The Department of the Treasury

1

Report to Congress on International Economic and Exchange Rate

Policies

For the period July 1, 2001, through December 31, 2001

THIS REPORT IS REQUIRED UNDER SECTION 3005 OF THE OMNIBUS TRADE AND

COMPETITIVENESS ACT OF 1988 (THE “ACT”). THIS REPORT REVIEWS DEVELOPMENTS IN

U.S. INTERNATIONAL ECONOMIC POLICY, INCLUDING EXCHANGE RATE POLICY.

Major Findings

• U.S. economic growth over the period of July 1, 2001 through December 31, 20011

 was disrupted by the

September 11 terrorist attack. Although the economic slowdown worsened, with real GDP declining in the

third quarter of 2001, the U.S. economy bounced back in the fourth quarter, supported by favorable fiscal and

monetary policies, and growth is continuing into 2002.

• Global growth continued to slow overall during the period, leading to export and import contraction in

all key economies. U.S. imports contracted at a faster rate than exports and the current account deficit

narrowed in the second half.

• Trade-weighted indices of the dollar showed little change over the period. Net capital flows into the United

States remained robust, reflecting continued strong global investor confidence in the health, dynamism and

attraction of U.S. markets.

• No major trading partners of the United States manipulated exchange rates under the terms of Section

3004 of the Act during the period. Treasury continues to monitor the exchange rate practices of major U.S.

trading partners and to encourage moves to more flexible exchange rate regimes when appropriate.

 

1

 “The period” means July 1, 2001 through December 31, 2001 in this report, unless otherwise indicated.

The United States Economy

Overview of the U.S. Domestic Economy

Although the U.S. economy was slowing through the

second half of 2000 and the first half of 2001, there

were signs of firming early in the third quarter of

2001 suggesting that growth might strengthen. The

September 11 terrorist attack and its aftermath caused

the economy to retrench. Consumers pulled back on

spending and capital investment continued to decline.

Real GDP in the third quarter fell at a 1.3% annual

rate, the first decline in nearly a decade.

Fiscal and monetary policies were already in place to

counteract the effects of the slowing economy and

those policies contributed to a return to growth in the

fourth quarter. Tax rebate checks and lower marginal

rates reduced taxpayers’ liability by about $44 billion

last year. The Federal Reserve lowered interest rates

six times in the first half of the year, and cut rates

another five times during the period. After growing

at a 1.0% annual rate in the third quarter, consumer

spending surged at a 6.1% rate in the fourth, and real

GDP rebounded at a 1.7% rate. GDP growth

continued to strengthen going into 2002.

Productivity rose even as the economy contracted, an

unusual development, and accelerated sharply from a

1.1% annual rate increase in the third quarter to an

-2%

0%

2%

4%

6%

8%

10%

1Q/98 3Q/98 1Q/99 3Q/99 1Q/00 3Q/00 1Q/01 3Q/01

U.S. Real Gross Domestic Product. 1997-2001

(% change over previous quarter, SAAR)

Source: Bureau of Economic Analysis (BEA)
The Department of the Treasury

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outsized 5.2% pace in the fourth quarter. Solid

productivity gains at about the 2.4% trend rate of

growth since 1995 are expected to continue.

Overview of U.S. International Sector

Current Account

The current account deficit fell to $417 billion, or

4.1% of GDP, in 2001 from a $445 billion, or 4.5%

of GDP, level in 2000. The narrowed deficit was the

net result of significant reductions in imports and

exports, both depressed by the slowdown in global

activity. The contraction in trade was particularly

severe for capital goods in both the United States and

its trading partners.

Financial Flows

Net financial flows into the United States remained

strong throughout 2001, although the composition of

the flows varied over the course of the year. These

inflows easily financed the U.S. current account

deficit and reflected international investors’

continued strong interest in investment opportunities

in the U.S. market.

International Investment Position

The net investment position of the United States at

the end of 2000, the latest date for which data are

available, was a negative $2.2 trillion with direct

investment evaluated at market value. Net

investment income payments to foreigners, however,

amounted to only $13.7 billion in 2001, as net

receipts of $95.2 billion from direct investment offset

net payments on portfolio investment.

The Dollar in Foreign Exchange Markets

The dollar, on a trade-weighted basis, showed little

change over the period notwithstanding a temporary

increase in uncertainties about the U.S. economy and

U.S. markets in the wake of the September 11

terrorist attacks. The Federal Reserve Board’s broad

nominal dollar index indicated that the dollar

appreciated 0.3% on a trade-weighted basis, after

appreciating 4.0% the first half of 2001. The real

dollar index depreciated 0.6% during the period, after

appreciating 4.4% during the first half of the year.

The dollar moved from ¥125 per dollar to ¥131 per

dollar and from $0.85 per euro to $0.89 per euro over

the period.

In the July-September quarter, the dollar depreciated

on expectations of a protracted cyclical downturn in

the United States. In an atmosphere of slowing

global growth, market participants became more riskaverse and pulled back from higher risk assets

generally. Some market participants, fearing greater

economic dislocation after the September 11 terrorist

attacks, sought to reduce their economic exposure to

U.S. markets. Some investors shifted assets into war

and conflict safe-havens, while others merely reduced

their external exposure.

However, in the October-December quarter, market

participants grew increasingly convinced that the

United States would adapt its economic policies

quickly to reduce the risks of a protracted downturn.

Data releases during November reinforced an

emerging sentiment that the US would lead the cycle

and prompted upward revisions of market forecasts

of U.S. growth. The rapid success of U.S. military

efforts in Afghanistan was also a factor supporting

the dollar. In contrast, economic data from Europe

2000 2001 Q1 Q2 Q3 Q4

Balance on Current Account

 Billions of $ -444.7 -417.4 -112.1 -107.9 -98.5 -98.8

 Per Cent GDP -4.5 -4.1 -4.4 -4.2 -3.9 -3.9

Select Financial Flows

 Net Direct Investment 135.2 1.9 11.7 24.3 -20.6 -13.5

 Net Sales of US Securities

 to Non Official Foreigners 432.9 514.2 149.5 131.8 73.3 159.6

 Net US Banking Flows -50.5 -9.1 -102.9 44.2 -.2 49.8

Trade in Goods 

Balance -452.2 -426.6 -112.6 -107.8 -105.5 -100.7

Total Exports 772.2 720.8 194.5 185.5 173.4 167.4

 of which:

 Agricultural Products 52.8 55.0 13.6 13.5 13.7 14.1

 Capital Goods Ex Autos 357.0 322.3 91.5 82.9 75.9 72.0

 Automotive Products 80.2 74.6 17.9 19.1 19.3 18.3

Total Imports 1224.4 1147.4 307.2 293.2 279.0 268.1

 of which:

 Petroleum Products 120.2 103.7 29.3 28.5 25.6 20.3

 Capital Goods Ex Autos 346.7 297.8 86.2 74.7 69.1 67.8

 Automotive Products 195.9 189.7 46.7 47.8 48.0 47.2

Advanced Technology (NSA)

Balance 5.3 4.8 4.8 3.5 -1.1 -2.3

 Exports 227.4 200.1 57.1 51.6 45.6 45.8

 Imports 222.1 195.3 52.4 48.0 46.7 48.2

2001

U.S. Balance of Payments and Trade

($ billions, SA, unless otherwise indicated)

Bilateral Exchange Rates

(Dollars per Foreign Currency Unit, June 2001 = 100)

70

80

90

100

110

120

130

140

Jan.99Mar.99May.99Jul.99Sep.99Nov.99Jan.00Mar.00May.00Jul.00Sep.00Nov.00Jan.01Mar.01May.01Jul.01Sep.01Nov.01Jan.02

Canada China Euro Zone Japan

Korea Malaysia Mexico Taiw an
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were not viewed as offering assurance about a

prompt return to growth, while Japanese data pointed

to continued depressed activity.

During the period G-7, Finance Ministers and Central

Bank Governors referred to exchange rates among

the major currencies in two communiqués (July 7,

2001, and October 6, 2001), each time stating: “We

will continue to monitor developments closely and to

cooperate as appropriate."

Major Industrial Economies

The growth of industrial economies fell sharply in

2001. G-7 countries, as a whole, experienced

negative growth in all but the first quarter of 2001.

Inflation in G-7 countries fell to a 1.2% y/y (year on

year) rate in December 2001 compared with 2.5% in

June 2001 and 2.4 % in December 2000.

Euro Zone Countries

Euro Zone growth slowed to 1.5% in 2001, down

sharply from 3.4% in 2000. Growth dipped to a

minus 0.7% (seasonally adjusted at an annual rate or

saar) rate in Q4 from 0.8% in Q3. Of the eight

largest Euro-12 countries, only Spain avoided at least

one quarter of negative growth. Early confidence that

the Euro Zone could escape the global slowing was

unduly optimistic. The area-wide unemployment rate

was 8.5% in December, up from a ten-year low of

8.3% reached early last year. During the second half

of 2001, the ECB cut its key lending rates by 125

basis points in response to slower growth.

The rate of increase in the consumer price index

spiked above a 3% y/y rate in the late spring of 2001

from a combination of food price increases and

continued high oil prices; the core inflation rate

remained over 2% through the end of 2001.

The euro appreciated 5% against the dollar during the

period, having depreciated nearly 10% during the

first half of 2001. The euro appreciated early in the

period but was able to maintain levels consistently

above $0.90 from only mid-August to mid-October.

The euro’s failure to sustain an appreciation against

the dollar during 2001 was, at least partially,

attributable to Europe’s vulnerability to the

worldwide slowdown.

Japan

The Japanese economy fell back into recession in the

second quarter of 2001 following a brief and shallow

recovery from the 1997-98 downturn. Real GDP

declined 1.7% in the second half of 2001, as both

private and public domestic demand contracted and

declining net exports also contributed to the

downturn. For the year as a whole, real GDP shrank

0.5% as declines in net exports and public demand

offset marginal growth in private demand. Deflation

remained entrenched, with consumer prices down

0.7% in 2001, the third consecutive year of decline.

The Bank of Japan, in an effort to end persistent

deflation, increased the liquidity it provided the

money market by raising its bank reserves target in

stages from ¥5 trillion to a ¥10-15 trillion range by

the end of the year. Short-term interest rates

remained virtually at zero throughout the period, and

the monetary base grew at a 22% annualized rate.

However, growth in broader monetary aggregates

remained slow (M2+CDs grew 2.8% saar) and there

was no sign of easing deflationary pressures. The

weakness in the growth in broad money is a

reflection of the weak balance sheets of Japan’s

financial and corporate sectors. Vigorous action is

needed to tackle these twin problems.

Japan's current account surpluses have declined in

recent years, from $119 billion or 3.0% of GDP in

1998 to $87 billion or 2.3% of GDP in 2001.

The yen depreciated 5.8% against the dollar over the

period, ending the year at ¥131.8, while also

depreciating 5.7% in real trade-weighted terms.

Despite the weaker yen, Japan's trade surplus

narrowed from $36.0 billion (sa) in the first half of

2001 to $35.5 billion in the second half, as declining

exports more than offset a $16.6 billion (8.3%)

decline in imports. In contrast, the current account

surplus widened to $46.9 billion from $41.6 billion,

as a narrowing services deficit and a widening

surplus on investment income more than offset the

modest decline in the trade balance. In real terms

there was a 7.9% fall in net exports from the first to

the second half of 2001 contributing to the downturn

in real GDP.

The U.S. bilateral trade deficit with Japan in 2001 fell

sharply to $70.6 billion (BOP basis) from the $82.9

billion level posted in 2000.

Japanese foreign exchange intervention in 2001 was

confined to September 17 – 28, in the aftermath of
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the September 11 attacks. Ministry of Finance data

indicate sales of $27 billion equivalent of yen were

made.

Canada

Economic developments in Canada paralleled those

in the United States in 2001. The Canadian economy

slipped from a slow growth rate of 0.9% saar in the

second quarter into negative growth of 0.6% saar

during the third quarter, rebounding to a 2.0% saar

growth rate in the fourth. Inflation remained low,

dipping to 0.7% y/y in December 2001 from 2.6% at

the end of the third, 3.3 % at the end of the second,

and 2.6% at the end of the first quarter. The Bank of

Canada (BoC) lowered interest rates in the second

half of the year as the economy weakened and

inflation remained subdued, although the spread of

Canadian interest rates over U.S. rates widened.

During the period, the overall current account surplus

fell to 1.3% of GDP from 4.0% of GDP in the first

half of 2001.

The Government of Canada (GOC) has pursued

sound reforms during the past decade, placing the

Canadian economy on a much stronger footing than

in previous years. In the early 1990s, interest rates

were in double digits, employment declining, fiscal

deficits were large and inflation high. The past

decade has seen remarkable improvements in each of

these areas. Productivity levels have improved in

Canada, and some sectors have levels comparable to

those in the United States. However, due importantly

to developments in the information and technology

(IT) sector, U.S. productivity remained much

stronger, thus supporting continued investment flows

from Canada to the United States.

The Canadian dollar fell 4.7% against the U.S. dollar

and 9.3% against the euro, while rising 1.5% against

the yen, during the period. Although the Canadian

dollar fell sharply against the euro during the period,

it has risen overall against the European currencies

during the past decade.

The BoC identifies the long-term decline in inflationadjusted (or real) non-energy commodity prices as a

significant factor in explaining the long-term decline

in the U.S.$/C$ exchange rate. A BoC price index

tracking these commodities fell 16.4% during the

period, reaching a level not seen since 1987.

Although widening interest rate differentials vis a vis

the United States might have provided some support

to the Canadian dollar, the market did not regard

these increased spreads as sufficiently attractive to

stimulate large scale inflows to Canada.

The Canadian dollar freely floats. A 1998 study by

the BoC of its foreign exchange intervention

concluded that its prior policy of regular intervention

had very limited impact on foreign exchange rates.

The BoC has not intervened in foreign exchange

markets since 1998.

Other Industrial and Emerging Market

Economies:

Overview of Emerging Market Finances

Risk aversion measures increased significantly after

the terrorist attacks on September 11th. According to

some measures, the risk premia paid on emerging

market debt reached or were near record highs.

These increases in measures of risk were driven more

by a “flight-to-quality” and less by a “flight-toliquidity”. However, following the September

attacks, there was no widespread, panicked selling of

all emerging market asset classes as occurred in the

1998 Russia-LTCM crisis. By November 2001, risk

levels had declined to levels maintained over 2000

and the first part of 2001. The yield spread over U.S.

Treasuries of JP Morgan’s Emerging Market Bond

Index Plus (EMBI+) peaked at 1,005 basis points at

the end of the third quarter, and declined in 4Q/2001

to a level lower than that recorded at end 2000.

In 4Q/2001, in spite of the turmoil created by

developments in Argentina, bond markets performed

strongly and equity markets, on average,

outperformed their developed market counterparts.

Contagion from Argentina was not widespread

during the period, as investors discriminated among

risks. Investors, in particular, took underweight

positions in risky credits (Argentina and initially

2000 2001 1Q/01 2Q/01 3Q/01 4Q/01

Issuance (US$ bil.) 216.4 163.2 42.2 50.1 27.2 43.7

 Bonds 80.5 88.6 26.8 28.7 11.6 21.5

 Equities 41.7 11.2 2.3 5.3 1 2.6

 Loans 94.2 63.4 13.1 16.1 14.6 19.6

Secondary Bond Markets (end period spread in bps)

 EMBI+ 756 731 784 766 1005 731

 Asia 489 356 450 397 494 356

 Latin America 706 833 763 803 1103 833

 Em. Europe 988 621 957 766 874 621

Stock Market Returns (%)

MSCI EM Free -31.8 -4.9 -6.2 3.1 -22.1 26.3

 Asia -42.5 4.2 -0.1 -1.6 -20.1 32.8

 Latin America -18.4 -4.3 -3.5 7.1 -24 21.8

 Em. Eur./M. East -23.4 -17.7 -22 4.5 -25.8 36.3

Financial Developments in Emerging Markets
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Brazil) while going overweight in those that seemed

more stable (primarily Asia and eastern Europe).

In 3Q/2001, unsettled financial conditions in

Argentina and Turkey and the September terrorist

attacks on the United States sharply reduced the gross

volume of emerging market fundraising in

international capital markets, which fell to levels last

seen at the time of the Russia-LTCM crisis. While

4Q/2001 saw some issuance rebound, the total

emerging market issuance ended the year at levels

comparable to the abnormally low years of the Asian

and Russian crises.

Latin America

Growth in Latin America weakened substantially

during the period, as the global decline in demand

and adverse country-specific factors intensified.

Mexico’s growth turned negative, weighed down by

the U.S. recession. Argentina suffered a real GDP

contraction and progressive deterioration of financial

conditions, leading to a financial crisis in January

2002. A central feature of the events leading to this

crisis was the government’s continuing failure to

achieve a degree of fiscal discipline that markets

considered sufficient. In Brazil, overall growth

turned negative, despite a strong improvement in net

export performance. On a regional level, the IMF

projects that real growth slipped to about 1% for

2001, much lower than the 4% rise experienced in

2000. Only Ecuador recorded more rapid growth in

2001 than in 2000.

However, Latin American access to external capital

was surprisingly resilient. Bond issuance declined by

only $2 billion in 2001, to $41 billion, and EMBI+

sovereign spreads widened just 30 basis points (bps)

during the period to 833bps over comparable U.S.

Treasuries. Nonetheless, there was increased

pressure on floating exchange rates and depletion of

international reserves in those countries with fixed

exchange rates.

Argentina

Significant economic, financial, and political turmoil

erupted in Argentina at the end of 2001, culminating

in January 2002 in a default on external obligations,

an end to foreign exchange convertibility (pegging

the peso to the dollar at 1:1). Following the decision

to float, the peso depreciated from an initial level of

1.40 pesos per dollar to as low as 3.25 pesos per

dollar in late March 2002 (3.75 in mid-day trading).

The peso has been bolstered recently by additional

foreign exchange restrictions imposed by the Central

Bank. Events leading up to this crisis resulted largely

from deteriorating monetary conditions during the

period. Large-scale bank deposit outflows ($18

billion in 2001) weakened Argentina’s foreign

reserve position, the credibility of its exchange rate

regime, and the solvency of its banking system. The

Government imposed comprehensive deposit controls

in early December 2001. Financial indicators

weakened significantly throughout the year -- the

Merval stock index fell by 50% in 2001, EMBI+

spreads widened from 800 bps in the first quarter of

the year to 4,500 bps by year end, while short-term

interbank rates rose from an average of 11% in 2001

to 29% by year’s end.

Underlying Argentina’s financial crisis was its

continued poor growth and weak fiscal performance.

Output in 2001 contracted by 3.3%, with the decline

increasing to nearly 5%, at an annualized rate, during

the period. This was the third consecutive year of

falling output. The unemployment rate rose to 18%

in 2001 from 15% the year before; consumer price

deflation (y/y -1.0%) continued; Argentina’s fiscal

deficit widened. Although Argentina’s trade balance

strengthened by $6 billion through the first three

quarters of the year, its current account balance

declined by $5 billion (to –2.9% of GDP) due largely

to rising interest payments and service imports. The

real, trade-weighted appreciation of the peso by

roughly 6% in 2001 followed a 15% rise during the

two previous years. Argentina’s inability to meet

program performance standards led the IMF to

suspend funding in December. President de la Rua

resigned soon thereafter, and, following a succession

of interim leaders, Eduardo Duhalde assumed the

presidency on January 2.

Brazil

The short term political, external, and fiscal risks that

plagued Brazil throughout much of 2001 subsided

toward year-end and in early 2002. In late

September, financial markets began to “decouple”

Brazil from Argentina. This was due to Brazil’s

stronger economic fundamentals, anticipation of

reduced debt payments in 2002, and a variety of

technical factors that increased demand for liquid

emerging market debt. The result was both a decline

in new sovereign borrowing costs (from about 1,250

bps to a still-high 800 bps above U.S. Treasuries) and

ongoing access to capital markets during the height

of Argentine volatility.
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6

Real GDP growth slowed to 1.5% in 2001 from 4.5%

in 2000. On a seasonally adjusted basis, q/q growth

was –0.8% and –1.6% in the third and fourth

quarters, respectively. This deterioration was due

largely to a worsening global environment, high

domestic interest rates, and a domestic energy crisis.

In 2001, Brazil’s trade surplus was $2.6 billion (0.5%

of GDP)—the first surplus since 1994. The current

account deficit was $23.2 billion in 2001 (4.6% of

GDP), versus $24.7 billion in 2000. Foreign Direct

Investment (FDI) fell to $22.6 billion in 2001 (97%

of the current account balance), down from $32.8

billion in 2000.

The CPI increased about 7.7% in 2001 and exceeded

the upper band of the official target (2%-6% band),

owing both to substantial increases in public

enterprise charges and the 45% depreciation in the

exchange rate in the year to end-September. The real

reversed its course and appreciated 18% from midSeptember to close the year at 2.3 real/US$--the same

level as end-June. The Central Bank of Brazil (BCB)

sought to limit inflation by minimizing exchange rate

depreciation through the sale of dollar-linked debt

($9.4bn net in the period) and spot foreign exchange

reserves ($6b in the period). During 2001, the

inflation adjusted trade-weighted exchange rate

depreciated 5.1%.

Net international reserves (excluding dollar-linked

liabilities of the BCB) increased during the period by

$2.1 billion to $36.2 billion. Short-term external debt

(residual maturity) was 119% of reserves. As a

percent of M2, net reserves decreased from 27.6% to

21.1%.

Mexico

Negative growth in Mexico was primarily driven by

the slowdown in the U.S. economy, which lowered

the demand for its exports during the period. Real

growth slowed to -1.6% y/y in 4Q/2001 (compared

with 4.7% y/y in 4Q/2000), bringing real annual

growth for the year down to -0.3%. A low annual

inflation rate of 4.4% for the year allowed the Bank

of Mexico to ease monetary policy to help stimulate

growth.

During 2001, the current account deficit reached

US$17.5 billion or 2.8% of GDP, down from 3.1% of

GDP in 2000. The capital account surplus of $22.7

billion was dominated by a historically high $24.7

billion FDI inflow, of which $12.5 billion was

associated with Citigroup’s acquisition of Banco

National de Mexico.

The authorities let the exchange rate float freely in

the period and the peso depreciated a modest 1.3%

against the U.S. dollar to 9.16 pesos/$. Net

international reserves rose $2 billion during the

period to $42 billion (14.2% of M2 and three months

of import cover).

Central and Eastern Europe

The region of Central and Eastern Europe continued

to experience solid growth in 2001, even if at a

slightly slower pace than in 2000. Growth in

Southeastern Europe is expected to show the greatest

acceleration in the area, led by a strong expansion in

Romania. Of the largest or more advanced

economies, only Poland came close to slipping into a

recession. Ukraine was one of the best performers,

with the economy growing by 9% in real terms, while

in Russia growth slowed from 8.5% to 5% in 2001.

Polish GDP growth dropped from 4.2% in 2000 to

1.1% in 2001 due to a cyclical downturn and tight

monetary policy. The other advanced transition

economies, Hungary and the Czech Republic, grew

by 3.8% and 3.5%, respectively (compared to 5.2%

and 2.9% in 2000).

Countries in this region experienced very different

exchange rate pressures in 2001. A sharp decline in

oil prices after September reduced upward pressure

on Russia’s exchange rate during the period, and the

ruble depreciated from 28.2 R/$ at the end of 2000

and 29.2 R/$ at the end of June 2001 to 30.5 R/$ at

the end of 2001. Overall, the ruble’s real

appreciation was an estimated 7% in 2001, compared

to 22% in 2000. The CBR’s intervention in the

foreign exchange market helped boost reserves $8.5

billion to $36.5 billion in 2001, although reserve

growth stagnated after September due to early debt

payments to the IMF and a worsening external

balance. In Ukraine, the hryvnia remained stable

during the period, strengthening slightly from 5.4/$ to

5.32/$. There were no significant interventions by

the central bank.

In the key Central European economies, the prospect

of future EU membership and inflows of capital in

the form of privatization payments and FDI have

resulted in a strengthening of the currencies in

nominal and real terms. Both Poland and Hungary

saw a brief, sharp drop in their currencies in July but

by year-end both the zloty and the forint had

strengthened. In the Czech Republic, the main policy

preoccupation during the period was a concern with

excessive crown appreciation in the face of the
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7

inflow of privatization receipts and EU accessionrelated funds, but the government did not undertake

any significant steps to limit the strength of the

crown. The strengthening of these three currencies

helped to bring inflation down in the region, with the

average inflation rate in 2001 in these three countries

only 4.8%, compared to 7.5% in 2000.

Asia

Growth in Asia remained subdued during 2001, with

several emerging Asian economies experiencing

recessions due to the weakening in global demand,

though it picked up considerably by year-end.

Exports experienced double-digit declines (from the

second half of 2000), particularly in economies

dependent on IT exports (Korea, Singapore, Taiwan,

and Malaysia). However, imports in many

economies fell even more sharply due to the high

import content of manufactured exports and weak

investment owing to excess capacity and an overhang

of corporate debt. As a result, current account

surpluses in these economies either remained

relatively unchanged or increased as a percent of

GDP.

Given weak growth and low inflation, Asian

countries eased monetary policies in line with the

Federal Reserve. However, monetary stimulus did

not translate into stronger credit growth in most

countries, given that many financial institutions

remained capital constrained and many corporations

remained overly indebted. Monetary easing did lead

to nominal exchange rate depreciation against the

U.S. dollar in some countries. Movements in real

effective exchange rates for most economies with

floating exchange rate regimes were mixed, while

real effective rates in economies with fixed exchange

rate regimes tended to appreciate. Given weak

growth and the threat of deflation, central banks

accumulated reserves to limit the appreciation of their

currencies.

Monetary authorities in most countries continued

their move toward inflation-targeting regimes. In the

Philippines, the authorities made final preparations

toward formally adopting an inflation targeting

framework. In Korea, the central bank adhered to an

inflation-targeting framework, with limited exchange

rate intervention. However, in Thailand, central bank

authorities, while nominally maintaining an inflationtargeting regime, appear to have returned to a greater

focus on exchange rate stability and capital flows,

raising interest rates early in the period despite core

inflation in the lower half of the target range. In

general, inflation targeting should lead monetary

authorities to focus less on short-term exchange rate

movements and more on the medium-term inflation

outlook. However, given the large effect exchange

rate changes have on inflation in most Asian

economies, monetary authorities will continue to

adjust monetary policy in response to exchange rate

changes.

China

According to officially reported data, China’s GDP

growth slowed to 6.8% y/y from 7.9% in the period.

The deceleration was mainly due to a decline in the

growth of consumption and merchandise exports.

Exports were adversely affected by the global

downturn, with export growth falling to 5.0%

year/year compared to 8.8% during the first half of

2001. However, the slowdown in domestic demand

caused import growth during the period to decline

faster than exports. The trade surplus for the second

half of the year (FOB-CIF) was 2.4% of GDP,

compared to 2.0% a year earlier. China’s current

account surplus for 2001 is expected to have declined

slightly from 2.0% of GDP a year earlier. Using U.S.

data, China’s bilateral trade surplus with the U.S. was

a non-seasonally adjusted $46 billion during the

period, compared to $37 billion during the first half

of 2001 and $84 billion in 2000.

China implements a de facto currency peg to the

dollar, which it has maintained within a tight band

since 1995. In real effective terms, the Renminbi

depreciated 2% during the period. Gross foreign

reserves grew $32 billion to $212 billion in the

reporting period as FDI inflows increased 15% to

$46.8 billion, reflecting China’s accession to the

WTO. Gross reserves at the end of the period were

relatively low, equivalent to 12% of M2, compared to

10% at the end of June 2001. According to BIS

figures, reserves measured 650% of short-term

external debt (residual maturity) at end-June 2001;

similar data for end-December 2001 are not yet

available. China continues to maintain wide-ranging

controls on both capital outflows and inflows.

Korea

Real GDP recovered in the period, growing at 5.1%

and 5.9% (estimated) in the third and fourth quarters,

respectively (q/q, saar), following 1.2% and 1.8%

growth in the first and second quarters. This rebound

in growth was driven by domestic demand, primarily

private consumption supported by stimulative
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monetary and fiscal policies. Merchandise exports

fell 19.4% during the period, compared to a year

earlier, due to weak global demand, while imports

fell 16.2% largely as a result of sluggish importintensive exports and weak investment. Accordingly,

Korea’s current account surplus as a percent of GDP

declined from 2.4% in 2000 and 2.6% in the first half

of 2001 to 0.7% in the period.

Korea maintains a floating exchange rate and uses

inflation targeting to set monetary policy, generally

intervening in the foreign exchange market only to

smooth what it considers excessive volatility. During

the period, the won depreciated 1% against the U.S.

dollar; however the real effective exchange rate

appreciated by 1.1%. The Bank of Korea reduced

policy interest rates by 100 basis points in the third

quarter to respond to weak economic conditions and

low inflation. Consumer prices rose 4.3% and 3.7%

(projected) in the third and fourth quarters (q/q,

saar). Despite Korea’s early repayment in August of

the outstanding balance of its IMF loans, gross

reserves increased by $8.6 billion during the

reporting period to $102.8 billion at year-end. This

increase was due mostly to interest earnings and

repayment of exceptional loans to Korean banks

extended during the Asian crisis rather than direct

central bank intervention in the foreign exchange

market. As of December 2001, reserves were 284%

of short-term external debt (residual maturity basis)

compared to 229% in June 2001. The ratio of

reserves to broad money (M3) was 13% in

December, and was relatively constant over 2001.

Korea has relatively few restrictions on capital flows.

Malaysia

After entering a technical recession in the first half of

2001, Malaysia’s economy contracted 0.5% in the

third quarter and grew 5.3% in the fourth quarter

(q/q, sa) – a relatively favorable result compared to

other export-dependent economies in the region that

were negatively affected by the global IT slump. An

expansionary fiscal policy helped to strengthen

domestic demand and cushion the downturn. Despite

negative merchandise export growth (down 16% y/y

in the period), the current account surplus remained

relatively unchanged at 9% of GDP in 3Q01 (latest

data available), as slowing exports were matched by

decelerating imports.

Malaysia has maintained a fixed peg to the dollar

since September 1998, when it also imposed capital

controls. Controls have since been relaxed, but

offshore trading of the ringgit remains prohibited and

foreign portfolio investment by residents continues to

be restricted. To limit short-selling, ringgit

borrowing by non-residents is also restricted. The

Malaysian authorities maintained the peg throughout

2001 despite occasional periods of downward

pressure on the ringgit. Such pressure intensified in

the first half of the year, as regional currencies

weakened and substantial capital outflows led to a

sharp decline in reserves. Pressure on the ringgit

subsided during the period following successive cuts

in U.S. interest rates, stabilization of regional

currencies, and capital inflows attracted by progress

toward corporate restructuring in Malaysia. At the

end of the period, reserves stood at $31 billion, equal

to 352% of short-term external debt (residual

maturity) and 32% of M2, up from $26 billion, or

299% of short-term external debt and 28% of M2, at

the end of June 2001. Due to the strengthening of the

U.S. dollar during the period, the ringgit appreciated

1.4% on a real trade-weighted basis.

Taiwan

Real GDP declined 1.9% during 2001, the result of

the global downturn, particularly in the market for IT

products. Declining investment severely dampened

domestic demand as well. This was the sharpest drop

in GDP since the 1970s . The economy declined 4%

(saar) in the third quarter but picked up during the

final quarter of 2001, growing an estimated 6% (saar)

as exports of computer and electronics goods rose.

Merchandise exports in the second half were still

23% below the same period in 2000. With domestic

demand still weak, the current account surplus rose to

8% of GDP during the second half of 2001 compared

to 6% of GDP during the same period of 2000.

During the reporting period, given weak growth and

limited inflation (with consumer prices rising at less

than a 2% annual rate) Taiwan significantly eased

policy interest rates. A weak banking system and

overly indebted corporations in non-IT sectors

hampered the stimulatory effect of monetary easing

on credit growth. However, monetary easing and

associated foreign exchange market intervention led

to a depreciation of the Taiwan dollar by 1.6%

against the U.S. dollar and by 4% on a trade weighted

basis. Gross foreign reserves rose $13 billion during

the period to $126.6 billion. As a percentage of M2,

reserves rose from 20.2% to 22.5%, while as a

percentage of short-term external debt (residual

maturity) they declined from 474% to an estimated

457% during the period. Taiwan maintains a series

of capital and administrative controls including limits
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9

on capital transactions by a citizen, select controls on

FDI inflows and outflows, restrictions on offshore

borrowing of the Taiwan dollar and at times limits on

large single foreign exchange transactions.

Elements of Manipulation

Section 3004 of the Omnibus Trade and

Competitiveness Act of 1988 (the Act) requires the

Treasury to analyze annually the exchange rate

policies of foreign countries, in consultation with the

IMF, and to consider whether countries manipulate

the rate of exchange between their currency and the

dollar for purposes of preventing effective balance of

payments adjustments or gaining unfair competitive

advantage in international trade. The Secretary of the

Treasury is required to undertake negotiations with

those manipulating countries that have material

global current account surpluses and significant

bilateral trade surpluses with the United States,

unless there would be a serious detrimental impact on

vital national economic and security interests.

• Treasury undertook a broad review of the

performance of major trading partners of the

United States and concluded that no major

trading partners of the United States manipulated

exchange rates under the terms of Section 3004

of the Act during the period.