Should the state of Barbados’ foreign currency reserves be cause for concern?
After narrowing in the aftermath of the global financial crisis and remaining broadly unchanged in recent years, global imbalances increased moderately in 2015, amid a reconfiguration of current accounts and exchange rates.
Shifts in 2015 were driven primarily by the uneven strength of the recovery in advanced economies, the redistributive effects of the sharp fall in commodity prices, and tighter external financing conditions for emerging markets.
Currency movements since end-2015 helped to partially reverse the trends observed last year, although market volatility following the result of the United Kingdom (UK) referendum to leave the European Union have led to a strengthening of the United States (US) dollar and yen along with a weakening of the sterling, euro, and emerging market currencies.
The implications for external assessments going forward, especially for the UK and the euro area, remain uncertain and will likely depend on how the transition is managed and on what new arrangements are adopted.
In varying degrees, most countries depreciated in nominal terms vis-à-vis the US dollar during 2015, leading to a sharp appreciation of the latter in real effective terms, as well as of currencies closely linked to it.
Closely tied to the US dollar, China’s currency also appreciated sharply in real terms.
The euro and the yen depreciated significantly both in nominal and real terms, as well as currencies of many commodity-exporting economies.
These sharp currency movements during 2015 occurred on the back of large shifts already in train from previous years, and contributed in different degrees to recent current account dynamics.
The evolution of external balances and exchange rates during 2015 was driven by a confluence of related factors.
Key drivers included the asymmetric recovery and associated monetary policies in systemic advanced economies, the sharp drop in commodity prices, and tightening external financial conditions for emerging markets, in part reflecting concerns related to China’s rebalancing process and prospects of monetary policy normalization in the US.
The importance of these factors varied during the course of 2015. The US dollar appreciated sharply throughout the year, reflecting the relatively strong outlook of the US economy and expectations of monetary policy lift-off, while China-related uncertainties gained prominence during the second half of 2015, accompanied by a further weakening of commodity prices.
This section explores the role of each of these factors in the evolution of external current accounts.
Stronger recoveries in the US and the UK – relative to the euro area and Japan – and divergence over the expected path of monetary policy, led to a significant strengthening of the US dollar and sterling, and a weakening of the euro and yen in 2015. These shifts contributed to a widening of the US current account deficit and an expansion of surpluses in both the euro area and Japan, the latter also supported by larger terms of trade gains. Meanwhile, the real appreciation of the renminbi helped contain China’s surplus. Exchange rate movements among major currencies, although not unprecedented, were sharp from a historical perspective, and built on trends in place since 2010-11.
Since late-2015, a partial reversal of some of these currency trends has taken place, especially for the yen and sterling, largely driven by revised expectations about monetary policies and idiosyncratic factors. Financial conditions, however, remain fluid, especially following the UK referendum, and the real effects of both the direction and volatility of reserve currency movements have yet to play out.
