Benchmarks for Net International Investment Positions

Alessandro Turrini and Stefan Zeugner

European Commission

International Financial Integration in a Changing Policy Context – the End of an Era?, Brussels, 2 March 2018

The views set out in this paper are those of the authors and do not necessarily reflect the official opinion of the European Commission.

2

Context

• Since 2008, current account imbalances in many EU and emerging countries have adjusted

• But stock imbalances remain large: in particular NIIPs, that result from past deficits and surpluses

• Issue for macroeconomic surveillance (including EU Macroeconomic Imbalance Procedure)

• Have NIIPs adjusted enough? How far to go further?

3

Diverging NIIPs. Too much? On what respect?

4

Aim of the paper

• Assessing NIIPs requires adequate benchmark

• Few existing analyses (e.g., Berti et al., 2010; Catão and Milesi Ferretti, 2014; Zorell, 2017) estimate common prudential thresholds across cross-country panels

• However:

Tolerance to external liabilities country-specific

How to judge large positive NIIPs?

5

NIIP benchmarks: norm vs. prudential threshold

Two complementary approaches:

NIIP norm – two-sided:

• NIIP in line with economic fundamentals.

Prudential NIIP threshold – one-sided:

• NIIP threshold associated with increased external sustainability crisis.

6

Estimating NIIP norms

• Directly regressing NIIP levels

Risk of spurious relation: NIIP (near)integrated in available samples.

• Alternative route:

Regress current accounts on main drivers

Predict current account norms on the basis of fundamental drivers (non-temporary, policy variables set at "normal value")

Cumulate current account norms over time

7

Current account model

• Similar to Phillips et al. (2013)

Annual frequency

Including large set of fundamental and non-fundamental controls (25)

Variables expressed as differences from world average where appropriate

Advanced and emerging country sample (65) over 1987-2016 period

• Policy at "normal" level=world average

• NIIP not a fundamental

8

Current account norms vs. DNIIP norms

Δ𝑁𝐼𝐼𝑃𝑡 = 𝑁𝐼𝐼𝑃𝑡 −11+𝑔𝑡𝑁𝐼𝐼𝑃𝑡−1 = 𝐶𝐴𝑡 + 𝐾𝐴𝑡 + 𝑉𝐸𝑡 +𝑁𝐸𝑂𝑡

Are current account norms a good approximation for Δ𝑁𝐼𝐼𝑃𝑡 norms?

• CA regressions yield broadly same coefficients as regressions on Δ𝑁𝐼𝐼𝑃𝑡 , but more precisely estimated

• One exception: "financial center" dummy (higher CAs and offsetting valuation effects)

• → Financial center dummy included in CA regression

but not included among the fundamentals

9

Cumulating current account norms

𝑁𝐼𝐼𝑃𝑡 = 𝑁𝐼𝐼𝑃0𝑌0𝑌𝑡+ 𝐶𝐴𝑖

𝑡

𝑖=1

𝑌𝑖𝑌𝑡

• Choice of 𝑁𝐼𝐼𝑃0 : year where NIIP has lowest absolute value in 1993-1996 period

Earliest year for which CA norms are available for all countries is 1997

Comparability: avoid large differences in incidence of initial value across countries

NIIPs were low in absolute value at mid-1990s

• Incidence of initial NIIP is limited

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NIIP norms for 2016, based on differing starting values

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NIIP prudential threshold: Approach

Signalling approach (Kaminsky et al., 1998)

Min [Prob(missed crises) + Prob(false alarm)]

External crisis definition According to definition in Catão & Milesi-Ferretti: default or IMF assistance). 64 countries, 1980-2015

Computation of threshold: global max guaranteed

Assessment

- Signal power

- Robustness to sample perturbations

- Robustness to choice of target function (equalisation of error probability, AUROC)

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NIIP prudential threshold: Findings

Findings

• Common -25% NIIP threshold

• NIIP has stronger signal power than other external stock variables, equaled only by "Net Marketable External Debt" (≈NIIP net of equity)

• NIIP/relative GDP per capita permits to

Obtain a threshold with higher signal power than pure NIIP

Obtain country-specific thresholds (about -50% on average)

• Interpretation: GDP per capita captures structural and institutional aspects related to external debt tolerance

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Estimating prudential thresholds: Results

Dep. var.: external crisis start in t+1, 1980-2015, for 64 countries. Sample omits within crisis observations

Thres-

hold

Signal

power

% Missed

crises

% False

alerts

Threshold

std. dev. AUROC

NIIP -25 0.33 0.22 0.45 7 0.72

NIIP - FDI 12 0.12 0.27 0.61 3 0.49

NMED -16 0.39 0.2 0.41 3 0.73

Net short-term debt 204 0.01 0 0.99 68 0.11

Short-term debt liabilities 12 0.3 0.08 0.62 19 0.62

Gross debt liabilities 25 0.1 0.04 0.86 109 0.52

Reserves 6 0.24 0.38 0.38 2 0.64

NIIP / relative per capita income -83 0.48 0.18 0.34 8 0.77

NMED/relative per cap. income -78 0.55 0.3 0.16 5 0.79

NIIP / imports -140 0.41 0.36 0.24 29 0.77

NIIP / external assets -192 0.42 0.33 0.25 44 0.73

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Interacting NIIP with income allows for better separating crisis vs. non-crisis episodes

Large red: crisis start in t+1, small red: crisis within 5 years, grey: no crisis 1980-2015, relative income is GDP in PPP per working-age person as % of G3

15

Additional robustness checks

• Alternative interaction terms (trade and financial openness, NIIP composition) performing less well

• Income-interacted NIIP also performs well with respect to sample and threshold uncertainty

• Results are broadly confirmed using a different crisis definition (currency crises according to Laeven and Valencia, 2012)

16

Estimated NIIP benchmarks

• NIIP norms and NIIP prudential benchmarks for 65 countries, 1995-2016

• Main patterns for NIIP benchmarks

NIIP benchmarks highly country specific

Prudential thresholds generally well below norm (2-sided)

Negative cross-section relation → tension between

factors underpinning scope for external borrowing and debt tolerance

Median NIIP and NIIP norms co-moving in time (but exceptions!)

Growing NIIP dispersion not matched by NIIP benchmark dispersion

17

NIIP norm vs prudential threshold, average over time

18

Median of NIIP, NIIP norm, NIIP pru thresh., World

-50

-40

-30

-20

-10

1995 2000 2005 2010 2015year

Median NIIP/GDP Median NIIP norm

Median NIIP prudential threshold

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St.dev. of NIIP, NIIP norm, NIIP pru thresh., World

20

40

60

80

1995 2000 2005 2010 2015year

NIIP/GDP standard deviation NIIP norm standard deviation

NIIP prudential threshold standard deviation

20

NIIP gaps – Main patterns

• Positive cross-section relation

• Few countries above norm but below prudential threshold (mostly lower income)

• Relatively persistent, stable distribution

• NIIP gaps signal asymmetric adjustment: negative reaction to negative NIIP gaps only, significant in the case of NIIP prudential thresholds

• [strong role of small countries with financial center status with large volatile NIIP]

• No significant reaction to lagged NIIP level relevance of country-specific benchmarks

21

Gaps with norm and prudential threshold, average over time

Risky, yet above norm

Risky and below norm

Below norm, but 'safe'

Above norm and threshold

22

NIIP adjustment follows negative prudential gaps, not NIIP levels

5-year non-overlapping periods. Country and time effects included. t-statistics in brackets.

Dep. Variable: avg. 5-year change of NIIP

Positive NIIP gap wrt. to norm, t-5 0.022

[0.41]

Negative NIIP gap wrt. to norm, t-5 -0.036

[-1.05]

Positive NIIP gap wrt. to 0.028

prudential threshold, t-5 [0.57]

Negative NIIP gap wrt. to -0.099***

prudential threshold, t-5 [-3.47]

NIIP if positive, t-5 -0.016

[-0.38]

NIIP if negative, t-5 -0.022

[-0.58]

Constant 3.44* 1.56 4.02

[1.91] [0.81] [1.34]

R² 0.078 0.106 0.075

Observations 323 323 323

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Conclusions

• NIIP dynamics have changed after the crisis: benchmarks needed for surveillance purposes

• This paper computes complementary country-specific benchmarks for NIIPs for advanced and emerging economies:

Two-sided NIIP norm

One-sided prudential threshold

• The benchmarks

permit interpretation of ongoing trends (e.g., fundamentals hardly explain growing global stock imbalances)

Are a better predictor of NIIP reversal than simple NIIP (or common benchmarks)

Help assessing current accounts (computing 'required current account' to reach country-specific target NIIP)

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Graph 11: ReqCA to reach NIIP norm v ReqCA to reach -10%

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APPENDIX

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Current account norms 2016

Fundamentals only explain some of CA patterns. Non-fundamental controls are important.

27

Graph 2: NIIP norms vs prudential thresholds, average

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45' line

-100

-50

05

01

00

NIIP

no

rm

-150 -100 -50 0NIIP prudential threshold

28

Graph 7: Frequency of NIIP gaps

29

Graph 8: Distribution of NIIP gaps wrt. NIIP norm, World

-400

-200

02

00

400

NIIP

ga

p w

rt. n

orm

1995 2000 2005 2010 2015

30

Graph 9: NIIP gaps wrt. NIIP prudential threshold, World

-200

02

00

400

600

NIIP

ga

p w

rt. p

rud

en

tia

l th

resh

old

1995 2000 2005 2010 2015

31

Graph 10: Positive NIIP gaps with respect to norm

32

Table 1: Baseline CA regression

(1) (2) (3) (4)

Dependent: Current account balance as % of GDP

Explanatory variables

Relative

to world

average

Interaction

term Coefficient

Statistical

significance

Relative income per capita in PPP (lagged) ✔ 0.034 ***

Relative income interacted with capital openness (lagged) ✔ ✔ 0.033 *

Ageing speed ✔ -0.025

Ageing speed wrt. world * income per capita (PPP) as %

of G3 mean ✔ ✔ 0.164 **

Old-age dependency ratio ✔ -0.047 *

Population growth HP-filtered (lagged) ✔ -0.576 **

Share of manufacturing in value added, instrumented ✔ 0.234 ***

Oil & gas balance / GDP 5Y-mov.av., if positive ✔ 0.427 ***

Mining products exports as % of total exports (lagged) 0.002

Domestic currency % use in world FX reserves -0.041 ***

Financial centre dummy 0.016 ***

NIIP / GDP (lagged, in USD terms) 0.032 ***

NIIP exceeding -60% of GDP (lagged) ✔ -0.030 **

VIX*(capital openness) (lagged) 0.084 ***

VIX *(capital openness) * reserve currency status ✔ -0.210 *

Annual real GDP growth expected 5 years ahead ✔ -0.310 ***

Public health expenditure / GDP (lagged) ✔ -1.739 ***

Health exp. wrt. world av., interacted with old-age dep.

ratio ✔ ✔ 4.773 ***

Structural fiscal balance, instrumented ✔ 0.272 ***

(FX reserve change)/GDP * capital closedness,

instrumented

✔ 0.338 **

REER growth (over 3 years, lagged) -0.086 ***

Construction investment / GDP (lagged) ✔ -0.099 ***

Change of private debt in pp. of GDP (over 3 years,

lagged) ✔ -0.059 ***

Private debt stock/GDP (demeaned by country historical

average) ✔ -0.011

Output gap / potential GDP ✔ -0.385 ***

Constant -0.392 **

R² 0.641

Adjusted R² 0.635

RMSE 3.42

Number of observations 1589

Durbin-Watson stat 0.54

Sample condition number 9.50

33

Table 2: NIIP pru threshold estimates for external crises

(1) (2) (3) (4) (5) (6) (7) (8) (9) (10)

Threshold

Signal

power

associated

to (1)

%

Missed

crises

(type 1

errors)

% False

alerts

(type 2

errors)

#

Crisis

starts

#

Obs.

with no

crisis

Threshold

standard

deviation

Alternative

threshold

equalising

% type 1

and type 2

error

Signal

power

associated

to (8)

AUROC

NIIP -25 0.33 0.22 0.45 45 1790 7 -34 0.31 0.72

NIIP - FDI 12 0.12 0.27 0.61 45 1790 3 7 0.02 0.49

NMED -16 0.39 0.20 0.41 45 1790 3 -22 0.31 0.73

Net short-term

debt 204 0.01 0.00 0.99 7 440 68 27 -0.68 0.11

Short-term

debt liabilities 12 0.30 0.08 0.62 12 667 19 23 0.03 0.62

Gross debt

liabilities 25 0.10 0.04 0.86 45 1789 109 49 -0.07 0.52

Reserves 6 0.24 0.38 0.38 45 1796 2 6 0.22 0.64

NIIP / relative

per capita

income -83 0.48 0.18 0.34 44 1749 8 -102 0.46 0.77

NMED/

relative per

capita income -78 0.55 0.30 0.16 44 1749 5 -53 0.50 0.79

NIIP / imports -140 0.41 0.36 0.24 45 1790 29 -114 0.38 0.77

NIIP / external

assets -192 0.42 0.33 0.25 43 1777 44 -134 0.35 0.73

34

Table 4. NIIP gaps vs. NIIP levels and NIIP adjustment

(1) (2) (3) (4) (5) (6)

Explanatory variables Dependent variable: 5-year change in NIIP

NIIP gap wrt. to norm, t-5 -0.0153

[-0.541]

NIIP gap wrt. to prudential

-0.0227

threshold, t-5 [-0.971]

Positive NIIP gap wrt. to norm,

t-5

0.0219

[0.407]

Negative NIIP gap wrt. to norm,

t-5

-0.0359

[-1.046]

Positive NIIP gap wrt. to

0.0281

prudential threshold, t-5 [0.570]

Negative NIIP gap wrt. to

-0.0989***

prudential threshold, t-5 [-3.467]

NIIP, t-5

-0.0200

[-0.833]

NIIP if positive, t-5

-0.0164

[-0.383]

NIIP if negative, t-5

-0.0220

[-0.580]

Constant 4.390*** 5.311*** 3.442* 1.562 4.160** 4.015

[2.875] [4.863] [1.905] [0.811] [2.452] [1.335]

Observations 323 323 323 323 323 323

R-squared 0.073 0.077 0.078 0.106 0.075 0.075

Number of countries 65 65 65 65 65 65

35

Table 5: NIIP adjustement and exchange rate regime

Dependent variable: 5-year change in NIIP Fixed exchange rates Flexible exchange rates

NIIP gap wrt. to norm, t-5 -0.04 0.00

NIIP gap wrt. to prudential

threshold, t-5 -0.04 -0.01

Positive NIIP gap wrt. to

norm, t-5 0.05 -0.03

Negative NIIP gap wrt. to

norm, t-5 -0.10** 0.02

Positive NIIP gap wrt. to

prudential threshold, t-5 0.029 0.05

Negative NIIP gap wrt. to

prudential threshold, t-5 -0.16** -0.07***

Observations 117 117 117 117 206 206 206 206

R-squared 0.21 0.21 0.28 0.28 0.05 0.05 0.05 0.08

Number of countries 33 33 33 33 51 51 51 51

Adjustment follows upon negative gaps, not positive ones

36

Table 6. NIIP levels and adjustment, by country groups

(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12)

EU Advanced non-EU Emerging

Explanatory variables Dependent variable: 5-year change in NIIP

NIIP gap wrt. to norm, t-5 -0.0565

0.000287

0.00615

[-1.266] [0.0105] [0.293]

NIIP gap wrt. to prudential threshold,

t-5

-0.0628**

-0.0172

-0.0392

[-2.359] [-0.721] [-1.659]

Positive NIIP gap wrt. to norm, t-5

0.0778

-0.00601

0.0328

[0.548] [-0.101] [1.088]

Negative NIIP gap wrt. to norm, t-5

-0.0794

0.00584

-0.0149

[-1.463] [0.324] [-0.427]

Positive NIIP gap wrt. to prudential

-0.0137

0.0316

-0.00460

threshold, t-5 [-0.384] [0.455] [-0.108]

Negative NIIP gap wrt. to prudential

-0.119

-0.0988***

-0.0598*

threshold, t-5 [-1.501] [-5.882] [-1.904]

Constant 1.770 5.021*** 0.390 1.771 14.77** 17.17** 15.06** 10.37 0.857 0.509 0.306 -0.265

[1.204] [5.758] [0.172] [0.575] [2.289] [2.233] [2.548] [1.455] [1.246] [0.708] [0.358] [-0.253]

Observations 138 138 138 138 65 65 65 65 134 134 134 134

R-squared 0.224 0.250 0.251 0.272 0.126 0.129 0.127 0.151 0.134 0.160 0.140 0.168

Number of countries 28 28 28 28 13 13 13 13 27 27 27 27

37

Table A1.2: NIIP cross-country averages

38

Graph A1.3. NIIP norms based on differing starting values

39

Graph A2.1: Signal power

a) Signal power as a function of different values

for an NIIP threshold

b) Signal power as a function of different values

for an NIIP/rel. p.c. income threshold

c) Signal power as a function of different values

for an NMED threshold

d) Signal power as a function of different values

for an NNMED/rel. p.c. income threshold

40

Graph A2.2: AUROC, selected indicators

41

42

Median of NIIP, NIIP norm, NIIP pru thresh., EU

-60

-40

-20

0

1995 2000 2005 2010 2015year

Median NIIP/GDP, EU Median NIIP norm, EU

Median NIIP prudential threshold, EU

43

CA norms vs 'norm' based on NIIP changes

44

45