Reducing large net foreign liabilities

• Published in: Review of international economics 2019-05, Vol.27 (2), p.549-577
• Main Authors: Fidora, Michael, Schmitz, Martin, Tcheng, Céline
• Format: Article
• Language: English
• Subjects: Accumulation; Emerging markets; Exports; Foreign exchange rates; GDP; Gross Domestic Product; Imports; Liability; Payments; Sovereign debt; Surpluses; Valuation
• ISSN: 0965-7576; 1467-9396
• DOI: 10.1111/roie.12388

In light of persistently large net foreign liability (NFL) positions in several euro area countries, we analyze 138 episodes of sizeable NFL reductions for a broad sample of advanced and emerging economies. We provide stylized facts on the channels through which NFLs were reduced and estimate factors that make episodes “stable”, that is, sustained over the medium term. Our findings show that while GDP growth and valuation effects contribute most to NFL reductions overall, stable reduction episodes also require positive transaction effects (i.e., current account surpluses), in particular in advanced economies. Considering the different components of a country's external balance sheet, we observe that reduction episodes were almost exclusively driven by a decline in gross external liabilities in emerging economies, while in advanced economies also gross external asset accumulation contributed significantly, in particular in stable episodes. Our econometric analysis shows that NFL reductions are more likely to be sustained if a country records strong average real GDP growth during an episode and exits the episode with a larger current account surplus that consists of a combination of relatively high exports, low imports and low net factor income payments. Moreover, we find evidence that nominal effective exchange rate depreciation during an episode is helpful for achieving episode stability in the short run, while IMF programs and sovereign debt restructurings also contribute to longer term stability.