When Are Current Account Imbalances Sustainable?

• Pages: 83-85

Page 83

From the late 1970s to early 1980s and again in the early 1990s, the lion's share of total international capital flows went to the developing countries of East Asia and Latin America. Many of these countries ran large and persistent current account deficits financed by these inflows. As the Mexican financial crisis in late 1994 demonstrated, however, abrupt reversals in international capital flows can cause serious problems for economies with large external imbalances.

The relationship between protracted current account deficits and external crises-such as an exchange rate collapse-has spurred interest in the question of what determines whether current account deficits are sustainable. An IMF Working Paper, Current Account Sustainability: Selected East Asian and Latin American Experiences, by Gian Maria Milesi-Ferretti and Assaf Razin, examines episodes of large and protracted current account imbalances during the early 1980s and the early 1990s in three East Asian developing countries (Korea, Malaysia, and Thailand) and in three Latin American developing countries (Chile, Colombia, and Mexico). Of the ten episodes examined, three ended in an external crisis. The authors find that the likelihood of a protracted current account imbalance resulting in an external crisis depends in large part on key macroeconomic and structural features of the economy-in particular, the level of savings and investment, the degree of openness, the level and flexibility of the exchange rate, and the health of the financial system.

Measures of Sustainability

Two pertinent questions that need to be addressed in evaluating the macroeconomic and external implications of persistent current account deficits are: Is the debtor country solvent, and is its current account imbalance sustainable?

Solvency. If a country has the ability to generate sufficient trade surpluses in the future to repay existingPage 84 debt, then it meets the solvency criterion. This, however, may not be the most appropriate criterion for evaluating the viability of external imbalances, because it takes for granted the country's willingness to pay its creditors and the willingness of foreign investors to lend to the country on current terms. Sustainability. The authors therefore propose the broader notion of sustainability, which explicitly takes into account willingness to pay and willingness to lend. For a country that has positive net...