Research & Policy Briefs From the World Bank Malaysia Hub No. 17, October 2018 When Is a Current Account Deficit Bad? Sharmila Devadas and Norman Loayza A current account deficit is sustainable when its underlying drivers support a smooth correction in the future. It is unsustainable when symptomatic of macroeconomic imbalances that would eventually trigger disruptive adjustments. Although a current account deficit in itself is neither good nor bad, it is likely to be unsustainable and lead to harmful consequences when it is persistently large, fuels consumption rather than investment, occurs alongside excessive domestic credit growth, follows an overvalued exchange rate, or accompanies unrestrained fiscal deficits. Even though a current account deficit is often paralleled by deteriorating net foreign assets, it may not be as informative about immediate-term financial vulnerabilities as the size, maturity, and currency composition of gross financial stocks. Waste not, want not Determinants of a current account deficit Current account imbalances remain a fixture of the international The first step towards evaluating whether a deficit is good or bad is to environment (Figure 1). Concerns about deficits revolve around insolvency understand its drivers – what underlying conditions might explain a deficit? (the potential inability to repay accumulated external debt without sharp Some of the drivers reflect economic, social, and demographic economic adjustments in the future) and illiquidity (the financial stress from characteristics that imply a benchmark for normal current account deficits; an increased risk of reversals or sudden stops in capital flows). This brief while other drivers include government policies and institutional features explores how a current account deficit (CAD) may (or may not) be bad from that may mitigate or exacerbate a departure from the benchmark. Empirical two angles: its sustainability based on underlying drivers, and the extent to analyses typically map the current account, as a ratio to national income, to which it heightens near-term financial vulnerabilities. factors affecting saving and investment (for an extensive list of determinants, see Calderón, Chong, and Loayza 2002, and Cusolito and Nedeljkovic 2013). The first part of the brief provides an overview of the balance of payments, examines its link to the national accounts, and explains the concept of Table 2 presents key fundamentals (income, demographics, trade and current account sustainability. It then explores the determinants of current financial characteristics) and policy levers (macroeconomic policies and the account deficits and discusses how, based on the normative assessment of institutional environment) that affect current account deficits. These these determinants, an unsustainable deficit could be identified. Finally, the determinants are used in several empirical studies and/or in the baseline brief notes that deficits may be over-emphasized in assessing financial External Balance Assessment (EBA) econometric model run by the stability risks and domestic financing constraints, but nevertheless remain at International Monetary Fund (IMF) (IMF 2018; Phillips et al. 2013). These the mercy of market perceptions. are discussed next. Income. Higher average output growth or productivity may either reduce or What does a current account deficit indicate about the increase a current account deficit. This depends on whether they signal a macroeconomy and when is it (un)sustainable? temporary or permanent increase in income. If temporary, saving would rise A country’s balance of payments – comprising the current account, the and the deficit declines, especially in the short term. However, with time to capital account, and the financial account – reflects the flow of transactions adjust, changes in investment could match that of saving when all the between domestic residents and the rest of the world (Table 1, Column B). income shock is invested domestically given existing portfolio composition The current account balance is also equivalent to the saving and investment considerations between domestic and foreign assets (Kraay and Ventura gap in the national accounts (Table 1, Column A, row in blue) and therefore 2000, 2002). If the income increase is permanent, consumption and reflects residents’ consumption and investment decisions. When a country investment would rise and the deficit increases. Empirical results suggest runs a current account deficit, its saving (the sum of changes in tangible that on balance, deficits do tend to rise with higher average output growth assets and changes in net financial assets) is less than its investment (I - S = or productivity. There is also a recognized relationship between the level of CAD). That is, a country experiences a negative transfer of financial wealth income and the current account deficit. According to the “stages of across borders when purchases of goods and services from abroad and the development” hypothesis, deficits in poor countries are high as their income paid to nonresidents exceeds the amounts residents receive from economies start to grow and import more physical capital; later, deficits fall the outside world. When is this a cause for concern? as countries reach advanced status. Empirically, deficits and development status have a negative relationship. Theoretically, from the perspective of external solvency over time, the present discounted value of future trade surpluses will need to at least equal Demographics. Population growth driven by rising birth rates results in a current net foreign liabilities. This condition in itself does not provide higher young dependency ratio (the number of persons under the age of 15 outright guidance to policymakers because it does not impose restrictions relative to the working-age population), which in turn is associated with on the nature or path of the current account balance. However, it does lower saving, and thus higher deficits. Growth in the working-age implicitly suggest that current and future policies and behaviors must be population, however, can have ambiguous effects, driving up both saving consistent with allowing a smooth adjustment toward servicing the debt and investment. A higher old-age dependency ratio (the number of persons with the proceeds from exports, remittances, and other income from aged 65 and above relative to the working-age population) would imply abroad. Thus, a current account deficit is sustainable if policies and behaviors lower saving. On the other hand, a rapidly aging population is associated underlying it can continue without them undergoing drastic shifts or leading with higher saving and lower deficits, as it partially signals higher longevity to a crisis (Milesi-Ferretti and Razin 1996). On the other hand, an unsustainable current account deficit could be generated by Figure 1. Current Account Imbalances (% of World GDP), macroeconomic imbalances, with eventual sharp adjustments in domestic 2013–17 Average demand, real wages, and the exchange rate, among other factors, leading to a current account reversal (Forbes, Hjortsoe, and Nenova 2017). In practice, East Asia (excluding EU (excluding Other Other the empirical assessment of current account sustainability has involved % China and Germany and Oil surplus United deficit United comparing the current account to GDP ratio against a “norm” based on 0.40 Japan) Germany China the UK) exporters Japan countries Kingdom countries States underlying drivers, and also assessing the ratio against a benchmark that would stabilize a country’s net foreign assets (NFA) to GDP at some observed 0.20 level. Both approaches can be considered as ways to measure the excess in current account deficits (Cusolito and Nedeljkovic 2013). 0.00 While a current account deficit may appear to be sustainable for the time -0.20 being given its underlying drivers, it is also important to consider that it could become unsustainable if investors’ perceptions about it shift, -0.40 triggered by a domestic or external shock, and large corrections in financial flows and asset prices ensue. Servén and Nguyen (2013) distinguish two -0.60 basic views on global imbalances. According to one view, such imbalances High-income Lower-middle-income are unsustainable as some countries spend too much and others too little, Upper-middle-income Low-income requiring eventual correction. The other view is that such imbalances can be self-sustaining, given the demand for scarce, safe financial assets. The latter Source: Authors' calculations based on the World Economic Outlook (WEO) April 2018 links closely to the exorbitant privilege of the United States given its reserve database and World Development Indicators (WDI). currency status. Imports and foreign liabilities are predominantly in its own Note: Country income groups are World Bank classification based on gross national income currency, making it significantly – and uniquely – less vulnerable to foreign (GNI) per capita. Oil exporters are countries with fuel exports that are at least 30 percent currency shortages and exchange rate depreciation. of merchandise exports. EU = European Union; UK = United Kingdom. Affiliation: Development Research Group, the World Bank. Acknowledgement: We are grateful to Aart Kraay and Luis Servén for useful comments, and to Nancy Morrison for editorial assistance. Objective and disclaimer: Research & Policy Briefs synthesize existing research and data to shed light on a useful and interesting question for policy debate. Research & Policy Briefs carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions are entirely those of the authors. They do not necessarily represent the views of the World Bank Group, its Executive Directors, or the governments they represent. When Is a Current Account Deficit Bad? Table 1. Overview of National Accounts and the Balance of Payments A. National Accounts of which: Domestic External B. Balance of Payments Supply of goods and services (Y = YD + M) Domestic output (YD) and import of goods and services (M) YD M Use (Y = IC + C + I + X) Intermediate consumption (IC), final consumption (C), investment (I) and exports of goods and services (X) IC + C + I X Gross Domestic Product (GDP = YD - IC) C+I X-M TB Trade balance (X - M) Gross National Disposable Income (GNDI) = GDP + Income balance (IB) C+I TB + IB Saving (S = GNDI - C) = Investment (I) + Financial saving (CAB) I TB + IB CAB Current account balance (TB + IB) KAB Capital account balance The double-entry bookkeeping system of the balance of payments means that the sum - ΔNFA Financial account balance of CAB and KAB is equal to ΔNFA (change in net foreign assets) 0 CAB + KAB = ΔNFA Source: Authors’ design, based on IMF (2009) and Lindner (2015). See IMF (2009) for further details of the components and compilation methodology of the balance of payments. • The supply of goods and services refers to all available final or intermediate products, produced domestically or imported. • The income balance (IB) includes net income receipts on net foreign financial assets; and workers’ remittances. • The capital account (KAB) reflects disposals (positive sign) and acquisitions (negative sign) of non-produced, non-financial assets (such as leases, licenses and land for embassies). The change in net foreign assets (ΔNFA) reflects increases in financial assets (negative sign/outflow), and financial liabilities (positive sign/inflow). risk among the current working-age population and future strains on to have a causal link with higher saving and a smaller deficit, possibly pension systems (IMF 2017; 2018). Empirical evidence generally bears out reflecting the public sector’s precautionary motive or focus on export-led these expectations. Deficits rise with higher dependency ratios, but decline growth, though this does not preclude reverse causality from surpluses to with higher aging speed. reserves. Conceptually, foreign exchange intervention that leads to an overvalued real exchange rate, typically under a peg, could contribute to a Trade factors. Higher terms-of-trade volatility and larger, more temporary oil widening current account deficit, as exports are “priced out” of world and natural gas net exports can be linked to a precautionary saving motive markets and high domestic interest rates meant to support the peg and thus lower deficits. On the other hand, persistent positive terms-of- encourage residents to substitute present for future consumption (Milesi- trade changes and increased trade openness can have an ambiguous effect Ferretti and Razin 1996). Capital controls, on their own, tend not to have on the current account deficit. Persistent positive terms of trade can statistically significant net effects on current account deficits, but they may incentivize saving through a precautionary motive, but they could also signal reinforce foreign exchange intervention while dampening financial depth greater wealth and investment opportunities, leading to higher effects (Chinn 2017; Phillips et al. 2013). When the quality of a country’s consumption and investment. Similarly, trade openness can induce both institutions is better, conceptually, this should reduce uncertainty and more exports and imports, and the better access to foreign financial markets promote economic growth. Both forces would increase investment but associated with trade openness facilitates payments for international would have an ambiguous impact on saving (lower uncertainty reducing transactions and can lead to higher investment (Chinn and Prasad 2003). Empirically, trade openness, higher terms-of-trade volatility, positive terms- of-trade changes, and net exports of oil and natural gas appear to reduce Table 2. Determinants of Current Account Deficits deficits. Nascent investigations point to potential explanatory power from Direction of Effect production and trade structures. Conceptually, upon joining global value chains (GVCs), downstream economies in the production process (countries Theory Empirical Determinant with relatively low ratios of domestic value-added exports to gross exports) CAD/NY CAD/NY Channel experience improvements in competitiveness that are temporary (as other S/NY I/NY countries eventually catch up), prompting a forward-looking saving motive Income in relation to the income boost from higher exports (ECB 2017). Empirically, Average output growth + /- + + + countries that participate in GVCs appear to have lower deficits the more Stage of development (per capita downstream they are and higher deficits the more upstream they are (ECB income level) - - ... - 2017; Haltmaier 2015). Other studies suggest that deficits can be partly explained by asymmetric trade liberalization favoring goods. The exports of Demographics countries focused on goods increases more than countries focused on Dependency ratio + + - - services (Barattieri 2014; Joy et al. 2018). For some countries, therefore, Aging speeda - - + + current account deficits could reflect increased consumption (of cheap Trade Factors manufactured goods) today against a future increase in income from higher Oil and natural gas net exports - - + + demand for services (Barattieri 2014). - - +/- + /- Terms-of-trade volatility Financial factors. The net effect of financial depth is conceptually unclear. It Trade openness (Sum of exports and could lead to higher financial saving, but it could also significantly boost imports/GDP) + /- - + + consumption and investment through looser borrowing constraints Financial Factors (Bandiera et al. 2000; Chinn and Prasad 2003). Empirical results, especially those based on credit expansion or excesses suggest a positive link to larger Financial depthb + /- + - + deficits (see, for example, IMF 2018 and Phillips et al. 2013). Meanwhile, Initial net foreign assets (NFA) + /- - + ... larger negative net foreign assets (NFA) entail higher interest payments and Reserve currency statusc + + - - a larger deficit, but through the erosion of wealth, may reduce imports. Macroeconomic Policies and Institutional Environment Empirical evidence supports a positive relationship – deficits rise with more Fiscal balance -/0 - + + negative NFA. However, this relationship may not hold for very highly Reserve accumulation - - + ... indebted nations, possibly due to more heightened concerns about Capital controls - - ... - sustainability (Phillips et al. 2013). Having a reserve currency (proxied by the Institutional environmentd + + - - share of a country’s currency in world international reserves) is associated with higher consumption and a larger deficit (Phillips et al. 2013). Source: Authors’ tabulation of the majority outcome of statistically significant results from the studies listed under References in the section entitled “Empirical Results from Literature Macroeconomic policies and institutional environment. A lower fiscal balance Survey” and the previous survey in Calderon, Chong and Loayza (2002). Note: Estimated effect is based on an increase in the determinant (and lower risk in the (government revenue less expenditure) could result in a bigger current case of institutional environment). account deficit, through government spending and its effects on aggregate a. Projected change in old-age dependency ratio (20 years out/current). demand. It could result in higher private consumption and investment, b. Credit to the private sector/GDP. Result also reflects excess credit effects depending on the interplay of complementary versus crowding out effects of (measured by the change in the ratio or the detrended value of the ratio). c. Own currency share in world international reserves. government spending (Chinn and Prasad 2003). On the other hand, a d. Index based on International Country Risk Guide (ICRG) data. reduction of fiscal balances can prompt an increase in private savings, in the Decline in deficit Increase in deficit Ambiguous expectation of future tax increase (a possibility known as the Barro-Ricardian CAD = current account deficit; NY = national income; S = saving; I = investment. Equivalence). Empirical findings consistently show a significant link between + = increase; - = decline. 0 = no effect. Bold + or - = relatively stronger effect. lower fiscal balances and bigger current account deficits – more so through ... = no statistically significant results; color coding is based on the majority sign of statistically insignificant results. 2 lower national saving than higher investment. Reserve accumulation appears Research & Policy Brief No.17 saving and higher growth increasing it), thus having an ambiguous effect on Deficits linked to production and trade structures, meanwhile, need not current account deficits. Empirically, however, the evidence suggests that a mirror domestic distortions but rather comparative advantages. Sound profit better institutional environment is associated with bigger deficits. maximization motives are likely at play in firms’ decisions to relocate abroad. Evidence suggests that innovating countries still earn most of the profits with From the above, we can see that a current account deficit can be an optimal the disaggregation of innovation and production (see Dedrik, Kraemer, and response given a country’s fundamentals, many of which signal strength (for Linden 2009; and Xing and Detert 2010 for a discussion of the iPod/iPhone example, higher average output growth, low terms-of-trade volatility, and production network). Value-added trade also paints a different picture of financial deepening). A deficit can also be optimal in response to competitiveness than gross trade. For instance, the United States continues fundamentals that reflect structural factors (such as the development or to have robust comparative advantage in manufacturing industries (Dai demographic stage of a country) or cyclical conditions (notably, a positive 2013), and its bilateral trade deficit with China is significantly smaller in output gap and a negative terms-of-trade shock). In the face of structural value-added terms than in gross terms (Johnson and Noguera 2012; Xing and factors, the current account deficit would take time to adjust to a balanced Detert 2010). Further, global firms operate across geographical borders and state (Calderón, Chong, and Loayza 2002). In response to cyclical factors, the this complicates the measurement of trade and income balances which are current account deficit may represent an appropriate buffer response residency-based (Avdjiev et al. 2018). Some current account deficits may (Ghosh and Ramakrishnan 2012; Kraay and Ventura 2002) and will likely reflect this tension between the nature of global economic activity and its rebalance (Cusolito and Nedeljkovic 2013). In either case, current account measurement, rather than outright excesses. deficits may warrant consideration of corrective policies if the deficits are misaligned with respect to normal or expected values. Governments can In terms of policy settings, a deficit coinciding with exchange rate have a beneficial effect if they implement such corrective policies. However, overvaluation (that may be propped by intervention which prevents the government policies can lead to abnormal current account deficits when exchange rate from being a shock absorber), excess credit, and relatively they generate price and cost distortions, promote excessive risk taking, and large budget deficits risks over-consumption and over-investment. Calling reflect reckless fiscal and monetary regimes. It can be argued that out such policy gaps that are resulting in suboptimal behavior, however, unsustainable current account deficits can be traced back to a government requires a normative stance and establishing benchmarks (see, for instance, failure in taking corrective policies or in inducing a proper economic Phillips et al. 2013 on identifying policy gaps under the IMF External Balance environment. Assessment (EBA)). The importance of establishing what drives current account deficits can be Identifying an unsustainable current account deficit based on its appreciated with the IMF’s recent EBA results (IMF 2018) for those countries determinants among the world’s largest 29 economies that have deficits (Figure 2). The Naturally, errors and omissions aside, the world must have a balanced model-based assessment of excessive current account deficits is given by current account; so, if some countries run deficits, others should run the sum of policy gaps and unexplained regression residuals after accounting surpluses. Whether the previous determinants point to a deficit being for current account “norms” (reflecting most of the fundamentals and sustainable depends on what they imply about meeting net external policies in Table 2, with the latter set at desirable levels) and cyclical factors. obligations over the long run, the presence of macroeconomic imbalances, For some countries (Brazil, India, and Mexico), estimated norms (the gray and how policymakers respond to underlying fundamental changes. The bar in Panel a) established a deficit that went beyond the actual one (black potential for long-term growth is key. A deficit should be driven by this dot in Panel a), given their lower income, higher growth potential, and faster growth prospect as well as reinforce it – by way of quality investments. population growth, resulting in no overall excesses. For the United States, which has the unique advantage of its reserve currency status, the current It matters then if fundamentals and policy settings are driving consumption account norm suggests a larger deficit than its peers (IMF 2017); while the and/or investment, and if they are reflecting distortions or problems U.S. actual deficit was 2.4 percent, the excess amounted to about 1.5 elsewhere. As noted in the previous section, a deficit is optimal given certain percent. For several countries with relatively large deficits (Argentina, income and demographic characteristics – higher productivity or average Canada, Turkey, and the United Kingdom), identified policy gaps (denoted by output growth, a low stage of development, and a high old-age dependency the negative yellow and red bars in Panel a) played a role in contributing to ratio. While the first two characteristics lead to higher investment, excesses. However, unexplained residuals (denoted by the negative blue foreshadowing future increases in potential output, the third depletes bars in Panel a) were found to be more important. In some instances, the saving, and thus, if a driving force of the deficit, ought to be occurring unexplained residuals were correlated with shortcomings in structural amidst an already strong net foreign asset position from past surpluses. policies, though not explicitly modelled (for example, labor market Figure 2. IMF Assessment of Current Account Deficits in 2017 a. Decomposing the Sources of Current Account Deficits b. Excess and Normal Current Account Deficits % of GDP Current account deficit, % of GDP REER Over (+)/ Undervaluation (-), % ^ 6 TUR 0 ARG* +25 4 GBR +8 2 CAN +7 AUS +9 0 ZAF +5 USA +12 -2 IND~ -1 -4 MEX~ -4 IDN -1 -6 FRA* +4 -8 BRA~ -2 ARG AUS BEL BRA CAN FRA GBR IDN IND MEX TUR USA ZAF BEL* +6 -6 -5 -4 -3 -2 -1 0 1 ^IMF staff assessment Cyclical factors EBA norm + EBA model-based excess deficit Fiscal balance gap Other policy gaps IMF staff-assessed excess deficit Unexplained regression residual IMF staff adjustment (reversed sign) EBA model-based non-excessive deficit *No difference between EBA model and IMF staff-assessed excess. Actual current account deficit ~No excess under EBA model or IMF staff-assessed result. Source: Authors' illustration based on data from IMF (2018). See IMF (2018) for further details on the current account and real effective exchange rate (REER) assessments. Note: IMF staff-assessed excess current account deficit/surplus = EBA model-based gap - IMF staff adjustment; where EBA model-based gap = Policy gaps + Unexplained regression residual = Actual current account deficit - Cyclical factors - EBA norm; where EBA norm comprises fundamentals and desirable policies. Cyclical factors = output gap and commodity terms-of-trade gap. Fundamentals = output per worker, expected GDP growth five years ahead, lagged NFA, oil and natural gas net exports, institutional/political environment, old-age dependency ratio (OADR), population growth, prime-age population (45-64) to working-age population ratio, life expectancy at prime age (standalone and interacted with future OADR), demeaned VIX, reserve currency status. Policy gaps = the differences between actual and desirable policies. Fiscal balance gap = the difference between current cyclically adjusted fiscal balance and one desirable in the future at full employment. Other policy gaps are for public expenditure on health (versus benchmark from regresssion on GDP per capita, demographics and income inequality), foreign exchange intervention (against 0, or non-zero if deemed necessary to reach reserves adequacy), private credit/GDP (deviation from detrended value), and capital controls (against cross-country average or own level, whichever is lower). IMF staff adjustment = outside-the-model adjustments for example, for measurement biases or special demographic features. If negative (positive), it reduces a negative (positive) EBA model-based gap. EBA = External Balance Assessment conducted by the International Monetary Fund (IMF); VIX = Volatility Index (Chicago Board Options Exchange). ARG = Argentina; AUS = Australia; BEL = Belgium; BRA = Brazil; CAN = Canada; FRA = France; GBR = United Kingdom; IND = India; IDN = Indonesia; MEX = Mexico; TUR = Turkey; USA = United States of America; ZAF = South Africa. 3 When Is a Current Account Deficit Bad? distortions in Turkey and South Africa). Most deficit countries also had Meanwhile, the conflation of the real resource constraint in the national indications of currency overvaluation, and, revealingly, the percent of accounts (abstaining from consumption releases real resources for overvaluation (denoted by the numbers in red in Panel b) was more strongly investment/exports) with domestic financing constraints exaggerates the correlated with the magnitude of excess deficits than with the size of the adverse implications of deficits – the saving-investment gap is often taken to actual deficits. reflect a contemporaneous insufficiency of domestic funds to finance domestic expenditure. Contrary to the loanable funds theory (loans are Out-of-model judgment to account for country-specific characteristics limited by the amount of saving in the same period), however, saving does (denoted by the green patterned bars in Panel a) led to overall IMF not constrain the creation of domestic credit by banks (Borio and Disyatat assessments of excess deficits that were less than the EBA-identified 2015; Lindner 2015). excesses. These corrections may at times seem rather arbitrary, including for characteristics such as large gold imports (Turkey), high mortality risk (South The previous discussion suggests that differences in actual vulnerabilities Africa), and mismeasurement (Canada and the United Kingdom). Although between current account surpluses and deficits may not be clear cut. meant as a starting point for country-specific analysis and policy discussion However, perceived vulnerabilities are undoubtedly greater for deficits, and not to predict future events, the models nevertheless ought to be tested which are used to proxy reliance on foreign borrowing and exposure to for their out-of-sample performance. This can not only improve their quality shifts in risk aversion and sentiment. During the taper tantrum in 2013, as assessment tools but also help dispel notions of arbitrariness. Brazil, India, Indonesia, South Africa and Turkey, dubbed the “fragile five” by Morgan Stanley, came under the heaviest investor scrutiny but had little in What current account deficits miss regarding near-term financial common other than current account deficits (Forbes, Hjortsoe, and Nenova vulnerabilities 2017). Against the backdrop of large gross financial flows and stocks, current account deficits are insufficiently informative about the immediate risks to Conclusion financial stability, for several reasons (Obstfeld 2012). First, there is a disconnect between accumulated current account balances and the net A bad current account deficit is characterized by underlying consumption international investment position (NIIP) (NFA adjusted for valuation effects and investment drivers, including policies, that raise doubts about a due to exchange rate and asset price changes), especially over shorter time country’s long-term external solvency or are symptomatic of problems spans. Valuation effects now account for a growing part of NIIP dynamics, elsewhere in the economy. A good deficit supports smooth transitions — for given the size of financial stocks (Forbes, Hjortsoe, and Nenova 2017). instance, from building productive capacity while accumulating external Second, sudden stops are gross events (Borio and Disyatat 2015) that debt to subsequently accumulating assets, and then drawing them down as present risks even without imbalances in the current account or NIIP, the population ages. While traditional determinants continue to help depending on the type of gross financial liabilities, maturity and currency explain deficits, the complexity of globalized economic activities requires a mismatches with respect to gross financial assets, and the potential more careful consideration of measurements and frameworks for assess- significant impact on asset prices. Financial liabilities that are more stable ments (for example, residency-based versus consolidated economic units). (such as foreign direct investment (FDI)), that foster greater automatic risk Good deficits, or even surpluses, are not necessarily safe from financial sharing (such as equity), or that correspond to investors with a longer time stress at any moment in time. The vulnerability to stress depends on the horizon limits the fallout from a negative domestic shock and reduces the characteristics of gross financial stocks, especially if large, and the balance probability of contagion of an external shock (Forbes 2013). For instance, sheets of different sectors. while Argentina and Turkey had been highlighted as having large excess current account deficits with some policy gaps, both have been especially Sound policies and institutional features can go a long way to attracting and vulnerable in recent times given the high share of short-term foreign sustaining a healthy demand for domestic assets. Australia, for example, has liabilities in their NIIPs (IMF 2018). Aggregate NFA may also hide imbalances demonstrated considerable resilience, despite having sizeable current across different sectors. For example, despite previous current account account deficits for much of its history - its vulnerability is less than what its surpluses, the Republic of Korea was badly affected during the global headline negative NIIP might suggest because its foreign liabilities are financial crisis. Banks and corporates with high external debts and negative mostly in Australian dollars, foreign currency debts are well hedged, net positions were hit by large financial outflows and sharp exchange rate macroeconomic policies are sound, and its economy shows no signs of depreciation (see, for example, Avdjiev, McCauley, and Shin 2016). major economic distortions (Belkar, Cockerell, and Kent 2007; IMF 2018). References Avdjiev, S., M. Everett, P. R. Lane, and H. S. Shin. 2018. “Tracking the International Footprints of Joy, M., N. Lisack, S. Lloyd, D. Reinhardt, R. 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