too high. - Need to rebalance domestic demand toward consumption. - Following the recent sizable appreciation, the real exchange rate appears no longer undervalued. - For now, the non‑oil current account surplus has not declined, and gaps in domestic policies that underlie a high saving rate remain. - Sustained external rebalancing will require continuing to address those gaps, including by implementing the authorities’ reform agenda. - Achieving a flexible, market‑based exchange rate will be a key complement to such policies. ### Mutual support, global demand, and adjustment dynamics - Steady policy action by economies on both sides of excess imbalances would be mutually supportive for external adjustment, and for global demand management and growth. - Current accounts are linked across countries; sustained current account adjustment requires adjustment of domestic demand and has spillover implications for growth and external balances. - If needed demand adjustments were made by economies with excess deficits without upward demand adjustments by those with excess surpluses, the result would be contractionary for the global economy. - Such an outcome is particularly undesirable now, as world output is still below its potential level; overall, the global economy needs demand‑creating policies. ### Recent exchange rate movements and their context - The pattern of recent exchange rate movements appears driven mostly by significant developments in commodity prices and divergences across economies rather than by previously identified gaps. - The direction of the pattern is expected and appears as a conjunctural response beneficial for the overall global economy at this time. - These currency movements will help adjustment to the large oil price shock. - The weakening of the euro and yen relative to the U.S. dollar will help lower the risk of deflation and support recovery in the euro area and Japan, with positive spillovers for other economies, including by easing global financial conditions amid overall global economic weakness. - The net effect on activity in the relatively strong U.S. economy is likely to be negative in the short term, via demand diversion, though this effect may be mitigated by U.S. monetary policy. ### Monetary easing, recovery agenda, and REER assessments - Recent monetary easing in the euro area and Japan appears broadly appropriate to the circumstances but is only one part of a recovery agenda. - Restoration of satisfactory growth ultimately requires stronger growth of domestic demand and a range of other policy measures to create demand and raise productivity and growth. - The REERs (real effective exchange rates): - Japan and the euro area REERs are moderately weaker than levels implied by medium‑term fundamentals. - The U.S. REER is moderately stronger than levels implied by medium‑term fundamentals. - This is expected in current circumstances but is also a symptom of an inadequate economic recovery and a reminder that a broader policy effort is needed. ### Downsides, risks, and financial spillovers - Large movements in nominal bilateral rates can pose costs and risks beyond external positions and trade‑weighted exchange rates: - Costs of possible sectoral dislocation. - Balance sheet risks, e.g., for economies and sectors heavily indebted in U.S. dollar debt. - The 2015 Spillover Report concludes such balance sheet risks, while generally much reduced from the past, remain relevant going forward for some economies and sectors more than others. - Shifting and diverging monetary policies complicate the global financial environment; watch financial risks and spillovers: - QE operations and persistently low interest rates can encourage excessive risk‑taking, including possibly excessively large capital flows to EMs. - Exit from especially accommodative monetary policy can disrupt markets, especially in EMs. - Policymakers, including in EM countries, should be prepared to respond flexibly to disruptions, drawing on a range of tools as appropriate to circumstances. - Economies with the largest current account deficits may be most vulnerable to such disruptions, with possible adverse consequences for other economies. - Risk of disorderly external adjustment in some deficit economies remains—especially if tightening of external financing conditions were joined by policy deterioration at the country level or if other adverse shocks materialize. - Country‑level risks would have spillovers and could possibly have systemic implications; e.g., if a group of EMs or others with excess current account deficits were affected by negative developments at the same time. - Addressing an excess deficit by removing its underlying drivers and adjusting gradually is preferable to a potential disorderly compression of such a deficit triggered by a sudden tightening of external financing supply. ### Scenarios, projections, and vigilance - The pattern of imbalances and excess imbalances will depend on whether policies move in recommended directions and on new financial market and other private sector developments. - The Spring 2015 WEO baseline projection: aggregate imbalances at the global level do not change greatly in the coming years in the absence of further shocks; this baseline assumes a partial recovery of oil prices over the medium term and is based on constant real exchange rates. - It is unlikely that all real exchange rates will be broadly constant going forward, and it is very difficult to predict accurately how they will move. - When significant shifts in exchange rates occur, they must be evaluated in the context of their drivers and other concurrent developments. - Exchange rates and current accounts will often fluctuate in response to new developments; some movements may reflect distortions or excesses. - Drivers may be unclear or mutually reinforcing (e.g., domestic demand, asset prices, credit, and capital inflows expanding strongly while the real exchange rate appreciates and the current account moves into sizable deficit). - External developments warrant ongoing scrutiny to avoid suboptimal scenarios and mounting vulnerabilities that risk painful endings. - Policy agenda calls for steady effort to address sources of existing excess imbalances and for policymakers to be alert to new developments that may add to or create excess imbalances. ### Role and refinements of the External Balance Assessment (EBA) methodology - The ESR staff assessments draw, along with other inputs, on estimates using the External Balance Assessment (EBA) methodology. - EBA analyzes current accounts and exchange rates based on fundamental characteristics and policies; it uses panel regressions to derive values consistent with fundamentals and policy settings. - EBA includes policy factors: fiscal, monetary, public health expenditure (which influences household saving), capital controls and foreign exchange intervention; assessments of desirable policy settings inform policy gaps and contributions. - EBA also includes a separate exercise focusing on external sustainability of NIIP positions and current account balances; used when NIIP stabilization is a dominant concern. - Output: estimated “Total Gaps” for current accounts and real exchange rates, summing estimated contributions of policy gaps (domestic and foreign/ spillover) and a regression residual. - Current account and exchange rate gaps shown in the ESR are staff assessments reflecting EBA estimates plus other information and judgment; EBA estimates are starting points and not adopted mechanically. - Where the regression residual is large, judgment is needed on whether it reflects distortions not captured by the regression or fundamentals missed by the model. - The current account regression‑based approach is often considered more reliable than real exchange rate regression approaches. - EBA refinements and features: - Weakness of REER index approach: indices are influenced by past averages and sustained distortions. - New supplementary tool: a real exchange rate regression using “level” exchange rates rather than indices; it supplements rather than replaces the index‑based tool and requires judgment on reliability. - Treatment of demographic factors has been refined and sample estimation periods extended; EBA models re‑estimated using data through 2013 (previously through 2010). - Treatment of capital controls explored; de jure and de facto indicators are imperfect; choice of index has little effect on overall pattern of EBA current account gap estimates. - Recognizing uncertainty in econometrics and interpretation, the ESR reports current account and exchange rate gaps as ranges. - Uncertainty is especially high in financial center economies with large balance sheets and where the EBA regression has a large unexplained residual. - An essential feature is multilateral consistency: current account gaps “add up” so assessments of too‑strong balances are matched by too‑weak balances. - Overall, staff‑assessed gaps often differ from one or more EBA estimates, but there remains a cross‑country correlation between assessments and EBA estimates, especially strong for current account assessments. *Source: 2015 External Sector Report (selected sections and Annex I).* ### Annex Figures ### Annex Figures ### Actual and EBA Estimated Cyclically Adjusted Current Accounts (Figure A1) - Chart axis range shown: -8, -4, 0, 4, 8, 12 (Percent of GDP). - Countries plotted (in order shown): Germany, Malaysia, Korea, China, Sweden, Netherlands, India, Japan, Mexico, Poland, Thailand, Euro Area, Belgium, Switzerland, United States, Italy, Australia, Canada, Indonesia, Russia, Spain, France, United Kingdom, South Africa, Brazil, Turkey. - Note: "As estimated by EBA model, based on output gap and commodity price cycle estimates. Staff assessments of underlying current account balances may take account of other temporary influences." - Source: IMF Staff Estimates. ### Contribution of Policies to Current Account Gaps (Figure A2) - Chart axis range shown: -6.0, -4.0, -2.0, 0.0, 2.0, 4.0, 6.0 (Percent of GDP). - Countries shown (order): Germany, Malaysia, Korea, China, Sweden, Netherlands, India, Japan, Mexico, Poland, Thailand, Euro Area, Belgium, Switzerland, United States, Italy, Australia, Canada, Indonesia, Russia, Spain, France, United Kingdom, South Africa, Brazil, Turkey. - Policy contribution categories shown in legend: Social Protection, Cap Controls & Intervention, Fiscal (global), Credit, Fiscal (domestic), Unidentified policies & other, Total. - Note excerpts: - "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." - "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 -2 percent of GDP which has an effect on current account gaps of almost 1 percent of GDP." - "Unidentified policies and other represent all the other factors that affect the current account gap, including uncertainty over the size of the gap." - Source: IMF staff calculations from EBA, incorporates desk judgment. ### Staff-Assessed Current Account Gaps and EBA Regression Estimated (Figure A3) - Chart axis ranges shown: -8 to 10 on both axes (Percent of GDP). - Countries plotted (order): Singapore, Germany, Malaysia, Korea, China, Sweden, Netherlands, India, Japan, Mexico, Poland, Hong Kong SAR, Thailand, Euro Area, Belgium, Switzerland, United States, Italy, Australia, Canada, Indonesia, Russia, Spain, France, United Kingdom, South Africa, Brazil, Saudi Arabia, Turkey. - Two series labeled: "EBA (CA regression)" and "ESR staff assessment". - Note: "For Saudi Arabia, the current account gap is a reflection of a fiscal policy gap related to the desirability of saving of oil export income." - Source: IMF Staff Calculations. ### Staff-Assessed REER Gaps and EBA Regression Estimated (Figure A4) - Chart axis ranges shown: -30, -20, -10, 0, 10, 20 on both axes (Percent). - Countries plotted (order): Singapore, Germany, Malaysia, Korea, China, Sweden, Netherlands, India, Japan, Mexico, Poland, Hong Kong SAR, Thailand, Euro Area, Belgium, Switzerland, United States, Italy, Australia, Canada, Indonesia, Russia, Spain, France, United Kingdom, South Africa, Brazil, Saudi Arabia, Turkey. - Series labeled: "EBA (from Index of REER regression)", "EBA (from Level of REER regression)", and "ESR staff". - Note: "In light of the special structure of the economy of Saudi Arabia, a REER gap is not identified in this case." - Source: IMF Staff Calculations. ### Cyclically-Adjusted Current Account Balances, 2011–2014 (Figure A5) - Chart axis ranges shown: -8, -6, -4, -2, 0, 2, 4, 6, 8, 10, 12 (Percent of GDP). - Countries plotted (order): Germany, Malaysia, Korea, China, Sweden, Netherlands, India, Japan, Mexico, Poland, Thailand, Euro Area, Belgium, Switzerland, United States, Italy, Australia, Canada, Indonesia, Russia, Spain, France, United Kingdom, South Africa, Brazil, Turkey. - Series by year shown: 2011, 2012, 2013, 2014. - Note: "As estimated by EBA model, based on output gap and commodity price cycle estimates. Staff assessments of underlying current account balances may take account of other temporary influences." - Source: IMF Staff Estimates. ### Net International Investment Positions, 2012–2014 (Figure A6) - Chart axis ranges shown: -100, -50, 0, 50, 100, 150, 200, 250, 300 (Percent of GDP). - Countries plotted (order by vertical labels): Hong Kong, Singapore, Switzerland, Saudi Arabia, Japan, Netherlands, Belgium, Germany, China*, Russia, Canada, UK, Korea, Malaysia*, South Africa*, Euro Area, France, India, Thailand*, Sweden*, Brazil, Italy, United States, Mexico, Indonesia*, Turkey, Australia, Poland*, Spain. - Years plotted: 2012, 2013, 2014. - Footnote: "* Data for 2014 is not available for these countries." - Source: (implied from figure) IMF dataset/chart. ### REER of Largest Economies, January 1980 – May 2015 (Figure A7) - Series plotted: log of REER index, Jan 2012=100, identical scaling across countries. - Sources: INS and GDS. - Countries displayed with log axis spanning roughly 4 to 5: United States, Japan, Euro Area, China (each panel shows "Lo g REER INS Index 2012m1=100" and "Log REER GDS Index 2012m1=100"). ### Actual REER: Monthly and Yearly Average, January 2010 – May 2015 (Figure A8) - X-axis monthly ticks shown from 2010m1 through 2015m5. - Y-axis label values sample shown: 65, 75, 85, 95, 105, 115, 125 (index scale). - Multiple country panels with identifying numbers (panel labels visible): - 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 - Sources: INS and GDS. ### Estimated Output Gaps, 2014 (Figure A9) - Chart axis ranges shown: -6, -5, -4, -3, -2, -1, 0, 1, 2 (Percent of Potential Output). - Countries plotted (order): Singapore, Germany, Malaysia, Korea, China, Sweden, Netherlands, India, Japan, Mexico, Poland, Hong Kong SAR, Thailand, Euro Area, Belgium, Switzerland, USA, Italy, Australia, Canada, Indonesia, Russia, Spain, France, UK, South Africa, Brazil, Saudi Arabia, Turkey. - Note: "Source: WEO. Saudi Arabia n.a." *Source: _062615 - Annex Figures (IMF Staff figures and notes).* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2015/_062615.pdf_