Public Information Notice: IMF Executive Board Discusses Balance Sheet Approach to Analysis of Debt-Related Vulnerabilities in Emerging Markets

March 22, 2005

Public Information Notices (PINs) are issued, (i) at the request of a member country, following the conclusion of the Article IV consultation for countries seeking to make known the views of the IMF to the public. This action is intended to strengthen IMF surveillance over the economic policies of member countries by increasing the transparency of the IMF's assessment of these policies; and (ii) following policy discussions in the Executive Board at the decision of the Board.

On October 20, 2004, the Executive Board of the International Monetary Fund (IMF) held a seminar to discuss the staff's application of the balance sheet approach to the analysis of debt-related vulnerabilities in emerging markets.


The Executive Board's discussion was focused on the staff paper "Debt-Related Vulnerabilities and Financial Crises-An Application of the Balance Sheet Approach to Emerging Market Countries." The paper takes a broad look at the evolution of various balance sheet indicators in emerging markets over the past decade, and examines in more detail several recent crisis and near-crisis cases. The paper's main purpose is to demonstrate how balance sheet analysis can be applied to assess international linkages and vulnerabilities, even with limited data. To this end, it advocates the use of a range of simple indicators and comparisons over time and between countries that provide a natural calibration of the results. The paper's policy conclusions echo the findings of recent staff work on liquidity management, confirming the importance of appropriate liquidity buffers, strong banking supervision, and sound liability management.

Executive Board Discussion

Ms. Anne O. Krueger, First Deputy Managing Director and Acting Chair of the Executive Board seminar, made the following remarks at the conclusion of the discussion:

The purpose of this seminar was to update the Board on one line of the staff's efforts at improving vulnerability analysis: the so-called balance sheet approach. A sectoral look at currency and maturity mismatches has proved useful as a complement to traditional flow-based analysis. The cross-country analysis and case studies-albeit ex post-presented in the paper for today's seminar illustrate how the debt structure and balance sheet mismatches can contribute to financial crises. The analysis of intersectoral linkages can provide useful insights as a diagnostic tool for detecting potential vulnerabilities, notwithstanding data limitations.

Directors had an opportunity to comment on our ongoing work in this area at two earlier informal seminars, in July 2003 and March 2004. Directors recalled that, at the most recent biennial review of surveillance, they had urged the staff to continue to refine such analytical techniques. The paper discussed today responded to calls by the International Monetary and Financial Committee to deepen cross-country analysis and monitor progress in reducing balance sheet vulnerabilities.

Developing a balance sheet approach is work in progress, and much more work is needed at both the analytical and operational levels. The discussion today has been very helpful in sharpening the staff's focus on the issues that need to be resolved to make this approach more operational. Directors have made many useful comments and suggestions, particularly on the design of specific vulnerability indicators and the direction, focus, and possible extension of the work program, which the staff will take into account in pursuing the balance sheet approach further.

Given the numerous analytical problems that still need to be resolved, I sense that Directors generally agree with the deliberate pace at which the staff has been integrating insights from the balance sheet approach into Fund operations, especially with respect to country surveillance. Our "soft" approach reflects, inter alia, resource and data constraints, which the staff will keep in mind when applying the balance sheet approach for vulnerability analysis. The need to avoid a mechanistic approach cannot be overemphasized. I should stress that there is no intention, at this point, to make the balance sheet approach a standardized element of Fund surveillance.

Going forward, we will work with member countries to improve the statistical basis for more meaningful assessments of balance sheet vulnerabilities, with due regard to balancing the costs and the benefits of such an endeavor to member countries. Raising authorities' awareness about intersectoral linkages and associated risks should help provide an additional incentive for improving the timeliness and quality of data. Country teams are encouraged to apply balance sheet analysis where they see fit, while being sensitive to country-specific circumstances, including the exchange rate regime, the degree of financial system development, and the openness of the capital account. Cross-country and intertemporal comparisons can help put balance sheet vulnerabilities in perspective.

The balance sheet analysis should preferably be applied to all countries. But, given our resource constraints, the priority of the Fund's work at this stage will necessarily be on countries where balance sheet weaknesses, particularly currency mismatches, appear largest and where our efforts will add the most value in terms of reducing vulnerabilities. These include emerging market countries and those of systemic importance where balance sheet developments can generate negative regional or international externalities. The staff will continue to work with industrial countries to refine balance sheet analysis, and to integrate the assessments into Article IV consultations where relevant. Specifically, the staff intends to continue to apply balance sheet concepts in its study of the potential risks from equity and housing price bubbles in mature countries.

As experience with the balance sheet approach and more cross-country data mount, we will continue to assess how fast and how far we can go in our future work. In due course, we will come back to the Board with a review of balance sheet studies to date, including lessons learned and a way forward.


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