l-6 assessing the external position - bank indonesia · 2019-07-31 · this training material is...
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L-6
Assessing the External Position
Presenter
Yoke Wang Tok
IMF − Singapore Regional Training Institute
OT 18.52 Macroeconomic Diagnostics February 26 – March 2, 2018
Objectives
Part I
• Provide a broad overview of external sector issues, focusing on diagnostic tools
• Examine the current account from a saving-investment perspective and a trade perspective.
• Explore the financial accounts seeking answers as to how the current account is financed.
Part II
• Define the nominal and real effective exchange rate
• Estimating equilibrium real effective change rates
MDS2
Overview of Main Issues
Over the past two decades, financial globalization has accelerated due to:
- liberalization of capital controls- improved technologies and lower costs
Financial globalization was expected to bring about large benefits
- better global allocation of capital- improved international risk-sharing possibilities
The surge in financial flows, however, also brought with it a spate of costly currency and financial crises
MDS3
Overview of Main Issues
The frequency and costs of crises stimulated interest in methods to diagnose external vulnerabilities and assess whether a country’s external position can be regarded as sustainable
In practice, whether an external position is sustainable requires assessments of
- Balance of payment flows- The real exchange rate- External debt- International reserves and the net foreign asset (NFA) position, and - The expected evolution of these variables over the medium term under
a set of policy parameters
4MDS
Part I: External Sector Assessment
5
External Sector AssessmentKey Analytical Questions
• What is driving recent trends in the Balance of Payments?- Current account- Capital and financial account
• Is the current account deficit or surplus excessive?
• How do we measure nominal and effective exchange rates?
• How do we assess competitiveness?
• Is the real exchange rate in equilibrium?-Concepts behind External Balance Assessment (EBA)-Measuring and Assessing Equilibrium Exchange Rate
6MDS
Conceptual Framework
7
External Sector Assessment
ER & Competitiveness
Capital & Financial Accts
Current Account
External Balance Assessment
All Relevant Indicators: Examples(use judgment)
Export Shares, Remittances, CA/Capital Controls, Unit Labor Costs, Terms of Trade, Business Environment, Mismatches—Currency/Maturity, External Financing Requirement
Reserves & Intervention
External Balance Sheet
Reserve Adequacy
Flows Stocks
External Sector AssessmentGuidance
Undertake a comprehensive assessment of the external position using a broad set of indicators
Analyze the role of domestic factors in generating external imbalances
Consider country-specific circumstances: e.g. income level, oil exporter or financial center.
What is your bottom line?- Is the external position consistent with macro fundamentals?- Are there any risks in the short term?- Is the position sustainable over the long term?
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Resources Available
IMF - External Balance Assessment (EBA and EBA-lite)- Debt Sustainability Analysis (External DSA) : L7- IMF Reserve Metric: L7
Other- Competitiveness Indicators (price and non-price)- Constant Market Share Analysis
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Balance of Payments
10MDS
Current Account
The current account balance is the difference between exports and imports of goods and services plus net income plus net current transfers
- Net income (Yf) includes:- interest paid on foreign debt- interest received on foreign assets- profit remittances- reinvested earnings- labor income paid to nonresidents
- Net current transfers (TRf) includes:- official and private grants- worker remittances from/to abroad
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CAB=X – M + Yf +TRf
Capital and Financial Account
The capital and financial account records transactions between residents and nonresidents that involve financial assets and liabilities, as well as capital transfers and acquisition and disposal of non produced, nonfinancial assets. They include:
- Key elements of Capital Account:- grants to finance acquisition of a fixed asset- debt forgiveness- international transactions in land & other natural resource rights
- Key elements of Financial Account - foreign direct investment- debt flows- equity flows
Depending on presentation, can include reserves and errors and omissions
Flows over time determine changes in the NIIP
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CA +E&O = - (ΔFI + ΔRES)
Usually very small
Balance of Payments Accounts(usually in US$ or euros)
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Current Account (CA)
Trade
Exports
Imports
Services
Income
Interest
Profits
Wages
Transfers (current)
Capital and Financial Account
Capital Account
Financial Account
Direct investment (FDI)
Portfolio investment
Equity
Debt
Other investment
Net international reserves (-RES)
Errors and Omissions
MDS
14
Billions of US$Current account balance (CAB) -29.1 -27.5 -17.7 -21.3
Balance on Goods and Services -6.2 -3.0 5.0 1.8
of which: Balance on Goods 5.8 7.0 13.3 12.3
of which: Balance on Services -12.1 -10.0 -8.3 -10.6
Exports of goods and services (XGS) 205.0 198.8 170.6 170.8
Goods 182.1 175.3 148.4 147.5
o/w Oil 17.9 13.8 7.8 6.7
o/w Non-oil 164.2 161.5 140.5 140.8
Services 22.9 23.5 22.2 23.4
Imports of goods and services (MGS) 211.3 201.9 165.6 169.1
Goods 176.3 168.3 135.1 135.1
o/w Oil 40.4 37.7 20.9 19.1
o/w Non-oil 135.9 130.6 114.1 116.1
Services 35.0 33.5 30.5 33.9
Primary Income, Net (Y) -27.1 -29.7 -28.2 -28.9
Income credit 2.6 2.1 2.8 3.5
Income debit 29.7 31.8 31.0 32.4
of which: Interest 1.4 1.2 1.0 0.0
of which: Other debit 28.3 30.6 29.9 32.4
Secondary Income, Net (TRF) 4.2 5.2 5.5 5.8
Memorandum Item:
Primary current account balance (CAP) -27.7 -26.3 -16.6 -21.3
Gross domestic product (in US$ billion) 914.6 890.6 859.0 941.0
A. Current Account (Billions of US$)
Indonesia: Current Account Balance
2013 2014 2015 2016
15
Billions of US$Financial Account -22.3 -45.1 -16.9 -30.8
Direct investment, net (FDI) -12.2 -14.7 -9.9 -11.1
Direct investment: Assets 11.1 10.4 9.3 10.3
Direct investment: Liabilities 23.3 25.1 19.2 21.4
Portfolio investment, net -10.9 -26.1 -16.7 -21.6
Portfolio: Assets 1.3 -2.6 1.0 1.4
Portfolio: Liabilities : Equity Securities -1.9 3.3 -1.5 3.8
Portfolio: Liabilities : Debt Securities 14.0 20.2 19.3 19.2
Other investment, net 0.8 -4.3 9.8 1.8
Other investment: Assets 3.4 3.4 11.2 0.6
Other investment: Liabilities 2.6 7.7 1.4 -1.3
Change in international reserves (- =
decrease) -7.3 15.2 -1.1 9.6
Memorandum Item:
Errors and omissions -0.5 -2.3 -0.3 0.0
Total debt inflows, net 16.6 27.9 20.7 17.9
Other Asset Flows (OAF) -38.9 -73.0 -37.5 -48.7
Stock of International Reserves (Bil US$) 99.4 111.9 105.9 115.5
*Capital Account is close to zero and not shown
C. Financial Account* (Billions of US$)
Indonesia: Financial Account 2013 2014 2015 2016
CA balance and financing the BOP
The current account balance can be thought of as the mirror image of changes in the capital and financial account of the BOP and changes in international reserves
CA = - (ΔFI + ΔRES)
This is an identity and does not imply causality
BOP data can be weak and deviations from the above identity are recorded as “errors and omissions”
16MDS
Analyzing the Current Accountbasic frameworks
Savings-Investment (S-I) perspective
Trade perspective
17MDS
Analyzing the Current AccountBasic Frameworks
Different frameworks for analyzing the current account could result in different perspectives for:
- Explaining the drivers of recent developments- Policy recommendations to address vulnerabilities
It is common to think of current account developments as being largely driven by exports and imports. From this perspective, exchange rates and competitiveness play a major role.
Before discussing this important topic, let’s consider the current account from a Savings-Investment (S-I) perspective
18MDS
Savings-Investment PerspectiveCA link to national accounts
19
GDP = C + I + X – M
Current AccountGross NationalDisposableIncome
Domestic Demand
GNDI = C + I + X – M + Yf +TRf
GNDI – C – I = CAB
(SG – IG) + (SP – IP) = CAB
GNDI –DD = CAB
Fiscal Policy
S – I = CABor
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Savings-Investment PerspectiveCA balance as inter-temporal choice
The current account balance seen from the perspective of the difference between savings and investmentmay be viewed as an additional source of financing or accumulation of assets
An open capital account thus affords an opportunity for a country to:
- increase current C or I by reducing the country’s net foreign asset position, and subsequently face repayment
- increase future C or I by increasing the country’s net foreign asset position, which means reducing current C and I.
20MDS
Savings-Investment PerspectiveCA drivers
Is current account deficit being driven by:
- Low savings?- High investment?- Is the source of imbalance private or public?- What are policy implications?
Similar questions for excessively large CA surpluses
21MDS
Trade Perspective
A more classic view considers the main drivers of the current account as:
- imports and exports- exchange rates and competitiveness
In today’s lecture we will discuss the determinants of exports and imports, but will leave a detailed presentation on exchange rates and competitiveness for later.
22MDS
Imports
+ +M = f (GDP, REER)
+ -M = f (GDP, Pm/PGDP)
M: Real ImportsGDP: Real GDPPm: Import deflatorPGDP: GDP deflatorREER: Real effective exchange rate (increase=appreciation)
Alternatives to GDP: absorption, GNI for aggregate imports; consumption, investment for disaggregated importsAlternatives to CPI-based REER: WPI, PPI, or ULC-based REER, etc.Potential additional variables: international import prices, ER volatility, capacity utilization, trade policy variables, etc.
23MDS
Exports
+ -X = f (PARGDP, REER)
+ +X = f (PARGDP, Px/PGDP)
X: Real exportsPARGDP: Trading-partner country GDPPx: Export price deflator (local currency)PGDP: GDP deflator
Empirical work usually includes measures of partner activity as it can be significant, even for a “small country”.
Additional variables: international export prices, ER volatility, capacity utilization, trade policy variables, etc.
24MDS
Import and Export Elasticities
The response of export and import volumes to price and income changes depends critically on elapsed time.
Empirical work generally shows quite small short-term elasticity coefficients, with estimates increasing over longer time periods.
25
EXPORTS Typical
Relative Price Elasticity: estimates
ST (1 year)
Commodities 0.1 to 0.7
Manufactures 0.5 to 1.0
LT (2 years) 0.5 to 2.0
Scale Elasticity 1.0 to 2.0
IMPORTS Typical
Relative Price Elasticity: estimates
ST (1 year) -0.1 to -0.7
Commodities lowest
Luxury goods highest
LT (>1 year) -0.5 to -1.5
Income Elasticity 1.0 to 2.0
MDS
Capital and Financial AccountAdvanced and Emerging Market Trends
Capital flows have grown over the past couple of decades in both size and volatility
Capital flows to EMs are larger as a percentage of GDP than AMs
Historically, EM flows have been largely FDI, but in the run up to the 2008 global crisis, portfolio and “other investment” (mainly bank-related) increased
Debt flows have proven more volatile and riskier to the financial system than FDI and portfolio equity flows
26MDS
Capital Flows to AMs and EMs
27MDS
SummaryIdentifying BOP trends
Potential drivers of current account changes:- competitiveness- domestic savings or investment- domestic or external cyclical factors- commodity prices
Composition of capital and financial account:- reliance on debt vs. non debt flows- reliance on volatile vs. stable capital flows- reliance on fx reserves to finance BoP balance
Are these effects temporary or persistent?How are stocks evolving: NIIP, external debt, reserves?Are domestic policy distortions contributing to CA?
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SummaryDifficulty of interpreting a current account deficit
As we have seen, the interpretation of whether a current account deficit is desirable or is too high or too low can only be made taking into account a wider view of the macroeconomic situation and the cause of the deficit
Nonetheless, countries with high current account deficits are in general more at risk in times of global uncertainty and risk aversion as shown in the following chart
29MDS
SummaryHigher deficits can increase vulnerability
30MDS
SummaryIdentifying external imbalances
Ultimately, question of “appropriate” size of CA balance is at the core of external sector analysis.
Need to take into account:- Cyclical (temp) and structural (permanent) factors- Stability and sustainability of sources of capital and
financial account flows (debt vs. non-debt)
The External Balance Assessment Methodology (EBA) and the External Debt Sustainability Analysis (DSA) are useful tools for this.
31MDS
Part II: Exchange Rates Assessment
32
Exchange Rates AssessmentOverview
• Exchange rates are central to external sector analysis.
• Overvalued ER - loss in price competitiveness:
- Slower growth and lower employment
- Unsustainable current account deficit. BOP crisis?
• Undervalued ER:
Growth above potential → Overheating and inflationary pressures
Excessive BOP surplus → over-accumulation of costly reserves
Depressed real wages and consumption
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Concepts of Exchange Rates & Competitiveness
Nominal Exchange Rate
The bilateral nominal exchange rate is the price of one unit
of a currency in units of another currency:
• R: price of one unit of the foreign currency expressed in units of
the domestic currency (e.g.: 1.27 Singapore Dollar = 1 US$)
• E: price of one unit of the domestic currency expressed in units
of the foreign currency (e.g.: 0.78 US$ = 1 Singapore Dollar)
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1E
R
36
Bilateral Nominal Exchange Rate
Symbol Units Appreciation ofdomestic currency
Depreciation of domesticcurrency
E $/Dom(IMF) ↑ ↓
R Dom/$(Textbook) ↓ ↑
Domestic currency =DomForeign currency =$
37
Bilateral Nominal Exchange Rate Bilateral rates send conflicting messages about the nominal value of a country’s currency against the USD
60
80
100
120
140
160
180
China Japan Philippines Thailand Indonesia
Source: CEIC Data Co.
Appreciation
January 1999 = 100
Nominal Effective Exchange Rate
Neither E nor R indicate how the currency of a country moves relative to the currencies of all its trading partners
The Nominal Effective Exchange Rate (NEER) is a geometric weighted average of bilateral nominal exchange rates of a currency against currencies of selected countries
• i = 1,…N the foreign country/economy• wi weight of currency of country i• t time index
MDS38
iw
ti
N
i
t ENEER )( ,
1
Real Exchange Rate
Neither E, nor R, nor the NEER indicate the relative (real) price ofgoods: given prices in local currencies and the exchange rate, does 1 bag of Thailand-produced rice exchange for 1 bag of U.S.-produced rice of the same type?
We need to use the real exchange rate (RER): nominal exchange rate times the ratio of the price levels:
MDS39
*
pRER E
p
RER = the real exchange rate
E = the nominal exchange rate
P= the domestic price level
P*= the foreign price level
The Real Exchange Rate
Consider
Example 1: suppose that E is fixed; if p increases more than p* (RER ) goods produced domestically (“Thailand”) become more expensive than the same goods produced externally (the “U.S.”): there is less incentive to buy / produce these goods domestically
Example 2: suppose that E decreases by 5%, p increases by 20% and p* by 10% (RER by about 5%); even if domestic currency becomes cheaper, domestic goods becomes more expensive than foreign goods
*
pRER E
p
Real Effective Exchange Rate
Even if we have bilateral RERs for all trading countries, how can we aggregate (i.e., average them) to obtain one single index?
The real effective exchange rate (REER) of a currency is the weighted geometric average of bilateral real exchange rates of that currency against the currencies of selected countries or groups of countries
• i = 1,…N the foreign country/economy• wi weight of currency of country i• t time index
MDS41
iw
ti
N
i
t RERREER )( ,
1
Why REER?
• Why is such an adjustment sensible for competitiveness assessment?
– A nominal depreciation matched by a positive inflation differential with trading partners leaves relative prices of domestic and foreign goods, expressed in a common currency, unchanged
– Similarly, a nominal depreciation matched by a rising cost differential gives exporters no additional edge over foreign competitors
43
Indicators of CompetitivenessREER AND NEER developments often diverge (1996 – 2011) [Jan 1996 = 100]
90
110
130
150
170
190
1996 1998 2000 2002 2005 2007 2009 2011 2014
NEER REER
China
60
70
80
90
100
110
120
130
1996 1998 2000 2002 2005 2007 2009 2011 2014
India
0
20
40
60
80
100
120
1996 1998 2000 2002 2005 2007 2009 2011 2014
Indonesia
Source: Haver Analytics
40
60
80
100
120
140
1996 1998 2000 2002 2005 2007 2009 2011 2014
Thailand
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ASEAN: diverging REER developments
80
85
90
95
100
105
110
115
120
125
Indonesia Thailand Malaysia Philippines
Real Effective Exchange Rates in ASEAN4(January 2011 = 100)
Source: IMF INS
45
Choice of Price or Cost Index
• Aggregate Price Index based measures– Consumer price index
– Wholesale or producer price index
– Export unit values
– GDP deflator
• Unit labor cost (ULC) based measures
• REERs based on CPIs and ULCs most common
• IMF publishes REERs based on CPIs for almost all countries and ULC-based REERs for most industrial countries
REER and Competitiveness
Analyzing REER trends provides insights into price competitiveness -> export performanceE.g. trade balance, export market shares, trade links
However, appreciation of REER over time does not necessarily indicate a loss of competitiveness (and vice-versa):
1) Export performance can also be influenced by non-price factors: quality, allocation of resources, etc.
2) REER appreciation can be consistent with the equilibrium REER appreciation
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47
Indonesia: What is this Picture Telling Us?
0,00006
0,00007
0,00008
0,00009
0,0001
0,00011
0,00012
0,00013
0,00014
50
70
90
110
130
150
170NEER REER USD/INR
Exchange Rates: Indonesia(Rebased, Jan 2010 = 100)
Sources: Haver; CEIC Data Co.
Depreciation of Local currency
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IMF methodology to estimate equilibrium REER
• Measuring and Assessing Equilibrium Exchange Rate
• Concepts behind External Balance Assessment (EBA)
• The REER is in “equilibrium” if it is consistent with internal and external balance:
• Internal balance: no output gap and no inflationary pressures
• External balance: current account is financed with a sustainable level of capital flows
Equilibrium and Internal/External Balance
• Economic impact
– External balance is important for economic stability competitiveness
– Overvaluation of a currency may induce global investors to speculate on a devaluation
– REER expectations may affect borrowers’ decisions about borrowing in national/foreign currency
– International/domestic politics
Why Do We Care About Equilibrium REERs?
MDS51
IMF methodology to estimate equilibrium REER
• Measuring and Assessing Equilibrium Exchange Rate
• Concepts behind External Balance Assessment (EBA)
EBA: Overview
• EBA consists of :
a) CA regression approach
b)REER regression approach
c) ES approach
• Not intended to be a forecast.
52
EBA: Overview
EBA: Overview
• Two stages:1. Positive (descriptive) analysis using regressions in order to understand
the CA and REER.
2. Normative analysis, where
• Norm = the level consistent with fundamentals and “desirable” policy settings
• CA and REER “gaps” interpreted as consequences of distortions and policy gaps
• Broader set of factors—policies, cyclical conditions
and global capital market conditions
http://www.imf.org/external/np/res/eba/index.htm
Broader Analysis
• Policies– Reserves/FX intervention
– Safety nets (public health expenditure)
– Capital controls
– Monetary policies
– Financial policies
• Fundamentals – Resource temporariness
– Growth forecast
– Cyclical conditions
– Global capital market conditions
Decomposition of the CA
CAit = (Cyclical/Temporary)it δ
+ α + (Fundamentals)it θ + P*it γ
+ (Pit - P*it) γ
+ (Residual)it
55
(1) Cyclical/temporary component:Subtract this from CA to compute“cyclically adjusted CA”.
(2) “Desirable norm”:Determined by fundamentals and “desirable” settings of domestic and foreign policies
(3) “Policy gap” or “policy distortions”:Deviations of “actual” policies from “desirable” settings, both domestic and foreign
(4) Residual, unexplained
(3)+(4) “Total EBA gap”
Think of possible determinants of the long-run S – I balance, such as:
Fiscal policy (a surplus contributes to saving);
Productivity (high productivity countries lend to low productivity countries and have higher CA balances);
Population dynamics (an expanding population draws down national savings);
Country risk (riskier countries attract less capital inflows to finance CA deficits)
Fundamentals
• Derive the Current Account (CA) Gap
• Once the CA Gap is known, calculate the REER that is needed to close the gap
• The CA balance does not need to be zero in the medium-term equilibrium. It will depend on the level of savings and the return on domestic investment relative to investments abroad.
Current Account Approach
Policy Gaps
• Policies of home country and trading partners can affect the external position
• Policy gaps: difference between actualpolicies and desirable policies
• Example: if the home country has a larger-than-desirable fiscal deficit, national savings is likely to be lower than desirable leading to an imbalance
• Issue: identifying desirable policies requires A LOT of judgment; easy to disagree
EBA: Indonesia 2016
Source: IMF Article IV for Indonesia (2017)
• Analyzing recent trends in the BOP can reveal weaknesses in different parts of the economy
• Examining CA developments from the trade perspective yields insights into a countries competitiveness
• Studying the CA from the savings-investment perspective forces one to consider the sources of financing
• Large CA deficits are not necessarily a concern but it does matter how it is financed and whether it is temporary or permanent
• Exchange rates are central to external sector analysis. Under- or overvaluation of exchange rates could be symptoms of internal or external imbalance
• The EBA methodology is used for assessing current accounts and exchange rates in a multilaterally consistent manner
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Key takeaways
The End
61