The International Monetary Fund (IMF) has just released its latest assessments of external positions for the 29 largest economies.

As discussed in this year’s External Sector Report, excess current account imbalances – that is, those beyond the levels warranted by country fundamentals – were broadly unchanged in 2016. They represented about one-third of total actual surpluses and deficits, with only small shifts in 2016.

Since 2013, however, there has been a rotation of these excess imbalances toward advanced economies, posing new risks and policy challenges.

On the bright side, excess imbalances narrowed in key emerging market economies, led by a smaller excess surplus in China and smaller excess deficits in others key economies (such as Brazil, Indonesia, South Africa, and Turkey), where policies supported external adjustment as prospects of U.S. monetary policy normalization became more evident and external financing conditions tightened.

But this has been accompanied by a widening of excess imbalances in several advanced economies and the continuation of large and persistent excess surpluses in others (e.g., Germany, Korea, the Netherlands, Singapore, and Sweden), an issue that we explore in detail in the report. Our historical analysis suggests that these large and persistent surpluses, outside oil-exporting countries and financial centers, are a fairly recent phenomenon and in the few cases where they reversed, policy actions on multiple fronts played a role.

What do these developments mean for economic policy?

The current constellation of excess imbalances – especially the persistent surpluses in the same group of countries and the resurgence of deficits in key debtor economies – indicate that automatic adjustment mechanisms are weak. That is, prices and saving and investment decisions are not adjusting fast enough to correct these excess imbalances. This partly reflects rigid currency arrangements but also structural features (like inadequate social safety nets and barriers to investment) which lead to undesirable levels of saving and investment in some economies. This calls for more forceful policy action.

While the increased concentration of excess deficits in advanced economies – mainly the United States and United Kingdom – could reduce deficit-financing risks in the near term, it could pose other downside risks if unaddressed, especially over the medium term. The concentration of deficits in a few countries raises the likelihood of protectionist measures. And the continued reliance on demand from debtor countries risks derailing the global recovery, while raising the chances of a disruptive adjustment down the road.

Given these risks, addressing external imbalances in a way that is supportive of global growth is a shared responsibility. It requires a recalibration of the policy mix in deficit and surplus economies alike.  

What can be done

As a general rule, excess deficit countries should move forward with fiscal consolidation, while gradually normalizing monetary policy in tandem with inflation developments. Excess surplus economies who have room in their budgets should reduce their reliance on easy monetary policy and allow for greater fiscal stimulus. Where monetary policy is constrained from playing a role, as is the case with individual euro area members, countries should look to fiscal and structural policies to facilitate relative price adjustments. Exchange rates should continue to be allowed to move in line with fundamental levels and interventions should be limited to addressing disorderly market conditions, as has been generally the case in recent years for most countries.

Moreover, countries should increasingly emphasize structural policies. Excess surplus countries should focus on lifting distortions that constrain domestic demand or limit trade competition. In excess deficit economies, policies should be directed to improving external competitiveness and overall saving, with particular emphasis given to reforms that boost education outcomes and strengthen the business climate.

Finally, our view is that protectionist policies should be avoided, as they are unlikely to meaningfully address external imbalances but they would be detrimental to both domestic and global growth.

Why we do this

Assessing countries’ external positions is a core mandate of the IMF. These assessments are an analytical tool to determine on a multilaterally-consistent basis the difficult – and often contentious – issue of when external imbalances are appropriate or when they signal risks. In fact, imbalances are often healthy and desirable – developing economies, who need to invest to catch up with living standards elsewhere, should generally run deficits, while others that are aging quickly, like Japan and Germany, need to run surpluses to meet related obligations in the future. Our focus, therefore, is on identifying the undesirable portion and on discussing policies to address them. 

The exercise is meant to avoid a tragedy of commons, where countries acting independently and in their own self-interest undermine the common good of supporting global growth and stability.

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2017 External Sector Report Individual Economy Assessments: South Africa

Foreign asset and liability position and trajectory

Background. South Africa’s economy is highly integrated in international financial markets, with large external assets and liabilities. Although valuation effects led to a marked improvement of the net international investment position (NIIP) in 2015 (from -8 percent of GDP at end-2014 to 16 percent of GDP one year later), this has since moderated, with the NIIP at 3.6 percent of GDP as of end-2016. The IIP is expected to weaken further over the medium term on account of current account deficits.1 External assets and liabilities were equivalent to 131 and 128 percent of GDP, respectively. For FDI (usually considered harder to liquidate), liabilities were lower than assets (43 and 55 percent of GDP, respectively), owing to valuation gains on FDI assets in China. Gross external debt rose to 48.5 percent of GDP at end- 2016 from 26 percent of GDP at end-2008 on the back of an increase in long-term debt. Short-term external debt (residual maturity) amounted to 15½ percent of GDP.

Assessment. Large gross external liabilities pose risks. Mitigating factors include the large external asset position and the sizable rand-denominated share of external debt (about half of total external debt).

Current account

Background. The current account (CA) deficit narrowed to 3.3 percent of GDP in 2016 from 4.4 percent in 2015, owing to an improvement in the trade balance as domestic demand growth weakened. The CA deficit is projected to further narrow to 3 percent of GDP in 2017 as the trade balance strengthens.

Assessment. The CA regression model estimates a CA norm of -0.7 percent of GDP, implying a CA gap of -2.4 percent of GDP for 2016. The CA gap is largely explained by structural factors not captured by the model. The ES approach estimates an NFA-stabilizing CA of -1.3 percent of GDP and a CA gap of -2.2 percent of GDP. Staff assesses the overall CA gap to be somewhat narrower, because (i) policy uncertainty is expected to unwind after key elections and (ii) net transfers to other members of the Southern African Customs Union (SACU) (not accounted for in the regression analysis) reduce the CA balance. Combined with estimation uncertainty, staff assesses the cyclically adjusted CA to be ½-2½ percentage points of GDP weaker than implied by fundamentals and medium-term desirable policy settings – broadly as assessed in 2015.

Real exchange rate

Background. The CPI-REER depreciated by 7 percent on average in 2016 relative to 2015. However, as of May 2017, the REER had appreciated 15 percent relative to the 2016 average.

Assessment. The REER is assessed through two REER-based regressions and by computing the implied REER gap from the CA gaps. Based on the 2016 REER-average, the REER approaches point to undervaluation of between 12.6 percent (level approach) and 28.8 percent (index approach). However, as gauging the appropriate REER for South Africa is challenging, owing to its structural changes since 1994, staff’s assessment puts much greater weight on the CA approaches, while acknowledging the results of the REER approaches. For the CA approaches, the estimated CA/REER elasticity applied to the CA gap range above points to overvaluation of between 2 and 9 percent.3 Combining all these methods, staff assesses a REER overvaluation of 0-10 percent for 2016, broadly consistent with the CA gap.4

Capital and financial accounts: flows and policy measures

Background. Net FDI flows were less negative at -0.4 percent of GDP in 2016, down from -1.3 percent of GDP in 2015. Portfolio investment picked up markedly to 5.9 percent of GDP, financing the CA deficit. Gross external financing needs stood at 18 percent of GDP in 2016.

Assessment. High reliance on non-FDI flows and high nonresident holdings of local financial assets pose risks. These are mitigated by a floating exchange rate, the fact that nonresident portfolio holdings are mainly denominated in local currency, and a large domestic institutional investor base

Overall assessment

The external position in 2016 was moderately weaker than implied by fundamentals and desirable policy settings.

In 2016, the current account gap remained broadly unchanged and South Africa remains highly reliant on non-FDI flows to finance its relatively high CA deficit. Despite the REER depreciation of recent years, structural rigidities result in a relatively slow pace of CA adjustment as well as a somewhat narrower estimated CA deficit norm than would be expected for an emerging economy.

Potential Policy Responses

Several measures would help to reduce the gap related to the external position by speeding up the pace of external adjustment, improving competitiveness, and increasing employment and savings. These measures include fostering entry into key product markets (such as power generation, transportation, and telecommunications); upgrades in infrastructure and education/skills; and greater financial inclusion. Reducing policy uncertainty, preserving government debt sustainability, and accelerating labor and product market reforms are also essential to continue to attract foreign inflows, especially durable inflows such as FDI. Seizing opportunities – such as large FDI inflow transactions – to build up reserves would strengthen the country’s ability to deal with FX liquidity shocks.