Table 2. Selected
Corrections of Large Current Account Deficits
and Associated Output, Real Exchange Rate, and Reserve Changes (In
percent) |
|
|
Years |
Change in Ratio of Current Account to GDP |
Change in Rate of Growth of GDP |
Change in Real Effective Exchange
Rate1 |
Change in Reserves2 |
Memorandum: Initial Current Account
Ratio |
|
Industrial countries |
Iceland |
198283 |
6.3 |
4.3 |
17.0 |
30.9 |
8.3 |
Greece |
198586 |
4.2 |
1.5 |
9.6 |
8.2 |
10.3 |
Italy |
199293 |
3.5 |
1.4 |
17.1 |
46.4 |
2.3 |
Finland |
199293 |
3.6 |
2.63 |
26.6 |
21.9 |
4.6 |
Developing countries |
Mauritania |
198889 |
21.4 |
0.9 |
8.9 |
28.0 |
6.4 |
Chad |
198687 |
14.9 |
2.83 |
24.5 |
54.0 |
7.9 |
Venezuela |
198889 |
14.7 |
1.63 |
3.3 |
58.7 |
9.2 |
Ecuador |
198283 |
7.5 |
4.1 |
7.0 |
51.5 |
8.5 |
Mexico |
198283 |
7.3 |
7.4 |
40.3 |
70.0 |
3.7 |
Turkey |
199394 |
5.6 |
13.2 |
17.0 |
7.0 |
3.7 |
Mali |
198687 |
5.3 |
7.3 |
19.6 |
57.7 |
10.3 |
Philippines |
198384 |
4.8 |
9.2 |
16.8 |
5.9 |
5.3 |
Kenya |
198081 |
4.0 |
1.8 |
4.5 |
33.8 |
12.3 |
|
Source: IMF, World Economic Outlook
and International Financial Statistics databases.
1Change of relative consumer price indices over the two
years. 2In first year. 3Average
output growth in the two years.
|
Expanded Private Capital Flows
As has been well documented elsewhere (for instance, by Mussa
and others (1994), and Goldstein and others (1993)), the size and
agility of private capital flows have vastly expanded in recent
decades. This development has had two major implications for the
international monetary system. First, it has made it more difficult
to maintain pegged exchange rates when the market comes to believe
that the exchange rate peg may not be viable--a difficulty that may
have been compounded by the fact that the stock of reserve assets
has not grown commensurately with private capital
flows.10 Second, it has allowed
countries to finance
current account deficits (and surpluses), presumably benefiting both
creditors and debtors, but also apparently delaying desirable
adjustment in some circumstances.
Table 3. Selected
Industrial and Middle-Income Developing Countries: Monthly Changes
in Gross Reserves (198593) Relative to IMF Quota |
|
|
Standard Deviation |
Maximum Loss (In percent of currentquota) |
Month/Year of Maximum Reserve Loss |
|
Industrial countries |
Australia |
19 |
56 |
1/92 |
Austria |
30 |
108 |
3/91 |
Belgium |
16 |
49 |
9/92 |
Canada |
16 |
49 |
9/92 |
Denmark |
61 |
215 |
1/93 |
Finland |
60 |
222 |
10/91 |
France |
20 |
64 |
11/93 |
Germany |
65 |
281 |
10/92 |
Greece |
61 |
116 |
10/93 |
Iceland |
32 |
99 |
9/92 |
Ireland |
54 |
240 |
9/92 |
Italy |
36 |
127 |
7/92 |
Japan |
22 |
61 |
3/90 |
Netherlands |
22 |
33 |
3/93 |
New Zealand |
31 |
97 |
6/88 |
Norway |
55 |
240 |
11/92 |
Portugal |
106 |
579 |
9/92 |
Spain |
83 |
530 |
9/92 |
Sweden |
78 |
317 |
11/92 |
Switzerland |
46 |
120 |
1/93 |
United Kingdom |
14 |
31 |
9/92 |
United States |
5 |
13 |
3/91 |
Middle-income developing
countries |
Argentina |
24 |
57 |
3/91 |
Bolivia |
18 |
55 |
1/90 |
Brazil |
30 |
60 |
1/86 |
Chile |
23 |
35 |
1/86 |
Colombia |
23 |
71 |
10/93 |
Costa Rica |
23 |
72 |
5/90 |
Egypt |
34 |
153 |
11/90 |
El Salvador |
21 |
61 |
5/90 |
Hungary |
27 |
45 |
12/92 |
Indonesia |
18 |
31 |
5/90 |
Israel |
46 |
98 |
10/91 |
Jordan |
57 |
334 |
8/91 |
Korea |
58 |
196 |
12/89 |
Malaysia |
68 |
193 |
12/92 |
Mexico |
52 |
167 |
11/93 |
Morocco |
20 |
38 |
3/89 |
Paraguay |
39 |
160 |
10/92 |
Peru |
18 |
47 |
9/91 |
Philippines |
30 |
96 |
5/93 |
Poland |
15 |
54 |
12/90 |
Singapore |
93 |
161 |
3/91 |
South Africa |
8 |
23 |
9/92 |
Thailand |
37 |
59 |
7/92 |
Tunisia |
27 |
93 |
4/91 |
Turkey |
36 |
112 |
12/93 |
Uruguay |
19 |
103 |
11/86 |
Venezuela |
15 |
28 |
7/90 |
|
Source: IMF staff calculations.
|
Maintaining exchange rate pegs
The crises of 199293 involving the Exchange Rate Mechanism
(ERM) of the European Monetary System (EMS) are the clearest recent
example of the difficulties of maintaining exchange rates in narrow
bands around central parities. The experience of this period
suggests the importance of early adjustment of unsustainable
exchange rates, the need for consistent and credible macroeconomic
policies to validate a fixed peg, and the massive force of
speculative flows when parities are not considered to be sustainable
by the private capital markets. Indeed, the experience during the
ERM crises indicates that, in the modern situation of international
capital mobility, massive pressures can arise because of doubts
about the sustainability of exchange rates, even if those exchange
rates appear to be in line with fundamentals.
However, access to private capital flows can also assist in the
defense of pegged exchange rates by enabling governments to secure
additional (borrowed) reserves with which to intervene in the money
markets. For example, during the ERM crisis in 1992, the United
Kingdom arranged a foreign currency borrowing program valued at ECU
10 billion, and Sweden arranged for credits totaling ECU 31 billion,
to help defend their exchange rates. In both instances, efforts to
defend the official parities proved unsuccessful. Thus, while access
to private capital flows may assist in defending pegged exchange
rates, it is clearly no guarantee of success.
Financing current account deficits
Current account deficits can arise for various legitimate
reasons (that is, not related to inappropriate policies), and
increased availability of private capital flows can help to finance
those imbalances. First, these deficits can result from long-term
differences between saving and investment across countries.
Countries with more profitable investment opportunities but
inadequate domestic saving can benefit from foreign capital;
likewise, countries with excess saving can obtain a higher return by
investing abroad. Second, different cyclical positions of countries
will lead to current account surpluses and deficits, as saving and
investment typically move differently over the cycle. As a result,
paths for consumption can be smoother than they would be if the
current account were always balanced. Third, current account
surpluses and deficits can result from unsynchronized portfolio
diversification across countries (for instance, if faster
liberalization in one country leads to net capital outflows).
Portfolio diversification generally improves the trade-off between
risk and return.
However, greater private capital flows may not always or
necessarily lead to greater economic efficiency and welfare. Inflows
may delay needed policy adjustment. For example, the persistent
inflows of capital to the United States since the early 1980s have
had the beneficial effect of helping to finance U.S. investment in
circumstances of low national saving (and a substantial fiscal
deficit). It might have been preferable, however, if sterner
external discipline had induced more strenuous efforts to correct
the underlying causes of the U.S. current account deficit.
Alternatively, the euphoria concerning the prospects for monetary
union in Europe led to massive inflows into high-inflation,
high-interest rate EMS countries during the 198792 period.
These inflows were often funded in currencies with lower interest
rates (mainly the deutsche mark).11
Similarly, there was
a sharp increase in capital flowing into emerging markets in
199293, complicating the task of economic policy in these
countries because of their limited ability to sterilize the inflows
and contributing to overvalued exchange rates. The counterpart of
excessive inflows is the rapid withdrawal of capital when sentiment
changes, which occurred in both cases cited above. Changes in
sentiment led to a massive speculative attack against a number of
European currencies, including some whose central parities were not
obviously overvalued on competitiveness grounds, and to
indiscriminate selling of Latin American bonds and stocks in the
immediate aftermath of Mexico's devaluation of December 1994.
The point here is not that international capital flows are
generally misdirected or that relatively free international capital
mobility is generally bad--quite the contrary. The point is that the
modern regime of international capital mobility is not perfect and
that the IMF's financing and surveillance activities may therefore
be able to help improve its performance.
Increased Integration of National Economies
Since the Second World War, trade in goods and in financial
assets has increased enormously. To some extent, growth in the early
postwar period involved merely a return of exports and imports to
prewar levels as reconstruction proceeded and wartime controls were
abandoned. However, trade continued to grow in later decades at a
sustained pace that has exceeded GDP growth in both industrial and
developing countries (Chart 3). This sustained growth has reflected
a fall in tariff and nontariff barriers as well as a reduction in
transport costs. The IMF has contributed to this process through its
success in promoting widespread current account convertibility.
Chart 3. Trade Flows1 Relative to GDP
(In
percent)
Source: IMF, World Economic Outlook and International Financial
Statistics databases, and staff estimates.
1 In goods and nonfactor services.
Integration of financial markets has been even more dramatic.
One feature of this integration has been expanded capital flows, as
discussed above. The immediate postwar period began with most
countries (with the notable exceptions of the United States and
Canada) having numerous restrictions on capital account
transactions. Capital account convertibility has now become
virtually complete among industrial countries and has been adopted
by a number of developing countries. This expansion of capital
account convertibility, coupled with technological and financial
innovations, has increased cross-border claims enormously. For
instance, the stock of international loans rose from 5 percent of
industrial country GDP in 1973 to 19 percent in 1993.12
Developing countries have also gained access to private capital, in
the form of bank lending in the 1970s and 1980s, and more
recently in the form of portfolio flows and direct investment (Table
4).
Table 4. Net External
Financing
Flows to Developing Countries and Economies in Transition
(In billions of U.S. dollars)
|
|
|
198788 |
198990 |
199192 |
199394 |
|
Developing countries |
Non-debt-creating flows, net |
31 |
53 |
66 |
118 |
Net credit and loans from
IMF |
9 |
3 |
1 |
1 |
Net external borrowing |
72 |
97 |
199 |
214 |
From commercial
banks |
21 |
29 |
26 |
28 |
From official
creditors |
38 |
43 |
35 |
29 |
Other |
13 |
25 |
138 |
213 |
Total, net external
financing |
94 |
147 |
265 |
332 |
Countries in
transition |
Non-debt-creating flows,
net |
1 |
1 |
11 |
24 |
Net credit and loans from
IMF |
2 |
1 |
5 |
5 |
Net external borrowing |
25 |
2 |
4 |
9 |
From commercial
banks |
7 |
8 |
8 |
9 |
From official creditors |
4 |
10 |
41 |
10 |
Other |
28 |
16 |
29 |
10 |
Total, net external
financing |
26 |
2 |
20 |
37 |
|
Source: International Monetary Fund (1995b,
Table A33). |
Increased economic integration has resulted in gains from trade
in both goods and asset markets that, in turn, have surely
contributed to postwar prosperity. This increased integration has
also meant that countries are increasingly exposed to shocks from
abroad, through both trade and capital market linkages. To be sure,
the game has been worth the candle; the benefits of integration have
generally far outweighed the costs. However, the appropriate speed
and necessary conditions for full capital market liberalization
remain important policy issues. To the extent that the external
shocks are small or are negatively correlated with domestic shocks,
greater external exposure may not be harmful; nevertheless, the
concern about external shocks or about shocks that may be amplified
because of openness is legitimate. For example, neither the debt
crisis of the 1980s nor the recent economic crisis in Mexico could
have occurred to economies that were effectively closed to trade and
capital movements.
For several reasons, developing countries tend to be more
exposed to external shocks than the larger industrial countries.
First, a number of developing countries are heavily dependent on
export earnings of a few primary commodities, making their current
account positions especially vulnerable to fluctuations in world
prices and foreign demand. Second, these countries often do not have
well-developed domestic financial markets, so they cannot fall back
on efficient domestic sources of financing for shortfalls in
government revenues. Third, developing countries cannot borrow
abroad in their own currencies and generally have to rely on foreign
currency financing (or reserve use) to deal with balance of payments
shortfalls. When an adverse external shock or a domestic disturbance
(including policy errors) generates a balance of payments financing
problem, foreign currency financing tends to dry up, and the
magnitude of the adjustment required to correct the payments
imbalance is magnified. Fourth, many developing countries have
accumulated large external debts in foreign currency; servicing
these foreign currency debts requires either trade surpluses or
other capital inflows. The existence of a large volume of
international foreign currency claims (or, more generally, large
foreign portfolio investments) exposes a country to changes in
foreign investor sentiment, which could force the authorities to
restrict domestic demand drastically to adjust the balance of
payments. Fifth, analysis of data for internationally traded assets
of developing countries suggests that these assets are subject to
problems of financial market inefficiency. In particular, there is
evidence of bandwagon effects, showing up in serially correlated
asset returns, perhaps because of the portfolio shifts into and out
of institutions specializing in emerging markets (International
Monetary Fund (1995a)). Moreover, contagion effects were present in
the weeks immediately following the December 1994 Mexican
devaluation, as internationally traded asset prices of different
Latin American countries facing different economic fundamentals
moved together much more closely than during earlier periods (Table
5).
Table 5.
Correlation of Returns on Selected Latin American Brady Bonds with
Returns on Mexican Brady Bonds, January 1993March 1995
(In percent) |
|
|
Jan. 1993- Jan. 1994 |
February- May 1994 |
Mid-May
1994- Mid-Dec.1994 |
Mid-Dec. 1994- Early March
1995 |
|
Argentina |
0.56 |
0.84 |
0.77 |
0.89 |
Brazil |
0.22 |
0.51 |
0.45 |
0.73 |
Venezuela |
0.55 |
0.65 |
0.47 |
0.78 |
|
Source: Folkerts-Landau and others (1995,Table
I.4)
|
Expanded Membership
The context of the IMF's operations has changed greatly as a
consequence of the substantial expansion of its membership. This
expansion resulted from two principal events in the postwar period:
the process of decolonization, which had begun in the late 1940s and
largely run its course by the 1970s, and the recently initiated
transformation of former centrally planned economies into market
economies. These two events have made the IMF into a universal
organization. At the same time, because most of the IMF's new
members have not established assured access to private capital
flows, the number of members that are likely potential users of IMF
resources has continued to expand.
In particular, most transforming economies are still much less
integrated into the world economy than many developing countries.
Correspondingly, these transition countries have generally not been
able to draw on private capital flows to anywhere near the same
degree as middle-income and more advanced developing countries
(Table 4), although some individual countries have attained market
access or are soon to do so. Accordingly, many transition
countries--like the poorer developing countries--have needed to rely
on official financing for much of their balance of payments support.
As most transforming economies do not benefit from large amounts of
official bilateral financing flows, the IMF has been heavily
involved in making balance of payments financing available to them,
subject to comprehensive conditionality to help ensure that
necessary structural policies are implemented in a framework of
macroeconomic stability.
In sum, when projecting the potential need for IMF resources,
the Bretton Woods conference did not anticipate the move to greater
exchange rate flexibility and the pervasive access of industrial
countries to private financing. However, it also did not anticipate
either the growth in world trade and capital movements and the
greater integration of national economies, which has left them more
exposed to external shocks, or the expansion of the IMF's
membership, which has created new demands for IMF resources by
countries where the correction of payments imbalances may typically
require somewhat more time than was envisioned at Bretton Woods.
These evolving needs explain why the membership has approved
periodic increases in IMF quotas.
7The last IMF-supported programs
for industrial
countries were implemented in Italy and the United Kingdom in 1977,
after the general move to floating exchange rates. Both countries
were experiencing balance of payments difficulties in the aftermath
of the first oil shock, and the Italian lira and the U.K. pound were
under severe downward pressure. The IMF, at that time, was still
seen as playing an important role in helping to deal with these
problems. Since the summer of 1992, the U.K. pound and especially
the Italian lira have depreciated substantially, particularly
against the currencies of other large European countries. These
depreciations have helped to bring large improvements to the current
accounts of both countries, and they have not involved the use of
IMF resources.
8It is sometimes suggested that the general
slowdown of industrial country growth since the early 1970s may be
attributed in some significant measure to the collapse of the global
system of pegged exchange rates. There is, however, no serious
empirical evidence to support this hypothesis. For a review of the
evidence on the effects of exchange rate volatility under floating
rates, see Goldstein (1995).
9See, for instance, Taylor (1989), and Frenkel,
Goldstein, and Masson (1989).
10Turnover on the three largest foreign exchange
markets increased threefold between 1986 and 1992, while foreign
exchange reserves of industrial countries increased by only 77
percent in U.S. dollar terms over that period. In April 1992, a
survey of foreign exchange markets estimated that global
daily turnover was $880 billion, compared with a stock of
nongold foreign exchange reserves of industrial countries equal to
roughly $414 billion (Mussa and others (1994)). Preliminary analysis
of a more recent survey by the Bank for International Settlements of
foreign exchange markets suggests that daily turnover now exceeds $1 trillion.
11This was termed a "convergence play" by Goldstein
and others (1993).
12Figures quoted in Mussa and others
(1994).