Macroeconomic Diagnostics (MDSx)

Module 9

The External Position

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Opportunities and Risks of Globalization

A country’s position with respect to the rest of the world: trade

in goods and services, borrowing/lending

Reflection of underlying macroeconomic concerns

Adverse shocks
Topic Linkages
From Net Exports to the Current Account

National Accounts – Constant (or chained) prices:

NX = X - IM
From Net Exports to the Current Account

NX CA
NOT
Comprehensive Comprehensive

National accounts Balance of

– Real domestic Payments
currency Nominal units –
US$
From Net Exports to the Current Account

CA = NX + Primary
Primary and SecondaryIncome
+ Secondary Income

Primary Income § Cross-border compensation of employees

§ Investment Income

Secondary Income § Transfers

Savings-Investment Perspective

GNDI º Gross National Disposable Income

GNDI º Y + Primary
Primaryand
+ Secondary
SecondaryIncome
Income
Savings-Investment Perspective

NX = Y - C - I -
14 2 43 G
Domestic absorption
Savings-Investment Perspective

CA = GNDI - C - I - G
Savings-Investment Perspective

S = GNDI - C - G (cons )

CA = S - I
Residual measure of savings:

S{ = CA
{ + {I
Residual BoP National
Measure Accounts
Savings-Investment Perspective

CA < 0
Investment funded by saving from
rest of the world.

CA > 0
Investment in ROW funded by our
saving.
Savings-Investment Perspective

Concerns about Current Account Deficit:

Will foreign savers be repaid?

Are investment projects of sufficient quality?

Savings-Investment Perspective

Concerns about Current Account Surplus:

High Savings
Low confidence; uncertainty; pension systems doubts

Low Investment
Political uncertainty; structural impediments
 Thailand: Current Account/GDP Thailand: Savings and
(in percent ) Investment/GDP (in percent)
45.0%
20.0%
40.0%
Savings
15.0%
Investment
10.0% 35.0%
5.0%
30.0%
0.0%
-5.0% 25.0%

-10.0% 20.0%

Source: Bank of Thailand / Haver Source: Bank of Thailand / Haver

Twin Deficits – Fiscal and External

CA = S - I
CA = S - I + S - IP P G G

CA = S - I P P
+ OB
{
Overall Balance
from Fiscal
Twin Deficits – Fiscal and External
Twin Deficits – Fiscal and External

Indonesia: Government Balance and Current Account

(in percent of GDP)
6.0%

Current Account
4.0%
Gov't Overall Balance
2.0%

0.0%

-2.0%

-4.0%

-6.0%

-8.0%
Q1.2005 Q1.2006 Q1.2007 Q1.2008 Q1.2009 Q1.2010 Q1.2011 Q1.2012 Q1.2013 Q1.2014 Q1.2015 Q1.2016

Source: Bank of Indonesia / Haver

Twin Deficits – Fiscal and External

Warning Signs:

Deterioration in current account reflects deterioration in public

S-I gap

Unsustainable public spending boom

Returns in public sector may be low

Terms of Trade
Terms of Trade

X = P *VOL( X )
$ $
X

IM = P VOL( IM )
$ $
IM

Small country: Bigger country:

Prices determined in world markets Can affect world price
Terms of Trade

PX$
$
= External Terms of Trade (TOT)
PIM
Terms of Trade by region
(index, 2010=100)
130

120

110

100

90

80

70 Western Hemisphere Europe Middle East Asia Africa

60
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Source: Haver / IMF staff calculations

Terms of Trade

Impact of price changes on value (in DOLLARS):

Export side impact =(D%PX$ ) * X initial

$

Import side impact =(D%PIM$ ) * IM initial

$
The Real Exchange Rate (RER)

Real cost of domestic currency in terms of foreign currency

A market signal for resource allocation:

Producers – Export versus Home Goods

Purchasers – Imports versus Home Goods

The Real Exchange Rate (RER)

Bilateral Real Exchange Rate:

Domestic Price
Et Pt Level
Qt = *
Nominal Exchange
Rate in units of FC
per unit of LC
Pt Foreign Price
Level

qt = et + pt - pt*
The Real Exchange Rate (RER)

CA = NX ( RER) + Primary
Primaryand SecondaryIncome
+ Secondary Income

Net exports sensitive to movements in the RER

Primary and secondary income assumed exogenous

The Real Exchange Rate (RER)

Current Account and Real Exchange Rate

115

110
Real exchange rate index

105
(app +, base=100)

100

95

90
-4.0% -3.0% -2.0% -1.0% 0.0% 1.0% 2.0%

← Current Account (CA) deficit Current Account (CA) surplus →

The Real Exchange Rate (RER)

Current Account and Real Exchange Rate

115

110
CA
D( ) = -h * %DRER
Real exchange rate index

105 Y
(app +, base=100)

100

95

90
-4.0% -3.0% -2.0% -1.0% 0.0% 1.0% 2.0%

← Current Account (CA) deficit Current Account (CA) surplus →

The External Financial Account

General principle:
Flow balance (receipts – outlay) and financing must correspond
one-to-one.

CA = FA
The External Financial Account

CA < 0 Deficit: receive financing from rest

of world.

FA < 0 Incurring obligations (liabilities).

CA > 0 Surplus: provide financing to rest

of world.

FA > 0 Acquiring claims (assets).

The External Financial Account

Elements of Financial Account (Asset plus – BPM6):

Foreign Direct Investment (FDI)

Portfolio
Equity Shares
Marketable Debt

Other
Loans
Derivatives

Reserves and Related Items (Accumulation Plus)

Shifting Financial Conditions

Non-Reserve Financial Account:

A function of home and foreign interest rates (all else held
equal).

FA (non - res) = f (r , r ;other factors)

FA (Non-reserve)
*
Shifting Financial Conditions

FROM THE MONETARY MODULE

Domestic monetary policy Tighter Looser
External financing More Less

CONSISTENT WITH MONETARY MODULE

External financial conditions Tighter Looser

External financing Less More

Financial Account Balance

Signals of inappropriate levels of financial inflows:

Shift away from more stable and productive FDI flows

Toward more volatile debt flows

Temporary abundance of debt financing –may not last

High or rising country risk premiums

Prolonged drawdown of reserves