The Bottom Line

• Author: Christian Keller, Christoph Rosenberg, Nouriel Roubini, and Brad Setser
• Position: Economist/Deputy Division Chief/Associate Professor of Economics and International Business at New York University/Visiting Scholar in the IMF's Policy Development and Review Department

Weaknesses in public and private sector balance sheets could be the sign of a crisis in the making.

The depth of the capital account crises of the 1990s and the devastation they left in their wake shattered any complacency economic and financial experts may have felt about their ability to accurately assess the financial health of a country relying solely on the traditional analysis of flow variables, such as annual GDP, the current account, and fiscal balances. Many observers realized that signs of impending trouble might have been spotted had they looked more closely at countries' balance sheets and, specifically, paid more attention to mismatches between the stock of a country's assets and the stock of its liabilities-that is, stock imbalances. Analysis of flows is, of course, still vital. But those seeking to prevent crises or to react to them more effectively need to ask questions about the health of a country's balance sheet. For example, does short-term foreign-currency-denominated debt exceed foreign currency reserves? Would a large outstanding stock of debt denominated in foreign currency make it more difficult to correct a flow imbalance (such as a current account deficit) without creating a deep crisis?

The balance sheet approach to crisis prevention and resolution begins with a look at a country's consolidated external balance sheet-the external debts that the country's government, its banks, and its firms have relative to their external assets (notably liquid external reserves). But close attention must also be paid to the balance sheets of individual sectors, because mismatches at the sectoral level might not show up on the consolidated balance sheet, yet could trigger a financial crisis just the same. The key sectors include the government sector (for the sake of simplicity, we include the central bank in this sector), the private financial sector (mainly banks), and the nonfinancial sector (corporations and households). The sectoral balance sheets are often linked-that is, one sector's debt may be another's asset, in which case, if the first sector has trouble servicing its debt, the second sector's assets deteriorate and it may, in turn, have difficulty repaying its creditors.

Analysis of balance sheet vulnerabilities is most useful if it is done in time to allow policymakers to identify and correct weaknesses before they contribute to financial difficulties. This puts a premium on timely information on stock variables, which is often hard to come by (see Box 1).

Box 1 Not enough information

Countries have not routinely gathered balance sheet information, primarily because they lack the resources to do so-one reason the IMF is placing a high priority on helping countries develop these data. In the meantime, partial information is available from several sources:

* Data collected by national authorities (available on the websites of many finance ministries and central banks); for subscribers to the IMF's Special Data Dissemination Standard (SDDS), this includes detailed data on reserves and foreign currency liquidity.

* Various databases and publications, including the IMF's monthly International Financial Statistics (IFS) and the Balance of Payments Yearbook (with International Investment Position data).

* Quarterly statistics, from the perspective of creditors, on the assets and liabilities of banks in the 28 countries and territories that report to the Bank for International Settlements (BIS), available as part of the Joint BIS-IMF-OECD-World Bank debt statistics.

* Annual debt tables published by the World Bank (Global Development Finance).

Together, these data provide reasonable coverage of the public sector's liabilities and liquid assets and of the country's aggregate external liabilities. Nonetheless, detailed information on short-term external liabilities, especially those of the nonofficial sectors, and on the domestic claims of the official sector, can be difficult to find. Data on overall assets and liabilities, particularly breakdowns by currency of stocks and flows, in the...