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Analysis
How creditor states lose money

How creditor states lose money

IMF study shows euro area still home to large imbalances

by David Marsh in Sacramento

Mon 6 Oct 2014

Some of the world’s leading creditor countries with sizeable current account surpluses, such as China, Germany and Singapore, have fared relatively badly in conserving wealth since the financial crisis, according to an International Monetary Fund analysis of the balance of power between the world’s top debtors and creditors.

Some countries that habitually run large deficits, such as the US, the UK and Australia, have done better. The study underlines that, in spite of relative European stability over the last two years, the euro area together with Switzerland (which keeps its currency aligned with the euro) remains a potent source of world economic imbalance. The 18-member grouping accounts for three of the five countries in the world with the largest current account surpluses in dollar terms last year (Germany, Switzerland and the Netherlands) and three of the six economies with the biggest net foreign indebtedness (Spain, Italy and France).

The US, the world’s largest foreign debtor in absolute terms with $5.7tn (34.0% of GDP) net debt at end-2013, four times higher than the next biggest debtor, Spain ($1.4tn in debts, 103.1% of GDP), has performed relatively well. The dollar value of its net foreign debts has nearly tripled since the 2007-08 financial crisis, yet this is partly because the value of US-domiciled assets held by foreigners has risen, reflecting the dollar’s ‘safe haven’ status.

This flow of international savings into the US, combined with the higher returns they generate, the IMF notes, has made the dollar ‘more secure’ as the world’s No.1 reserve currency.

The IMF study shows how large-scale corrections in current account balance of payments disequilibria since the 2007-09 financial upheavals has had little effect on global debt imbalances, which the Fund sees as an important threat. Big debtor economies from both the advanced and emerging market economies ‘remain vulnerable to changes in market sentiment, highlighting continued possible systemic risks,’ the IMF says.

According to the IMF’s data, among the emerging market countries with sizeable net liabilities, Brazil, India, Mexico and Turkey – respectively the third, seventh, eighth and ninth largest world net debtors in absolute terms – appear most exposed, although their relative debt deterioration since 2006 has been limited.

Surveys of global stocks of foreign debts and liabilities, alongside capital and trade flows captured in classic balance of payments data, may gain future prominence in the IMF’s policy-making toolkit. Some countries on the IMF executive board are proposing this form of analysis to check the health of national economies.

Among creditors, Japan, the world’s biggest in absolute terms, has extended the gap with China, the No.2 creditor, as a result of the former country’s low growth and the rising value of its overseas holdings. Japan had net foreign assets of $3.1tn at end-2013 (62.4% of GDP, up from $1.8tn (41.2% of GDP) in 2006). This compares with $1.7tn in net foreign assets for China (17.8% of GDP), nearly four times its $476bn in 2006, but barely changed as a proportion of GDP that year (17.0%).

Another less-than-optimal asset management performer was Singapore, the world’s No.10 creditor, which suffered a relative fall in net foreign assets between 2006 and 2013 (to 213.9% of GDP from 251.0%) despite very large current account surpluses, because of unfavourable growth differentials and negative valuation effects. (However, in dollar terms, Singaporean assets grew to $637bn from $371bn.)

The net foreign assets of Germany, the world’s No.3 creditor, swelled to 46.2% of GDP from 26.9%, far less than would have been predicted by its massive current account surpluses. Among other European creditor nations, Switzerland (the world’s fifth biggest creditor) showed a similar sub-optimal outturn, while Norway (No.8) did far better at translating current account surpluses into net increases in foreign assets.

China’s increase in net wealth, like that of Germany, has lagged well behind the cumulative sum of its current account surpluses partly because assets held abroad – many in US Treasury securities - have been relatively low-yielding. The other main Asian and Middle Eastern asset owners, Saudi Arabia (the world’s No.4 creditor), Taiwan (No.6), Hong Kong (No.7) and Kuwait (No.9), all showed similar lags, with Taiwan turning in the best relative performance. Germany’s returns, although not as good as Japan’s, have been better than China’s because it has more invested overseas, unlike the latter, in equities rather than in debt.

In contrast to the large creditor nations, the UK has been a star performer in assets and liabilities. The overall fall in sterling since 2006, combined with a fortuitous juxtaposition of growth in the UK and key economies where the UK invests, has serendipitously allowed Britain to run a high current account deficit while at the same time sharply cutting its net foreign indebtedness.

In 2013 the UK current account shortfall was $114bn (4.5% of GDP), well above the $71bn (2.8% of GDP) of 2006, making it in 2013 the world’s second biggest current account deficit, after the US. Yet the UK’s net foreign liabilities, which in 2006 totalled $762bn (30.6% of GDP), making the UK the world’s third biggest debtor that year (after the US and Spain), fell dramatically, so that Britain by 2013 was no longer in the top 10 debtor nations.

The IMF does not give an up to date figure for the UK’s net liabilities, but a separate IMF database records the figure as only 2% of GDP in 2013. It says the UK is one of several countries, along with Belgium, Canada, Finland, Greece and South Africa, where valuation effects had a positive influence on overall asset-liability balances, counteracting the effect of current account movements.

Among other countries with large current account deficits, Australia is another, like the UK, where positive growth and valuation effects produced a surprising improvement in the foreign balance between 2006 and 2013, with net liabilities falling to 49.6% of GDP from 59.2%.

France is in a less propitious state. The current account deficit in 2013, at $37bn (1.3% of GDP), although the seventh largest globally, was much smaller than in the UK. Despite this, unsatisfactory valuation effects caused by the make-up of its foreign assets and liabilities have pushed overall net French foreign indebtedness to $578bn (20.6% of GDP), propelling it into an unwelcome entry in the world’s top 10 debtors at No.6 in 2013. Italy, the other big debtor in the euro area, was the fourth biggest global debtor with net foreign liabilities of $739bn (35.6% of GDP).

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