Assessment of external imbalances and country risk perception

The scale and persistence of the current account surplus or deficit positions of a large number of countries were one of the main causes for concern in terms of global economic stability during the years prior to the economic and financial crisis. While these global imbalances did not trigger the crisis, and as they have not diminished with the ensuing adjustments (see Chart 1), their nature, their causes and the consequences potentially arising from them remain to the fore of international economic debate. Insofar as cross-country divergences in current account balances are the result of differences in levels of development, demographic factors and other characteristics relating to economic structure, they should not be a cause for concern globally. However, when they are the outcome of deep-seated macroeconomic imbalances, in many cases induced or amplified by unsuitable economic policies, they are factors of vulnerability that may pose a threat to global financial stability. Thus, persistently high deficits that are unsustainable in the long run may give rise to foreign exchange crises and capital outflows from the countries that generate them, with significant externalities for other economies; similarly, bloated surpluses, such as those of certain countries in the years running up to the crisis, may be indicative of excess saving which, naturally, has repercussions ultimately for the countries that are recipients of this investment, contributing to heightening vulnerability in the face of real and financial shocks. Several multilateral organisations – such as the G-20, the International Monetary Fund (IMF) and the European Union – have designed surveillance mechanisms to detect excessive imbalances in countries’ external positions and redress them. The IMF took the initiative here some years back, when it conducted its analysis of current account balances and real exchange rates under the CGER. In 2012, the IMF began to regularly publish a new analysis on the external sector – in its External Sector Report – with a view to assessing the external position of a broad group of countries from a multilateral perspective. In this connection, it developed a new method called the External Balance Assessment (EBA), which is a reform of the CGER analysis that had been used until then. The new method incorporates an analysis of the determinants of the current account balance and the real exchange rate – using two different regression models – for a panel of countries, that include structural and cyclical factors and others relating to policy variables. Moreover, the EBA includes a normative analysis that evaluates to what extent deviations between the policies adopted and those that would be desirable – according to IMF-defined criteria – contribute to generating current account or real exchange rate imbalances, in order to formulate recommendations on such policies. The empirical regression models for the current account balance and the real exchange rate are thus cornerstones of the IMF’s analysis and assessment of external imbalances. This article posits an extension of the analysis conducted for the current account balance, incorporating the international financial markets’ risk perception of each country. The economic literature suggests that the dynamics of the current account balance can vary depending on the degree of safety of the country as an investment recipient. As the experience of the United States shows, countries perceived as safe destinations for investment can sustain high current account deficits over long periods, and the foreign capital flows they receive are less dependent on changes in their macroeconomic fundamentals. Conceivably, these differences in risk perception for different countries may also be more significant in crisis periods. This article presents an extension of the IMF’s framework of analysis, incorporating two additional aspects into the Fund’s equation for the current account balance: the different degree of risk (or the degree of safety) with which different countries are perceived, and the distinction between periods of calm and phases of global stress. The results obtained are robust and allow an assessment other than that of the IMF to be made of the current account imbalances for the year 2012 for a broad range of countries. This analysis is a continuation of that performed in Sastre and Viani (2014), the starting point for which was the regression published by the Fund in its first pilot report on the external sector (2012). Subsequently, the IMF partly revised its methodology on publishing its second report, in June 2013. This new estimation is now taken as a benchmark to incorporate the extensions mentioned. The second section briefly describes the main elements of the analytical framework of the EBA and the proposed extension. Then, in the third section, the main findings of the new regression are discussed, while in the fourth section these results are used to determine the extent to which current account balances correspond to the fundamentals of economies and appropriate policies, or whether they incorporate genuine elements of imbalance. Finally, the closing section draws the main conclusions of the article.