Although there have been some signs that global imbalances may be stabilizing, they “are likely to remain large for the foreseeable future,” a low-risk but potentially high-cost and disruptive threat to the world’s economy if they were reduced suddenly, IMF Managing Director Rodrigo de Rato said in a speech to the Harvard Business School Alumni Dinner in Washington on February 26.
He also raised concerns about the threats to global financial markets by the practice of the so-called yen carry trade in which investors borrow in yen to take advantage of low Japanese interest rates and buy securities in countries like Brazil, New Zealand, or Turkey, where rates are higher.
The risks to the global system, he said, could occur if there were a sharp narrowing of the interest rate differential—caused, for example, by a sharp appreciation in the yen or a depreciation in the high-yielding currencies or both.
Only a day after the Managing Director’s speech, markets provided a timely reminder of the potential risks. A sudden fall in stock prices in China sent global equities markets into a sharp decline, and jittery investors scurried for less risky investments across the board. Many of those who had borrowed yen to invest in emerging market currencies acted to unwind their position, buying the Japanese currency to pay off loans. The result was an appreciation in the yen and a decline in the value of target currencies, such as the Brazilian real, the Mexican peso, and the Australian and New Zealand dollars.
The global imbalances, which have become a growing concern, are reflected in a large and stubborn deficit in the U.S. current account and persistent surpluses in Asian emerging market countries, especially China, as well as in oil-exporting countries and Japan. The Fund has held meetings with key economies—China, the euro area, Japan, Saudi Arabia, and the United States—to discuss how to wind down those imbalances gradually while maintaining world economic growth. Global imbalances and the multilateral consultations will be a topic of discussion at IMF-World Bank spring meetings next month in Washington, D.C.
On the positive side, de Rato said in his Harvard Business School speech, the U.S. federal deficit, a major factor in its current account shortfall, has narrowed and there has been “some progress on greater exchange rate flexibility in China and on structural reforms in the euro area and Japan.” Moreover, Saudi Arabia and other oil exporters are following through on plans to increase investment.
Ripple effects of global imbalances
But “less welcome” developments, which de Rato called the “ripple effects of the continuing global imbalances,” include signs of strains in currency markets, especially affecting the euro and the yen, that “could trigger a sudden shock to financial markets,” and growing protectionist sentiment around the world that “could result in a slow strangulation of global growth.” He said he is worried that “some political leaders and many citizens seem overly complacent about the risks of protectionsim…. We know that the prosperity of the past 60 years has been founded on increased trade. But we are also aware that many people doubt the benefits of trade.”
He also said most of the depreciation in the dollar that has helped reduce the U.S. current account deficit has been against the euro and the pound sterling. “What would be better is for China to make more use of the flexibility it gave itself over a year ago to allow an appreciation of the remnibi against the dollar.” That would give China the ability to use monetary policy to curb investment and growth and would permit other Asian countries to allow their currencies to appreciate without losing competitiveness.
Camilla Andersen James Rowe
Elisa Diehl Ina Kota
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