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Deficits, Surpluses a Challenge for Global Economy: IMF

By Alessa Flores | Wed, 08/05/2020 - 13:58

Before COVID-19, the world economy was already facing economic imbalances. However, these were accentuated as the pandemic progressed. According to the International Monetary Fund (IMF), the crisis has hindered trade and generated significant movements in exchange rates, as well as a "limited" reduction in deficits and surpluses in global accounts. 

Despite the fact that some countries in the world believe that they have left the COVID-19 crisis behind, the IMF considers that the threat to the world economy has not left the picture. With the arrival of new waves of contagion, a change in the direction of capital flows and commercial deterioration may play against recovery. 

Though IMF sees imbalances as inevitable in the global economy, an excess could damage countries' and the global economy. Martin Kaufman, Deputy Director of the IMF's Strategy, Policy and Evaluation Department, believes “the challenge is to determine when imbalances are excessive or pose a risk.” For example, economies that borrow too much too quickly from abroad may incur in external deficits and become vulnerable to sudden shutdowns of capital flows. Other countries may face risks by investing too much of their own savings abroad, considering the internal investment needs, according to Daniel Leigh, Deputy Division Chief in the IMF's Research Department. 

According to the IMF's 2020 External Sector Report: Global Imbalances and the COVID-19 Crisis, about 40 percent of total current account deficits and surpluses in 2019 were excessive. IMF’s 2020 external forecast shows high uncertainty and variability across countries. Likewise, 2020 saw a sharp contraction in trade where global volume of goods in the first months of the year was about 20 percent lower than in 2019. Moreover, IMF expects the downturn in 2020 to be more serious for services trade than could be expected based on the prospective fall in aggregate demand, indicating a strong role for special factors, such as travel restrictions.

Faced with this situation, the IMF has generated a series of recommendations for providing relief and promoting economic recovery. In the medium term, policies should focus on addressing the health crisis and the burden of infection in homes and businesses. Later, economies should prioritize providing general incentives through "temporary and targeted policies, including cash transfers, wage subsidies, tax relief and extension or postponement of debt repayments to provide relief to businesses," explains the report. Additionally, countries should focus on managing capital outflows and currency pressures to respond to external shocks, such as drops in oil prices or tourism, as well as being flexible to modify the exchange rates as needed and when feasible. 

IMF has also developed a series of special recommendations for emerging markets and developing economies. “(Countries) that are facing disruptive balance of payment strains without access to private external financing should ensure that their health spending is not compromised," the IMF report says.

IMF’s recommendations were also tailored to each country. In the case of Mexico, it was advised that in the short-term, the country should "provide sufficient policy support in response to the COVID-19 pandemic; maintain floating ER as the main shock absorb, with FX interventions to prevent disorderly market conditions.” In the long term, Mexico should “implement pro-growth and inclusive fiscal and structural reforms, as well as improve
competitiveness and business climate," says the report. Finally, it is recommended that Mexico's policies should continue to address domestic imbalances to prevent excessive external imbalances, "gradually narrowing larger-than-desirable fiscal deficits while engaging in reforms of state-owned enterprises and opening markets to more competition, relaxing restrictions on foreign direct investment and strengthening the social safety net.”

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Alessa Flores Alessa Flores Senior Journalist and Industry Analyst