IMF Issues Report Assessing Countries’ Exchange Rates (Text)

The following is a reformatted version of International Monetary Fund staff research released today assessing the real effective exchange-rate, or REER, valuations of 28 countries and the euro area, their currency interventions and reserves. The assessments were made in a report dated June 20 and titled “2013 Pilot External Sector Report -- Individual Economy Assessments.” Click here to find the full report.

AUSTRALIA

Real exchange rate: Australia has experienced a structural savings/investment imbalance for some time in part related to a capital intensive mining sector resulting in a strong exchange rate. These structural factors aside, and after accounting for some depreciation since May, model results would suggest that the real exchange rate remains overvalued by 5-15 percent. Aside from these structural factors, there are a number of short-term factors contributing to the current overvaluation of the exchange rate, including the continued gap between domestic and foreign interest rates and increased portfolio inflows. The high exchange rate is accelerating structural change by increasing price competition for the non-commodity tradable sector.

FX intervention and reserves: Although domestic banks’ external liabilities are sizable, they are either in local currency or hedged with little or no counterparty risks, so reserve needs for prudential reasons are also limited.

BELGIUM

Real exchange rate: Models point to a real exchange rate moderately stronger by around 0 to 10 percent than the level consistent with medium-term fundamentals and desirable policy settings.

FX intervention and reserves: The euro has the status of a global reserve currency. Reserves held by the euro area are typically low relative to standard metrics, but the currency is free floating.

BRAZIL

Real exchange rate: A combination of indicators suggests that the real exchange rate is overvalued by some 10-15 percent. Model-based estimates suggest that the real effective exchange rate is above the level implied by medium-term fundamentals and desirable policies, partly reflecting sizable net capital inflows.

FX intervention and reserves: Reserves have increased to more than adequate levels with respect to various criteria including the IMF’s composite adequacy metric. There is no need for further reserve accumulation for precautionary purposes, although temporary further accumulation could be part of an overall strategy to manage capital inflows.

CANADA

Real exchange rate: Models suggest a real effective exchange rate overvaluation of 5-15 percent relative to medium-term fundamentals and desirable policy settings.

FX intervention and reserves: A free floater with minimal reserves who has not unilaterally intervened since September 1998.

CHINA

Real exchange rate: Taking account of these developments and uncertainties in the model-based estimates, staff assesses the real exchange rate to be moderately undervalued by some 5-10 percent compared to medium-term fundamentals and desirable policies.

FX intervention and reserves: Reserves are somewhat above the IMF’s composite metric (161 percent at end 2012), and further accumulation would be undesirable.

EURO AREA

Real exchange rate: Building from a view of external positions in individual euro area economies and staff estimates, the real exchange rate (in 2012 average) is close to equilibrium as suggested by medium-term fundamentals and desirable policy settings. Differences across euro area economies have remained roughly the same as in previous staff evaluations: real exchange rates seem moderately undervalued in surplus economies, while remain overvalued in most deficit economies. By early April 2013 the real effective exchange rate is estimated to have risen by about 2½ percent from its 2012 average.

FX intervention and reserves: The euro has the status of a global reserve currency. Reserves held by the euro area are typically low relative to standard metrics, but the currency is free floating.

FRANCE

Real exchange rate: Structural rigidities and rising unit labor costs relative to France’s main trading partners in the euro area have contributed to loss of competitiveness and an estimated overvaluation of between 0 and 5 percent.

FX intervention and reserves: The euro has the status of a global reserve currency. Reserves held by the euro area are typically low relative to standard metrics, but the currency is free floating.

GERMANY

Real exchange rate: Various methodologies indicate a range of estimates from an undervaluation of about 2 percent to 10 percent suggesting that the real exchange rate in Germany is moderately undervalued relative to the value consistent with medium-term fundamentals and appropriate policies.

FX intervention and reserves: The euro has the status of a global reserve currency. Reserves held by the euro area are typically low relative to standard metrics, but the currency is free floating.

HONG KONG SAR

Real exchange rate: The real exchange rate is broadly consistent with medium-term fundamentals and desirable policies. A number of empirical methodologies confirm this assessment, with analysis pointing to a range of under/overvaluation of -15 to +7 percent.

FX intervention and reserves: Currently reserves are adequate for precautionary purposes, and future accumulation should be limited to that required by the automatic adjustment of the currency board system. Hong Kong SAR holds significant fiscal reserves, held offshore and built up through a track record of strong fiscal discipline.

INDIA

Real exchange rate: The real effective exchange rate is some 3 percent above the average of the last 20 years. Despite nominal depreciation since July 2011, the real exchange rate has appreciated somewhat due to India’s large inflation differential with its trading partners. The real exchange rate is broadly consistent with medium-term fundamentals and desirable policies.

FX intervention and reserves: Reserves stand at 166 percent of the IMF’s composite metric and 170 percent of short-term debt covering about 6 months of imports. As such, reserve levels are broadly adequate for precautionary purposes.

INDONESIA

Real exchange rate: In 2012, the real effective exchange rate depreciated by a modest 2 percent. The model estimates suggest the real exchange rate is in line with medium-term fundamentals and desirable policies. Going forward, greater exchange rate flexibility would help the economy better absorb external shocks and facilitate necessary adjustment, supported by appropriate macro-financial policies and growth-oriented structural reforms.

FX intervention and reserves: At end-2013, reserves are projected to be adequate at around 125 percent of the IMF’s composite metric. With a sustained current account deficit projected over the medium term, this level of reserve cover could help to reduce risks associated with increasing reliance on foreign financing. Given volatile capital flows, some foreign exchange intervention may be warranted to smooth currency fluctuations.

ITALY

Real exchange rate: Various approaches suggest a real effective depreciation of 0-10 percent, would be appropriate.

FX intervention and reserves: The euro has the status of a global reserve currency. Reserves held by the euro area are typically low relative to standard metrics, but the currency is free floating.

JAPAN

Real exchange rate: Relative to medium-term fundamentals and desirable policies, the sharp depreciation since 2012 implies moderate undervaluation, with estimates ranging from ranging from a 20 percent undervaluation to a 10 percent overvaluation as this assessment is subject to greater than usual uncertainty given market volatility. The exchange rate is expected to move in line with fundamentals over the medium-term assuming the implementation of comprehensive and credible fiscal and structural reforms.

FX intervention and reserves: Reserves are higher than other reserve asset issuers (about 20 percent of GDP) on legacy accumulation. The level of the yen is market determined. Isolated fx interventions during safe haven periods appear to have reduced short-term exchange market volatility, while having ambiguous effects on the exchange rate level.

KOREA

Real exchange rate: The REER is assessed to be around 2-8 percent below the level that is consistent with medium-term fundamentals and desirable policies, i.e. moderately undervalued, though less than during the last ESR round.

FX intervention and reserves: Reserves are adequate at 180 percent of short-term external debt and 130 percent of the IMF’s composite metric, within the 100-150 percent recommended range. Including forward positions, the reserve coverage looks more comfortable. Therefore, there is no need for further reserve accumulation for precautionary purposes although going forward, a slow increase in line with rising liabilities would be reasonable. Continued nominal exchange rate flexibility would be desirable with intervention limited to smoothing volatility.

MALAYSIA

Real exchange rate: Estimates based on EBA suggest that the exchange rate is undervalued relative to medium-term fundamentals and desirable policies by about 17 percent. However, as noted above, the model-based methodologies do not fully capture Malaysia’s structural characteristics and there is a broad range of uncertainty around such estimates. We assess the REER to be undervalued by about 5-15 percent.

FX intervention and reserves: Official reserves are about 128 percent of the IMF’s composite reserve adequacy metric, and cover about 280 percent and 32 percent of short-term external debt and broad money, respectively. Therefore, current reserve levels are adequate and there is no need for additional accumulation for precautionary purposes. BNM intervention seeks to limit excess exchange rate volatility and has generally been two-sided. Thus, during the global financial crisis foreign reserves fell by about 33 percent between August 2008 and March 2009, and a decline was again recorded in August-September 2011.

MEXICO

Real exchange rate: A range of metrics and methodologies suggest that the current level of Mexico’s exchange rate is broadly in line with medium-term fundamentals and desirable policy settings.

FX intervention and reserves: The current level of foreign reserves is adequate according to a range of standard reserve coverage indicators, at the middle of the range of the IMF’s composite adequacy metric. Going forward, there is the case for a gradual increase in reserves consistent with the expected gradual rise in foreign-held liabilities. The Fund FCL arrangement has been an effective complement to international reserves against global tail risks.

THE NETHERLANDS

Real exchange rate: Relative profitability in manufacturing has been broadly stable, and a range of approaches suggest a moderate undervaluation of 0-5 percent.

FX intervention and reserves: The euro has the status of a global reserve currency. Reserves held by the euro area are typically low relative to standard metrics, but the currency is free floating.

POLAND

Real exchange rate: Model-based estimates suggest the exchange rate is broadly consistent with medium-term fundamentals and desirable policy settings.

FX intervention and reserves: Reserves are broadly adequate, standing at about 140 percent of the IMF’s composite reserve adequacy metric, but are less than 100 percent of short-term debt at remaining maturities plus the current account deficit. The Fund FCL arrangement helps as a buffer to external shocks. The zloty has floated freely.

RUSSIA

Real exchange rate: model-based approach points to a real exchange rate undervaluation of 0-10 percent. However, alternative competiveness indicators, such as estimates of equilibrium dollar wages of the manufacturing sector using broad cross-country panel data, suggest that ruble is broadly in line with medium-term fundamentals, consistent with the current account assessment.

FX intervention and reserves: Reserves, which include National Wealth Fund savings, were around 172 percent of the IMF’s composite adequacy metric at end-2012. Reserves assets are adequate, and there is no need for further reserve accumulation for precautionary purposes. Over time it would be appropriate to invest oil reserve fund assets in less liquid and higher-yielding instruments, limiting the costs of reserve holdings. The exchange rate has shown greater flexibility, and interventions have been limited since early 2011.

SAUDI ARABIA

Real exchange rate: Empirical models linking the real effective exchange rate to the real price of oil suggest that the rate is broadly in line with fundamentals.

FX intervention and reserves: Reserve assets are more than adequate for precautionary purposes (measured by traditional metrics); foreign assets accumulation is consistent with the intergenerational transfer of oil revenues.

SINGAPORE

Real exchange rate: While non-standard factors (Singapore is a very small, very open economy that serves as a regional financial center) make quantitative assessment difficult, the real exchange rate appears around 0−10 percent weaker than warranted by medium-term fundamentals (including rapid population aging) and desirable policies.

FX intervention and reserves: With the nominal effective exchange rate as the intermediate target, intervention is undertaken as required to achieve monetary policy’s inflation and output goals. At end-2012, official reserves covered 26 percent of short-term external debt, but are much higher than thresholds for other traditional adequacy metrics. Reserves are also a larger share of GDP than in most other financial centers, but this may reflect in part that most other financial centers are located in reserve-currency countries or currency unions. While non-standard factors warrant generous reserve buffers, current levels appear adequate and there is no clear case for further reserve accumulation for precautionary purposes.

SOUTH AFRICA

Real exchange rate: Direct approaches to estimating the equilibrium exchange rate are complicated by structural changes since 1994 and the high volatility exhibited by the REER. Model-based estimates suggest that the CPI-based REER was slightly undervalued as of 2013 Q1. However, several indicators of external competiveness, including South Africa’s declining share on world’s exports and the ULC-based REER, point in the opposite direction. Applying mechanically trade elasticities to close the current account gap suggested an overvaluation of 10-15 percent by the first quarter of 2013. Although the rand depreciation since then should help reduce the current account gap, structural factors will likely keep the external position weaker than justified by fundamentals and desired policies.

FX intervention and reserves: Some reserve accumulation is desirable.

SPAIN

Real exchange rate: Model-based REER analysis suggests the real effective exchange rate is about 8-12 percent above the level consistent with medium-term fundamentals and desirable policies. Achieving domestic equilibrium, especially full employment, would, however, likely imply an even greater gap.

FX intervention and reserves: The euro has the status of a global reserve currency. Reserves held by the euro area are typically low relative to standard metrics, but the currency is free floating.

SWEDEN

Real exchange rate: Despite the continued strengthening of the krona, the model estimates suggest a real exchange rate undervaluation of some 3.5-8.5 percent relative to its long-run equilibrium.

FX intervention and reserves: Though such pre-emptive reserve accumulation is a conservative move by the central bank, given the large gross external liabilities of banks, maintaining FX liquidity buffers--in the form of reserves and swap lines--is advisable.

SWITZERLAND

Real exchange rate: Model-based estimates suggest that the real effective exchange rate is overvalued by 5-10 percent relative to its medium-term fundamentals and desirable policy settings.

FX intervention and reserves: The introduction of the floor was appropriate in light of the risk of economic contraction and deflation. The credible exchange rate arrangement mitigated the need for reserve accumulation initially, but reserves are on the rise again with a large scale intervention from the SNB as a result of the intensification of the European crisis and, to a lesser extent, a continued increase in global liquidity. The central bank has access to dollar swap lines with the US Federal Reserve.

THAILAND

Real exchange rate: A number of methodologies suggest that the Thai baht is consistent with medium-term fundamentals and appropriate policies.

FX intervention and reserves: Thailand’s gross reserves are more than adequate and there is no need to build up reserves for precautionary purposes. Intervention has smoothed volatility but sterilization costs have increased and there is room for more two-way exchange rate flexibility.

TURKEY

Real exchange rate: Model results point to a real effective exchange rate that is 10-20 percent stronger than the level that can be explained by medium-term fundamentals and policy deviations from desirable settings.

FX intervention and reserves: Turkey’s gross reserves of $119 billion at end-2012 increased from $88 billion the year before. The 2012 reserves account for 115 percent of the IMF composite adequacy metric versus 99 percent in 2011. Reserves cover of short-term debt rose to 87 percent in 2012 compared with 71 percent in 2011. Reserve coverage is also adequate when using other traditional metrics. However, reserves accumulation is warranted for precautionary reasons given uncertainty in global liquidity flows.

U.K.

Real exchange rate: Various methodologies suggest a decline in the real effective exchange rate of the order of 5-10 percent may be appropriate given medium-term fundamentals and desirable policy settings, although, there is uncertainty regarding the precise magnitude of exchange rate misalignment. For instance, the recent depreciation of the real exchange rate has not propelled an improvement of net exports suggested by standard trade elasticities.

FX intervention and reserves: Reserves held by the UK are typically low relative to standard metrics, but the currency is free floating.

U.S.

Real exchange rate: Estimates relying on current account assessments suggest a mild overvaluation given underlying fundamentals and desirable policies. The range of direct estimates of equilibrium real exchange rates is instead centered around zero, reflecting primarily the dollar’s current weakness relative to a long-run average. On balance, staff assesses that a further depreciation of the dollar in the range of 0-10 percent would be associated with a level of the dollar and a current account balance broadly consistent with medium-term fundamentals and desirable policies.

FX intervention and reserves: The dollar has the status of a global reserve currency. Reserves held by the U.S. are typically low relative to standard metrics, but the currency is free floating.

To contact the reporter on this story: Brendan Murray in Washington at brmurray@bloomberg.net

To contact the editor responsible for this story: Chris Wellisz at cwellisz@bloomberg.net

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