The tenth edition of the International Monetary Fund External Sector Report (ESR, August 2021) shows how the current account deficits of the global economy widened in 2020 during the pandemic. On the flip side, the ESR also argues that, overall, the misalignment between fundamentals and current account balances has not been exacerbated.
The pandemic has widened current account imbalances …
The sum of the absolute values of current account deficits and surpluses fell from 2.8% of global GDP in 2019 to 3.2% last year, reversing a downward trajectory since 2015.
The report highlights four major impacts caused by the pandemic to explain this increase. First, the dramatic fall in travel and tourism has dramatically reduced the balances of countries dependent on tourism receipts, including some Caribbean countries, Thailand, Turkey, Spain and others.
In addition, the demand for oil and its price have suffered a profound collapse. Although oil prices started to recover in the second half of the year, oil-exporting countries experienced a sharp decline in current account balances during the year. On the other hand, oil importing countries have seen corresponding decreases in their oil trade deficits.
The boom in trade in medical products has also had its effects: a 30% increase in external demand for essential medical supplies needed to fight the pandemic, such as personal protective equipment, and inputs and raw materials for its health. production. Importers and exporters of these items have suffered corresponding impacts.
Changes in household spending habits due to the pandemic have also had an impact on foreign trade. “Staying at home” meant spending less on contact-intensive services and buying more durable consumer goods, including electronics used in telecommuting and distance learning. It is no coincidence that the economic recovery has been faster in Asian countries which export such manufactured products.
Figure 1 projects where the sum of current account balances in the global economy would have disappeared without the effects of the pandemic, according to the IMF report:
The extraordinarily lax monetary policies adopted by the major central banks have made financing the widening current account deficits problem-free. This was a difference from previous crises, when external financing difficulties pushed some countries into recession.
The policies of flattening the pandemic curves have led governments to raise large volumes of loans to cover expenses related to health services and economic support to families and businesses, which has had asymmetric effects on trade balances. . Richer economies have used their available fiscal space more than poorer economies to implement even more aggressive fiscal policies, borrowing relatively more than poorer economies. The corresponding decline in current account balances, on average, was therefore larger. As a result, the pandemic slowed the already “declining” flow of funds from the richest to the poorest countries.
… without exacerbating the overall misalignment between fundamentals and current account balances
An important exercise included in each annual IMF External Sector Report goes beyond monitoring current account balances to examine the extent to which current account imbalances can be considered “excessive” relative to economic fundamentals and appropriate economic policies. The calculation is made for each of the 30 economies considered to be systemically relevant and covered by the report.
Excessive imbalances are associated with an overvaluation of real effective exchange rates, when deficits are larger (or surpluses smaller) than suggested by adequate fundamentals and policies. Symmetrically, there is also an excess when larger surpluses (smaller deficits) than predictable from fundamentals and appropriate policies suggest undervalued real effective exchange rates. Excessive imbalances can generate instability by fueling trade tensions and increasing the likelihood of sharp asset price adjustments.
Despite the increase in global current account balances in absolute terms by 0.4 percentage point of global GDP, excessive global imbalances, i.e. the sum of the absolute values of the balances considered to deviate from the levels corresponding to fundamentals and adequate medium-term policies – remained at around 1.2% of global GDP, close to previous levels. The risks and obstacles to the recovery of the global economy remain strongly linked to the local trajectories of the pandemic, the consequences of which in terms of divergence between countries are still being felt.
According to the IMF report:
Twelve of the 30 economies were aligned in 2020 at levels consistent with their medium-term fundamentals and policies deemed appropriate: Australia (AUS), Brazil (BRA), China (CHN), Hong Kong (HKG), India (IND) , Indonesia (IDN), Italy (ITA), Japan (JPN), South Korea (KOR), euro area (EA), Spain (ESP) and Switzerland (CHE).
In turn, nine economies exhibited a devalued real effective exchange rate or larger balances (i.e. larger surpluses or smaller deficits) than suggested by fundamentals and adequate policies: Germany (DEU), Malaysia (MYS), Netherlands (NLD), Poland (POL), Sweden (SWE), Thailand (THA), Singapore (SGP), Mexico (MEX) and Russia (RUS).
The other 9 economies — Argentina (ARG), Belgium (BEL), Canada (CAN), France (FRA), Saudi Arabia (SAU), South Africa (ZAF), United Kingdom (GBR), United States ( USA), and Turkey (TUR) – had current account balances which suggested that their real effective exchange rates had appreciated excessively, i.e., surpluses or deficits smaller than those indicated by the fundamentals and adequate policies.
Figure 2 gives an overview of where the real effective exchange rate (REER) was and, therefore, the positive or negative current account spreads (AC) last year, compared to what would be fundamentals and appropriate policies in each of the 30 economies. .
Mexico and Turkey look like outliers for special reasons. Mexico’s external position has over-strengthened in 2020 as, while significant fiscal expansions have taken place in other major economies (whose real fiscal balances have gone relatively further below their desirable to medium-high levels). term), Mexico had an insignificant fiscal response to the pandemic and a further weakening of the domestic investment climate.
Turkey’s external position in 2020 was moderately weaker than the level implied by medium-term fundamentals and desirable policies. In the case of Turkey, according to the ESR:
“Expansionary monetary policy and rapid lending by state banks put pressure on the pound last year through dollarization, imports and financial account channels, leading to its turn to the sale of foreign exchange reserves to support the pound. Despite the sharp depreciation of the real exchange rate, the CA deficit resurfaced due to lower exports (including tourism) and robust imports (including gold). The monetary tightening that began in late 2020 led to a return in capital inflows and a modest accumulation of reserves, but reserve outflows and losses resumed in March 2021, amid growing political uncertainty and depreciation of the economy. delivered. Political uncertainty, large gross external financing needs and relatively low reserves increase Turkey’s vulnerability to shocks. It is only over time that the undervaluation of the REER, with its usual lags, will help bring the current account back to its norm, aided by less expansionary policies.. “
Where are the current imbalances?
The development of current account balances will depend on future budgetary trajectories. The United States – the largest economy among cases of appreciated REER – is expected to delay the adjustments, judging by the tax measures sought by the Biden administration. In turn, Germany – and its devalued REER – would have an even more imbalanced position if it resorted to quick fiscal adjustments. A tightening of global financial conditions impacting capital flows to emerging and developing economies could also affect their balances (although factors mitigating these risks can be pointed out).
Going forward, countries with excessive current account balances should seek to reduce their budget deficits in the medium term and implement reforms that increase their competitiveness. At the same time, economies with excessive current account surpluses and some fiscal space should adopt policies aimed at strengthening recovery and growth in the medium term, including through increased public investment.
Meanwhile, as Martin Kaufman and Daniel Leigh point out:
“A synchronized surge in global investment or health spending to end the pandemic and support recovery could have significant effects on global growth without increasing global balances. “
Otaviano Canuto, based in Washington, DC, is Senior Fellow at the Policy Center for the New South, Non-Resident Senior Fellow at the Brookings Institution, Lecturer in International Affairs at the Elliott School of International Affairs – George Washington University, and Director at Center for Macroeconomics and Development. He is a former vice-president and former executive director of the World Bank, former executive director of the International Monetary Fund and former vice-president of the Inter-American Development Bank. He is also a former Deputy Minister of International Affairs at the Brazilian Ministry of Finance and a former Professor of Economics at the University of São Paulo and the University of Campinas, Brazil.