The dynamics of international investment positions

Focusing on euro area countries with large net external liabilities, this chapter presents an overview of recent developments in external assets and liabilities and analyses their economic implications, their sustainability and related adjustment needs. It also provides a discussion of adjustment dynamics. Over the last decade, differences in the external positions of euro area countries have increased substantially. Some Member States have accumulated large net external liabilities, raising concerns about their implications for growth and external sustainability. The same period has also witnessed a build-up in gross asset and liability holdings. In the countries concerned, rising external liabilities have led to deteriorating investment income balances, entailing a rising wedge between GDP and GNI. The deterioration of income balances due to higher liabilities has been partly contained by rapid economic growth (at least in pre-crisis years) and favourable yield developments, but these factors have now turned much less supportive. External positions can be subject to large valuation effects, which, however, seem to have a large temporary component. Beyond the effect on GNI, available empirical evidence indicates that high net external liabilities can weigh on growth and increase the economyís vulnerability to shocks, raising the issue of the sustainability of external positions in some euro area countries. In recent years, euro area Member States with large external liabilities have gone through a current account rebalancing process that was first driven by demand compression but has also been gradually supported by improvements in competitiveness and export market shares. As a result of this process, external imbalances have diminished. A quantitative assessment of external sustainability shows that, notwithstanding recent progress, in 2011 some Member States had not yet moved to a sustainable NIIP trajectory. In these countries, further adjustment was still needed, the short-term impact of which ó particularly in terms of employment ó will depend on economic policies, especially in terms of structural reforms.