10.4 Growth in imports of goods and services
Sources: OECD; World Bank
Increases in the volume of imports of consumer goods are a direct signal of consumer demand. They imply that domestic producers cannot meet the required price, quality or quantity.
Compressibility
When examining a developing country it is important to check the compressibility of imports, that is, the extent to which there are non-essential goods which need not be imported in times of stress on the balance of payments. If all imports are essentials such as foods and fuels it may not be possible to reduce the import bill.
Sources
A country which imports from just one or two main trading partners is vulnerable to economic shocks from its suppliers, especially if they cease to export those particular goods, if prices rise sharply or if there is some political disturbance.
International comparisons
The distinction between OTS and BOP figures is discussed on pages 134–5. For international comparisons, aim for consistency and watch the FOB/CIF basis. As a crude rule of thumb, imports CIF are around 10% greater than imports FOB. The figure varies from 20% for some Latin American countries to under 4% for North America and some European countries where local cross-border trade keeps shipping costs lower than for geographically remote countries.
Trade balance, merchandise trade balance
Measures: The net balance between exports and imports of goods.
Significance: Shows a country’s fundamental trading position.
Presented as: Money values.
Focus on: Total balance; balance in relation to the current account.
Yardstick: A deficit is potentially more of a problem than a surplus. See Current-account yardstick (page 146).
Released: Monthly, at least one month in arrears.
Overview
The trade balance is the difference between exports and imports (see above). It may measure visible (merchandise) trade only, or trade in both goods and services.
Invisibles are difficult to measure, so the balance of trade in goods and services is less reliable and more likely to be revised than the visible balance.
This brief should be read in conjunction with the previous briefs on exports and imports. Note especially the comments on goods and services (page 136) and special factors (pages 138–9).
Arithmetic
Small variations in imports or exports can have a significant effect on the trade balance. For example, if exports are $10 billion and imports are $11 billion, a 10% rise in imports to $12 billion will double the trade deficit from $1 billion to $2 billion.
Income elasticity
The relationship of exports and imports to economic growth (their income elasticity) is important. For example, Japan’s imports tend to increase by a relatively small amount when its GDP grows by 1%. At the same time its exports rise rapidly when its trading partners’ economies expand. Thus if Japan’s economy grows at the same pace as the rest of the world, its trade surplus will tend to widen.
Supply constraints
A large trade deficit may signal supply constraints, especially if it is accompanied by high inflation and/or the deficit has emerged recently owing to a rise in imports. This suggests that companies are unable to boost output to match higher domestic demand. The deficit may act as a safety valve and divert potentially inflationary pressures. Alternatively, an increasing trade deficit may signal a loss of competitiveness by domestic companies.
Table 10.3 Trade and current-account balances
Net savings and the resource gap
The balance of trade in goods and services measures the relationship between national savings and investment. A deficit indicates that investment exceeds savings and that absorption of real resources exceeds output.
For developing countries, the difference between exports and imports of goods and services is more usually called the resource gap; that is, the extent to which the country is dependent on the outside world. Many developing countries have resource gaps equivalent to 25–50% of GDP. In 2007 Liberia’s was over 150% of GDP.
Current flows
For the industrial countries a trade imbalance is not necssarily a problem; it reflects choice as much as necessity.
For most of the past 200 years Britain has run a deficit on visible trade which has been more than offset by one of the world’s largest surpluses on invisibles. Countries with large manufacturing sectors, such as Japan and Germany, have tended to run visible-trade surpluses and invisibles deficits. The current account is a better indicator of overall current flows (see pages 146–8).
Eliminating a trade deficit
There are two main ways in which an external trade deficit might move back into balance.
A change in the volume of trade. If demand in the deficit country contracts or grows more slowly than that in the surplus country, the volume of exports will increase relative to the volume of imports.
A change in relative prices through a change in the exchange rate or a change in domestic prices. Imports become dearer and exports cheaper if the deficit country’s currency falls in value or if inflation is lower in the deficit country than in the surplus country. This will tend to depress the demand for imports and boost exports.
Attempts to regain balance through government export subsidies or import barriers such as quotas or tariffs are essentially imposed volume or price changes (which also cause market distortions). For example, a ban on imports will generate extra, possibly inflationary, demand for domestic goods.
Similarly, trade surpluses may be eroded by faster economic growth, a stronger currency or higher inflation in the surplus country.
10.5 Current-account balances
Sources: OECD; World Bank
Current-account balance
Measures: Net current payments, the difference between national savings and investment.
Significance: Identifies international payments which arithmetically must be matched by capital flows and changes in official reserves.
Presented as: Money total.
Focus on: Trends; size in relation to GDP.
Yardstick: The OECD average current-account balance was −0.4% of GDP during the late 1980s, −0.2% during the 1990s and −1.2% in 2000–2008.
Released: Usually monthly, quarterly by some countries; atleast one month in arrears.
Overview
The current-account balance is the balance of trade in goods and services (see above) plus income and current transfer payments.
Countries which produce monthly current-account figures base their initial estimates on simple projections of previous income and transfers, which themselves may be revised. Consequently this component of the current account is even less reliable than the goods and services balance and is subject to heavy revision.
Income
This mainly reflects past capital flows. Countries with current-account surpluses acquire foreign assets which generate further current-account income in future periods. Also referred to as RIPD (rents, interest, profits and dividends). Compensation to non-resident employees is also included here.
Global imbalances
In its latest World Economic Outlook, the IMF forecasts that this year the current-account balances of the main trading regions will fall below 2% of world GDP for the first time since 2004. America’s deficit is expected to shrink by almost half as a share of global GDP from its level last year. The oil exporters’ current-account surplus is set to drop by more than two-thirds. But China and South-East Asia’s surplus is forecast to be broadly unchanged. International deficits and surpluses should offset each other, but the data are subject to measurement error. The figures since 2005 suggest the world is running a surplus with itself. The discrepancy is thought to arise from delays in the recording of imports.
Global imbalances
*Excluding Germany
Source: IMF World Economic Outlook
The Economist, October 22nd 2009
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Transfer payments
These include foreign workers’ remittances to their home countries, pension payments to retired workers now living abroad, government subscriptions to international organisations and payments of foreign aid.
Host countries with large populations of foreign workers (including Germany) experience transfer outflows. However, for many developing countries workers’ inward remittances save the current account from becoming an unmanageable deficit. Remittances are a particularly important source of foreign currency for poor countries with workers in the rich oil-exporting Gulf states.
Current-account deficits
A visible-trade deficit can be covered by exports of services or net inflows of income and transfers, but the overall current account cannot remain in deficit indefinitely. It has to be financed by any or all of inward investment, loans from overseas, sales of overseas assets and depletion of official currency reserves.
Direct inward investment in businesses may create new employment, output and exports which should help to eliminate future current-account deficits. Nevertheless capital inflows might be withdrawn at inconvenient times, and they create potential RIPD current-account outflows.
Savings
The current account is sometimes taken as a measure of the gap between domestic savings and investment, although strictly speaking this is measured by the balance of trade in goods and services (see above).
Since government budget deficits represent government dissaving, some commentators argue that if a budget deficit is cut any current-account deficit will fall automatically. This line of reasoning became popularwhenAmericadevelopedlarge current-account and budget deficits in the mid-1980s. The fallacy of the argument was demonstrated when the American current-account deficit subsequently fell without a corresponding reduction in the budget deficit.
The correlation between the budget deficit and the current-account deficit holds good only if private-sector savings and investments remain unchanged, which they generally do not.
Acquisition of net foreign assets
Although the current account does not quite measure net savings, it does measure the net acquisition of foreign assets. In other words, external debt grows by the size of a current-account deficit (see above).
Foreign direct investment
The flow of foreign direct investment (FDI) fell by 39% in 2009 to just over $1 trillion, from a shade under $1.7 trillion in 2008, according to the UN Conference on Trade and Development. All kinds of investment – equity capital, reinvested earnings, and intra-company loans – were affected by the downturn. Rich countries saw FDI inflows plunge by 41%, and foreign investment into developing countries fell by more than a third. Not every country was badly hit. FDI into China, where economic growth remained robust, declined by only 2.6%. Foreigners actually invested more in Germany and Italy last year than in 2008. Despite FDI plunging by 57% last year, America remained the world’s top investment destination.
Foreign direct investment
Source: UNCTAD
The Economist, February 11th 2010
Capital- and financial-account flows
Measures: International capital flows.
Significance: Major contributor to exchange-rate fluctuations. Outflows represent the acquisition of assets overseas.
Presented as: Money totals.
Focus on: Direct and portfolio investment.
Yardstick: Use current-account balance as indicator.
Released: Quarterly, at least one month after the quarter end. Revised often.
Overview
The capital and financial account records international capital and financial flows. These are frequently neglected by commentators but they are important because they are directly related to the current-account balance and to exchange rates. The increase in direct investment flows particularly reflect the increased globalisation of the world economy.
Foreign direct investment (FDI) refers to an investment made to acquire lasting interest in enterprises operating outside of the economy of the investor. Further, in cases of FDI, the investor’s purpose is to gain an effective voice in the management of the enterprise. The foreign entity or group of associated entities that makes the investment is termed the “direct investor”. The unincorporated or incorporated enterprise – a branch or subsidiary, respectively, in which direct investment is made – is referred to as a “direct investment enterprise”. Some degree of equity ownership is almost always considered to be associated with an effective voice in the management of an enterprise; the IMF suggests a threshold of 10 per cent of equity ownership to qualify an investor as a foreign direct investor.
An outflow of capital today implies current-account income in the future. Indeed, with global deregulation, it is easier for companies to raise their market share by setting up production facilities overseas. The initial direct investment shows as a capital-account outflow. Subsequently remitted profits add to current-account inflows and boost GNP relative to GDP. The value of goods sold, however, does not show up in external trade or increase GDP in the way that exports from home would.
International investment position (IIP)
Measures: Balance sheet levels of external assets and liabilities.
Significance: Indicates cumulative cross-border activity.
Presented as: Value at end-quarter or end-year.
Focus on: Changes in totals and main components and holders.
Yardstick: US-owned assets abroad were $19.9 trillion at the end of 2008; foreign-owned assets in the United States were $23.4 trillion.
Released: Normally annually, about six months after year-end.
Overview
This is a stock indicator rather than a flow. The IIP measures the level of inward and outward investment with the rest of the world.
Official reserves
Measures: Gold and foreign currencies held by the government.
Significance: Indicates a country’s ultimate ability to pay for imports; signalspressures on the balance of payments.
Presented as: Nominal value at end-month, often in dollars; watch for unrealistic valueor revaluation of gold and currencies.
Focus on: Totals and changes.
Yardstick: A crude rule of thumb is that reserves should be sufficient to cover threemonths’ imports. A sudden large change of tens or hundreds of millionsof dollars in one month may indicate exchange-rate pressures.
Released: Monthly; in some countries immediately after the month-end.
Overview
Central banks hold stocks (reserves) of gold and currencies which have widespread acceptability and convertibility, such as the dollar. These reserves are used to settle international obligations and to plug temporary imbalances between supply and demand for currencies.
Intervention
Central banks frequently intervene in the markets to influence their currency’s exchange rate. This affects their reserves.
For example, if the Federal Reserve (the American central bank) decides that the dollar is too strong against the yen it may sell (anonymously) dollars in exchange for yen on the open market. The extra supply of dollars creates new demand for yen and tends to depress the exchange rate of the dollar relative to the yen. The Fed increases its foreign currency reserves by the value of the yen purchased.
Conversely, if the Fed thinks that the dollar is too low, it might use its currency reserves to buy dollars and prop up the dollar exchange rate. Intervention in this direction can continue only so long as the central bank has reserves that it can sell.
Central banks might sensibly intervene to smooth erratic fluctuations in currencies, but it is a fool’s game to use intervention alone to try to hold a currency at, or move it to, some previously determined level if that is not the level at which market supply and demand are in equilibrium. Such an exchange-rate objective can only be met in the longer term through domestic economic policies (see Exchange rates, page 154).
Sterilisation
&n
bsp; When a central bank sells reserves and buys its own currency, the domestic money supply is reduced in size by the amount of domestic currency swallowed up by the bank. Purchases of foreign currencies boost the money supply. Such intervention is said to be sterilised if the central bank neutralises the effect on the money supply with some other action, such as the purchase or sale of government bonds.
Interpretation
Changes in the level of official reserves suggest foreign-exchange intervention and, therefore, pressures on the currency:
a fall in the reserves suggests that there was intervention to offset currency weakness;
a rise suggests intervention to hold the currency down.
However, reserves change for reasons other than intervention, including government borrowing or payments overseas, and fluctuations in the rates used to convert holdings of gold and currencies into a common unit of account. The total value of reserves can also be misleading if gold is valued at some anachronistic rate, as it frequently is.
Strictly speaking, the level of reserves alone is not a guide to a country’s ability to pay its way. That is determined in the short term at least by the government’s ability to borrow overseas. If the reserves are running low it is a good idea to look at the country’s IMF position (see SDR, page 160), its current level of external debt and its ability to borrow overseas.
External debt, net foreign assets
Measures: Net borrowing by the public and private sectors.
Significance: Liability which can be repaid only from export earnings.
Presented as: Money totals.
Focus on: Total and debt service in relation to exports.
Yardstick: See Table 10.4.
Released: Annually without fanfare.
Overview
Countries which persistently run current-account deficits accumulate external debt. This can become a major problem since essentially the debt repayments and interest can be financed only from export earnings. Table 10.4 indicates the problems for some of the world’s largest debtors.
Guide to Economic Indicators Page 13
