Report to Congress on International 

Economic and Exchange Rate Policies

U.S. Department of the Treasury

Office of International Affairs

October 30, 2013

This Report reviews developments in international economic and exchange rate policies and is submitted 

pursuant to the Omnibus Trade and Competitiveness Act of 1988, 22 U.S.C. § 5305 (the ―Act‖).1

 

1

The Treasury Department has consulted with the Board of Governors of the Federal Reserve System and 

International Monetary Fund management and staff in preparing this Report.
1

Table of Contents

KEY FINDINGS............................................................................................................................. 2

INTRODUCTION .......................................................................................................................... 6

U.S. MACROECONOMIC TRENDS............................................................................................ 6

THE GLOBAL ECONOMY .......................................................................................................... 9

THE DOLLAR IN FOREIGN EXCHANGE MARKETS........................................................... 13

ANALYSES OF INDIVIDUAL ECONOMIES .......................................................................... 13

ASIA........................................................................................................................................... 13

China..................................................................................................................................... 13

Japan ..................................................................................................................................... 19

South Korea .......................................................................................................................... 21

Taiwan................................................................................................................................... 23

EUROPE...................................................................................................................................... 24

Euro Area .............................................................................................................................. 24

United Kingdom.................................................................................................................... 28

WESTERN HEMISPHERE.............................................................................................................. 29

Brazil..................................................................................................................................... 29

Canada................................................................................................................................... 30

Mexico .................................................................................................................................. 31

GLOSSARY OF KEY TERMS IN THE REPORT ..................................................................... 33
2

Key Findings

The Omnibus Trade and Competitiveness Act of 1988 (the "Act") requires the Secretary of

the Treasury to provide semiannual reports on the international economic and exchange rate 

policies of the major trading partners of the United States. Under Section 3004 of the Act,

the Report must consider "whether countries manipulate the rate of exchange between their

currency and the United States dollar for purposes of preventing effective balance of

payments adjustment or gaining unfair competitive advantage in international trade."

This report covers developments in the first half of 2013, and where pertinent and available,

data through end-September 2013. This Report reviews the macroeconomic and exchange

rate policies of economies accounting for 72 percent of U.S. foreign trade and of global

economic developments more broadly in the first half of 2013. The Report concludes there has 

been some progress on the goal of achieving strong, sustainable and balanced growth and the 

necessary exchange rate adjustments, but the record is mixed, and further progress is needed. 

The Administration's policies to promote growth and jobs are bearing fruit. U.S. real GDP grew 

by an annual rate of 1.8 percent during the first half of 2013, accelerating from the 1.5 percent 

pace in the second half of last year. A consensus of private forecasters expects growth to 

strengthen in late 2013 and to accelerate to 2.8 percent in 2014. Growth has been supported by 

consumer spending and residential investment in an environment of improved household balance 

sheets, accommodative credit conditions, and faster job creation. Nonfarm payrolls have been 

increasing by an average of 185,000 per month over the last year and 7.6 million private sector 

jobs have been created since February 2010. The unemployment rate has dropped to 7.2 percent 

as of September 2013, the lowest level since November 2008. The federal deficit has fallen 

rapidly this year, acting as a headwind to growth. In the fiscal year that just ended, the deficit is 

expected to decline from 7 percent of GDP to just over 4 percent, its lowest level since FY2008. 

Relative to GDP, this is nearly 6 percentage points of GDP smaller than the FY2009 deficit of 

10.1 percent of GDP. The Administration remains committed to further reducing the deficit, 

consistent with economic conditions, and to placing public finances on a long-term sustainable 

path.

This year has seen stronger growth in advanced economies, coupled with a reassessment of the 

relative growth prospects of emerging economies. Overall, the IMF projects the global economy

will expand by 2.9 percent in 2013, down from 3.2 percent in 2012. Looking forward, the IMF

projects global growth will strengthen to 3.6 percent in 2014. There are signs that the lengthy 

recession in the euro area has come to an end, although unemployment remains very high in 

many countries. Growth has slowed in many emerging market economies due to the waning of

post-crisis stimulus, slowing global export demand, including softer commodity demand from 

China, and tighter credit conditions. Many emerging market currencies have depreciated in 2013 

due to global and local factors. After an initial market selloff in May, markets began to 

differentiate among emerging market countries according to the strength of their policy

frameworks and their current account positions. Many emerging markets have strengthened their 

economic institutions and policy frameworks over the past decade and thus increased their 

resilience to shifts in capital flows. Generally, in those countries with stronger frameworks, 

currencies and financial markets have retraced earlier declines. 
3

The policy requirements necessary to support global rebalancing vary. 

Within the euro area, countries with large and persistent surpluses need to take action to boost 

domestic demand growth and shrink their surpluses. Germany has maintained a large current 

account surplus throughout the euro area financial crisis, and in 2012, Germany’s nominal 

current account surplus was larger than that of China. Germany’s anemic pace of domestic 

demand growth and dependence on exports have hampered rebalancing at a time when many 

other euro-area countries have been under severe pressure to curb demand and compress imports

in order to promote adjustment. The net result has been a deflationary bias for the euro area, as 

well as for the world economy. 

Among the major emerging market economies, many in Asia have tightly managed exchange

rates with varying degrees of active management. This report highlights the need for greater

exchange rate flexibility in these economies, most notably in China, as well as the need for

greater transparency on exchange rate management, official intervention, and reserves, along 

with stronger discipline over actual and verbal intervention.

The RMB is appreciating on a trade-weighted basis, but not as fast or by as much as is needed, 

and intervention as resumed. RMB appreciation is not only good for the U.S. economy, but good 

for the economies of China, broader Asia, and the world. In the first nine months of the year, the 

RMB has appreciated 6.3 percent on a nominal effective basis, and 6.6 on a real effective basis, 

the most among the currencies covered in this report. This, in considerable part, reflects the 

yen’s depreciation against the dollar and weakness in many EM currencies. However, the pace 

of nominal RMB appreciation against the dollar has been more modest (2.2 percent year-to-date 

as of October 18, 2013), with very little appreciation for several months. 

Over the longer term, through mid-October 2013, the RMB has appreciated by a total of 12

percent against the dollar and 16 percent on a real, inflation-adjusted basis from June 2010, when 

China moved off its peg against the dollar, and has appreciated about 45 percent in inflationadjusted terms since China initiated currency reform in 2005. In the most recent IMF Article IV

consultation with China, the IMF concluded that the RMB was moderately undervalued against a

broad basket of currencies and the IMF's Pilot External Sector Report estimates that the RMB

was undervalued by about 5 to 10 percent on a real effective basis, as of July 2013. 

Chinese authorities have a stated commitment to further reform of the exchange rate mechanism. 

At the February 2013 G-20 Finance Ministers and Central Bank Governors Meeting in Moscow, 

China joined other G-20 members in pledging ―not to target exchange rates for competitive 

purposes,‖ and reaffirmed its commitment "to move more rapidly toward more marketdetermined exchange rate systems and exchange rate flexibility to reflect underlying 

fundamentals, and avoid persistent exchange rate misalignment." China also committed at the 

2012 G-20 Leaders Summit in Los Cabos, Mexico, to reduce the pace of reserve accumulation

and increase the transparency of its exchange rate policy. 

From late 2011 through early 2012, official intervention fell as concerns about a slowdown in 

China and the financial crisis in the euro area lowered capital inflows into China. As these 

concerns receded in late 2012 and in the first half of 2013, official intervention resumed on a 
4

large scale. Official Chinese data show that the PBOC and Chinese financial institutions 

collectively purchased a record $110 billion in foreign exchange in both January and September 

2013. The evidence that China has resumed large-scale purchases of foreign exchange this year, 

despite having accumulated $3.6 trillion in reserves, which are more than sufficient by any 

measure, is suggestive of actions that are impeding market determination and a currency that is

significantly undervalued. 

China still does not disclose its intervention in foreign exchange markets. As a result, market 

participants and other observers must resort to estimating Chinese intervention using published 

reserve levels. In line with the practice of most other G-20 nations, China should disclose

foreign exchange market intervention regularly to increase the credibility of its monetary policy 

framework and to promote exchange rate and financial market transparency. 

Japan has not intervened in the foreign exchange markets in almost two years, though the 

authorities issued numerous public statements regarding their desire to "correct the 

excessively strong yen" in the weeks following Prime Minister Abe's election. Shortly 

thereafter, the Japanese government joined the G-7 statement of February 2013 affirming that

its economic policies would be based on domestic objectives using domestic instruments, and

would not target the exchange rate. Since then, Japanese officials have clearly ruled out

purchases of foreign assets as a monetary policy tool and have refrained from public comment

on the level of the exchange rate. Japan was also part of the subsequent G-20 statement in

February 2013 that countries would not target exchange rates for competitive purposes. This

commitment was affirmed by G-20 Leaders in September 2013 at the St. Petersburg Summit. 

We will continue to closely monitor Japan's policies and the extent to which they support the 

growth of domestic demand. In order to support a stronger economic recovery and increase 

potential growth, it is important that Japan calibrate the pace of fiscal consolidation to the 

recovery in domestic demand and take ambitious and effective steps to increase domestic 

demand. Monetary policy cannot offset excessive fiscal consolidation or be a substitute for 

structural reform that raises trend growth and domestic demand. It is critically important for the 

global economy that Japan’s economic policies work primarily through an increase in domestic 

demand. 

Although the Korean won depreciated at a moderate pace against the U .S. dollar in the first half 

of 2013, the IMF's July 2013 Pilot External Sector Report finds that Korea's real effective 

exchange rate remains undervalued in a range from 2 to 8 percent. While the Korean 

government does not publish intervention data, market participants estimate that the authorities 

intervened in early 2013 to limit the pace of won appreciation as the Japanese yen weakened, 

switched to limiting won depreciation in June, as financial market volatility increased, and then 

switched back again to limiting won appreciation in September 2013. As of end-September 

2013, Korea's foreign exchange reserves stood at $326 billion. The September 2012 IMF Article 

IV consultation report on Korea noted that reserves were adequate and there was "no need for 

further reserve accumulation beyond what would be needed to keep pace with rising foreign 

liabilities over time." We will continue to encourage Korean authorities to limit foreign 

exchange intervention to the exceptional circumstances of disorderly market conditions. In 
5

addition, in line with the practice of most other G-20 countries, Korea should disclose foreign 

exchange market intervention shortly after it takes place.

Based on the analysis in this report, Treasury has concluded that no major trading partner of the 

United States met the standard of manipulating the rate of exchange between their currency and 

the United States dollar for purposes of preventing effective balance of payments adjustments or 

gaining unfair competitive advantage in international trade as identified in Section 3004 of the 

Act during the period covered in the Report. Nonetheless, Treasury is closely monitoring 

developments in economies where exchange rate adjustment is incomplete and pushing for 

comprehensive adherence to recent G-7 and G-20 commitments. Treasury will continue to 

monitor closely exchange rate developments in all the economies covered in this report, with 

particular attention to the need for greater RMB appreciation, and press for further policy 

changes that yield greater exchange rate flexibility, greater transparency on intervention, a more

level playing field, and support for strong, sustainable and balanced global growth.
6

Introduction

This Report focuses on international economic and foreign exchange developments in the first 

half of 2013. Where pertinent and when available, data and developments through endSeptember 2013 are included.

Exports and imports of goods to and from the ten economies analyzed in this Report accounted 

for 72 percent of U.S. merchandise trade in 2012.

U.S. Macroeconomic Trends

The U.S. Economy Continued to Grow at a Moderate Pace 

Real GDP grew by 1.8 percent at an annual rate during the first half of 2013, accelerating 

slightly from a 1.5 percent pace in the second half of last year. The economy’s performance 

improved in the second quarter of 2013, with growth picking up to a 2.5 percent annual rate from 

1.1 percent in the first quarter, due primarily to stronger growth of fixed investment and a 

smaller drag on activity from declining government spending. Growth of private domestic 

demand – the sum of consumption, business fixed investment and residential investment –

accelerated to a 2.6 percent pace from 1.5 percent in the first quarter. Although the economy 

continues to face challenges in 2013, the housing sector is showing clear signs of recovery, 

households are making progress repairing their balance sheets, firms are making capital 

investments, and labor market conditions are steadily improving. A consensus of private 

forecasters expects growth to strengthen in late 2013 and accelerate further in 2014.

Growth during the first half of 2013 reflected stronger growth of consumer spending as well as a 

larger build-up of inventories, which helped offset small negative contributions from the 

government sector and net exports. Consumer spending rose at a 2.0 percent annual rate during 

the first half of 2013, accelerating from a 1.7 percent pace during the second half of 2012. 

Business fixed investment was about unchanged in the first half of 2013, after rising at a 4.9 

percent rate during the latter half of 2012. Growth of investment in equipment investment was 

little changed at a 2.4 percent pace in the first half of this year. However, investment in 

intellectual property products slowed, rising just 1.1 percent following a 4.2 percent increase 

during the second half of 2012, and structures investment declined 6.5 percent at an annual rate 

in the first half of 2013, after surging by nearly 12 percent in the latter half of last year. 

Inventories were a substantial drag on growth in late 2012, but they have made large positive 

contributions to growth thus far in 2013 of roughly 0.7 percentage point on average in each of 

the first two quarters. 

Residential investment had grown at a double-digit pace in each of the last four quarters; the 

pace moderated to a 13.4 percent annual rate during the first half of 2013 from a 17.0 percent 

pace during the second half of last year. Residential investment grew by 15.5 percent over the 

four quarters of 2012, the strongest yearly increase since 1983, and has contributed positively to 

GDP growth in each of the past eleven quarters following a five-year period of subtracting from 

GDP growth. 
7

Export growth slowed sharply during the final two quarters of 2012, reflecting a general 

slowdown in the global economy, but import growth was negative on average. In 2013, exports

fell slightly in the first quarter (the first decline in exports since the recovery began), but 

rebounded sharply in the second quarter of this year. However, import growth advanced notably, 

especially in the second quarter, and offset the growth of exports during the first half of the year. 

As a result, net exports subtracted an average 0.1 percentage point from real GDP growth in the 

first and second quarters of 2013 after adding roughly 0.3 percentage point on average to growth 

in the final two quarters of 2012. 

Ongoing fiscal contraction at all levels of government weighed further on growth during the first 

half of 2013, with government spending falling by 2.3 percent at an annual rate following a 

decline of 1.7 percent during the final two quarters of last year. Even so, the drag on economic 

activity from declining government spending eased. Altogether, the public sector subtracted less 

than 0.1 percentage point per quarter from GDP growth on average in the first two quarters of 

2013 compared with a subtraction of 0.3 percentage point per quarter in the second half of 2012. 

The economy is expected to expand at a moderate pace through the end of 2013 and gradually 

accelerate over the course of 2014. A consensus of private forecasters currently expects real 

GDP to grow at an average annual rate of roughly 2.2 percent in the second half of 2013 and 2.8 

percent over the four quarters of 2014.

Recovery in the Housing Sector Continued

Activity in the housing market has picked up notably over the past two years, supported by 

improving house prices, loosening credit conditions, a faster pace of job creation in the economy, 

and relatively low mortgage rates. A variety of indicators continued to show improvement in the 

first half of 2013, albeit at a more tempered pace than in late 2012. Single-family housing starts 

stood at a 628,000 annual rate in August 2013, slightly below four and one-half year highs 

recorded earlier in the year and up 17 percent from a year earlier. Sales of new single-family 

homes rose 12.6 percent over the year ending in August to 421,000 at an annual rate, and sales of 

all existing homes (including single-family homes, as well as condos and co-ops; 94 percent of 

all home sales) increased 10.7 over the year ending in September percent to nearly 5.3 million at 

an annual rate. The stock of homes on the market remains relatively lean, and the pace of 

household formation remains below its historical trend. 

Interest rates and house prices are rising: the benchmark 30-year mortgage rate rose over a full 

percentage point from early May to August before retracing partially, and is now in the 4.25 

percent range; and house prices have been rising on a year-over-year basis since early 2012, with 

gains now approaching those seen prior to the housing downturn. As a result, housing 

affordability has fallen just over 20 percent from its peak in early 2012. Even so, affordability is 

still high by historic standards, as mortgage rates remain relatively low and house prices are well 

below their peaks. Higher home prices have pushed more homes into positive equity and 

lessened the strains on mortgage markets coming from distressed loans. The outlook for housing 

remains favorable: home builder and home buyer confidence are the highest they’ve been in 

several years, and both new residential construction and sales are expected trend up over the rest 

of the year.
8

Labor Market Conditions Improved

Job creation proceeded at a steady pace through the first eight months of 2013. On average, 

nonfarm payrolls increased by 185,000 per month over the nine months through September

2013, comparable to the 180,000 average monthly pace during the second half of last year. 

Nearly 7.0 million jobs have been created since February 2010, including 7.6 million in the 

private sector. Between June 2012 and June 2013, the unemployment rate fell by 0.6 percentage 

point to 7.6 percent, and dropped further in September 2013 to 7.2 percent, the lowest level since 

November 2008. Despite these gains, private employment is still 1.3 million lower than at the 

start of the recession in December 2007 and the unemployment rate is 2.2 percentage points 

higher. Some progress has been made in reducing long-term unemployment, but the share of the 

unemployed out of work for 27 weeks or more remains high. This rate stood at 36.9 percent as 

of September 2013, down from a record level of 45.3 percent in March 2011 but more than 

double the 17.5 percent share averaged prior to the start of the last recession in 2007.

Inflation Remained Moderate

Energy prices have increased a bit from their early 2013 lows. The front-month futures price of 

West Texas Intermediate (WTI) crude oil averaged $106.57 per barrel in September 2013, up

from a low of $91.50 per barrel in April 2013 and almost $12 higher than its year-earlier

average. The U.S. average retail price for regular gasoline rose sharply during the fall of 2012, 

peaking at $3.88 per gallon in mid-September, but as of October 7, 2013, stood at $3.37 per 

gallon.

While headline inflation rates mainly reflected fluctuations in energy prices in recent months,

core inflation has generally trended lower. The consumer price index rose 1.5 percent during the 

year ending in August 2013, slower than the 1.7 percent increase in the previous twelve months. 

Core consumer inflation moderated to 1.8 percent over the year ending in August from 

1.9 percent over the year-earlier period. Slack in labor markets, as well as low capacity 

utilization, have contained inflationary pressures. Compensation cost growth as measured by the 

Employment Cost Index (ECI) for private-industry workers rose 1.9 percent during the year 

ending in June 2013, compared with a 1.8 percent rise in the twelve months through June 2012.

Putting Public Finances on a Sustainable Path Remains a Priority

The federal deficit has fallen rapidly this year, acting as a headwind to growth. In the fiscal year 

that just ended, the deficit is expected to decline from 7 percent of GDP to just over 4 percent, its 

lowest level since FY2008. Relative to GDP, this is nearly 6 percentage points of GDP smaller 

than the FY2009 deficit of 10.1 percent of GDP. The Administration remains committed to 

further reducing the deficit, consistent with economic conditions, and to placing public finances 

on a long-term sustainable path. The Administration’s FY 2014 Budget proposal would replace 

the sequestration with $1.8 billion in well balanced deficit reduction measures. Along with the 

$2.5 trillion in deficit reduction measures put in place since FY 2011, that would bring the total 

amount of deficit reduction over the next decade to $4.3 trillion. The Administration’s budget 

plan would cut the deficit to less than 3 percent of GDP by 2017 and roughly 2 percent by 2023 

and put Federal debt on a declining path as a share of the economy. 
9

The Global Economy

Global economic growth has slowed in 2013. The 

IMF projects the global economy will expand by 

just 2.9 percent in 2013, down from 3.2 percent in 

2012, with growth declining in both advanced and 

emerging market economies. Real GDP in the 

advanced economies is projected to expand by 1.2

percent in 2013 compared with 1.5 percent in 2012

and 1.7 percent in 2011, mostly the result of the 

recession in the euro area carrying over into the 

first part of 2013. Real GDP is projected to expand 

by 4.5 percent in the emerging market and 

developing economies, down from 4.9 percent in 

2012 and 6.2 percent in 2011, led by a moderation in growth in China. The IMF expects that the 

pace of global growth will pick up in 2014 to 3.6 percent, mostly reflecting a pick-up in growth 

in the advanced economies, led by the United States, and the euro area emerging from recession

with positive growth on a year-on-year basis.

Nonetheless, four years after the recovery from 

the financial crisis began, output in many 

advanced economies has yet to return to its precrisis level. Even among the countries where 

output has moved above pre-crisis levels, growth 

remains far below levels implied by pre-crisis 

trends. Only Australia, which saw the mildest 

recession among the advanced economies, has 

seen a robust recovery. As noted, there are some 

encouraging signs as real GDP growth in the 

United States is expected to increase to near 3 

percent in 2014, growth will accelerate in the United Kingdom and Canada, and there are signs 

that the lengthy recession in the euro area has come to an end. .

Output in all the major emerging market economies 

has expanded beyond pre-crisis levels, but growth is 

slowing in many due to the waning of post-crisis 

stimulus in their own economies, lower commodity 

prices, and limited progress on key reforms. The 

IMF expects China will experience slower growth 

over the medium-term as it rebalances demand away 

from investment. Real GDP growth in emerging 

market economies is projected to increase modestly 

to 5.1 percent in 2014. 

The strength of U.S. private demand growth has 

been a pillar of support to the global economy, and the expectation of increasing U.S. growth 
10

over the coming year is a major factor in the IMF’s more optimistic outlook for 2014. As a 

result of the improving economic outlook for the United States, the Federal Reserve has begun to 

consider tapering the pace of its quantitative easing. Although the process of normalization of 

U.S. macroeconomic policy, when it occurs, could have spillover effects on other economies, the 

benefits of a stronger U.S. economy to the global economy will outweigh any such impacts. 

In May, many emerging market currencies depreciated and their bond and equity markets sold 

off as U.S. Treasury yields rose and questions emerged about the strength of activity in a range 

of emerging economies. In subsequent months, financial markets have been increasingly 

differentiating pricing on the basis of various countries’ fundamentals. This volatility stems 

from a variety of factors, some of which were global and some that were local. Some emerging 

economies have seen a widening of their external deficits and face difficult policy challenges as 

growth has slowed while inflation has remained above target. Other economies have 

considerably stronger fundamentals and larger policy toolkits than in years past, including 

having more scope for implementing countercyclical fiscal and monetary policies as needed and 

more flexible exchange rate regimes. Stronger policy frameworks, including through greater 

exchange rate flexibility; monetary policy easing, consistent with inflation dynamics; and strong 

regulatory and supervisory policies, will enable emerging market economies to better deal with 

the challenges that lie ahead. At the G-20 Leaders’ Summit in St. Petersburg in early September, 

leaders stated that they would continue to monitor financial market conditions carefully, while 

G-20 central banks have committed to carefully calibrating and clearly communicating future 

changes to monetary policy settings.

Global current account imbalances have declined in recent years, but much of the decline reflects 

a contraction in demand on the part of current account deficit countries rather than strong 

domestic demand growth in current account surplus countries. Several very large and persistent 

surpluses have seen no adjustment in some cases (Germany, Taiwan) or have widened further in 

others (Korea). The euro area's overall current account, which was close to balance in 2009-

2011, increased to a surplus of 2.3 percent of GDP in the first half of 2013. Germany’s current 

account surplus rose above 7 percent in the first half of 2013, while the current account surplus 

for the Netherlands was almost 10 percent. Ireland, Italy, Portugal and Spain are all now running 

current account surpluses as import demand in those economies has declined. Thus, the burden 

of adjustment is being disproportionately placed on peripheral European countries, exacerbating 

extremely high unemployment, especially among youth in these countries, while Europe’s 

overall adjustment is essentially premised on demand emanating from outside of Europe rather 

than addressing the shortfalls in demand that exist within Europe. 

China's current account surplus has declined from a peak of 10.1 percent of GDP in 2007 to 1.9 

percent of GDP in 2011 and 2.5 percent in the first half of 2013. The appreciation of China’s 

real effective exchange rate has been an important factor in reducing the current account surplus. 

At the same time, cyclical factors, such as weakness in demand from advanced economies, and 

shifts in terms of trade have also played a role. As discussed later in the report, the RMB 

remains significantly undervalued.

Achieving strong, sustainable, and balanced global growth requires further adjustments to occur 

across many different parts of the world economy. Most immediately, where demand is weak or 
11

 Foreign Currency Reserve Accumulation 

Major Holders

Sept 2013

Average Monthly 

increase, $ millions

Reserves $ 

billions

Feb 2009 to 

Dec 2012

Dec 2012 to 

Sep 2013

Global 11,168 84,409 30,982

China 3,663 30,424 39,008

Japan 1,206 4,629 1,473

Saudi Arabia* 692 4,702 6,400

Russia 466 2,303 -776

Switzerland 478 9,231 1,139

Taiwan 413 2,369 1,049

Brazil 359 3,863 -394

Korea 326 2,523 1,023

Hong Kong* 292 2,921 -1,806

Singapore 266 2,044 968

India 248 507 -1,565

* data through August 2013, ** data through July 2013

external surpluses excessively large, macroeconomic policies need to promote stronger levels of 

demand support. This is most especially true given the continuing need of deficit countries to 

boost their respective levels of national saving. In the absence of stronger domestic demand in 

the larger surplus economies, global growth has suffered and will continue to suffer if global 

adjustment continues to occur mainly through weakened demand in the deficit economies. This 

should go hand-in-hand with a strong follow-through on past G-20 commitments to move more 

rapidly to market-determined exchange rates, where such 

exchange rate regimes do not exist. 

Global foreign currency reserve accumulation slowed in the first 

nine months of 2013, with China accounting for most of the 

increase, as shown in the table to the right. China’s foreign 

currency reserves rose at an average monthly rate of $39 billion 

in the first nine months of 2013, an average increase of $130

million a day. Saudi Arabia’s reserves also rose in the first nine 

months of 2013 at an average monthly pace of $6.4 billion,

above its February 2009 to December 2012 average. Japan, 

Switzerland, Taiwan, Korea and Singapore also accumulated

reserves, but the pace of accumulation was comparatively

muted. 

In recent years, the IMF has developed a reserve 

adequacy metric, as shown in the table to the right. 

It currently shows that, as of end-2012, China, 

Indonesia, India, Russia, Brazil and Thailand had 

reserve levels in excess of the adequacy range. 

China’s reserves, which now total $3.7 trillion, 

exceeded the midpoint of the IMF’s reserve 

adequacy metric by almost 30 percent. Excess 

reserve accumulation is an impediment to the 

smooth functioning of the international monetary 

system. 

On a real effective basis, the renminbi has appreciated 

the most in the first nine months of 2013 among the 

currencies covered in this Report, followed by the U.S. 

dollar and the euro. The yen and Brazilian real have 

weakened the most during this period.
12

U.S. International Accounts

Current Account 

The U.S. current account deficit was 2.7 percent of 

GDP in 2012, a 3 percent of GDP decline from its 

peak in 2006 of 5.8 percent of GDP. The deficit 

declined to 2.4 percent of GDP in the second quarter 

of 2013, the smallest deficit in fifteen years. Since the 

recession’s trough in the second quarter of 2009, the 

value of exports has increased by 48.9 percent, while 

the value of imports has increased by 48.3 percent –

through the second quarter 2013. As of end June 

2013, the U.S. net international Investment position 

was -$4.5 trillion, or -27.0 percent of GDP. The value of U.S.-owned foreign assets was $21.0 

trillion, and the value of foreign-owned U.S. assets was $25.5 trillion.

U.S. Balance of Payments and Trade

($ billions, seasonally adjusted unless indicated) 2011 2012 Q2-12 Q3-12 Q4-12 Q1-13 Q2-13

Current Account

 Balance on goods (for details, see lower half of table) -744.1 -741.5 -186.5 -179.0 -182.4 -179.5 -175.7

 Balance on services 187.3 206.8 51.2 50.0 55.0 56.8 57.9

 Balance on income (including employee compensation) 232.6 223.9 57.5 54.6 57.0 50.9 53.1

 Net unilateral current transfers -133.5 -129.7 -32.7 -32.3 -31.9 -33.1 -34.2

Balance on current account -457.7 -440.4 -110.5 -106.7 -102.3 -104.9 -98.9

Balance on current account as % of GDP -3.0 -2.7 -2.7 -2.6 -2.5 -2.5 -2.4

Capital and Financial Account (financial inflow = +)

 Net official assets 134.3 474.8 70.7 122.1 87.7 125.5 -5.6

 Net bank flows 506.2 -6.9 50.4 -127.5 -23.9 98.7 282.2

 Net direct investment flows -178.8 -221.9 -36.7 -54.8 -53.1 -55.5 -57.7

 Net sales of securities -10.2 208.5 -67.1 76.1 104.0 -94.0 -110.5

 Net liabilities to unaffiliated foreigners by nonbank concerns 10.2 -65.2 -8.8 1.6 -4.1 -43.3 -48.4

 Other * 88.8 57.0 9.3 10.6 26.5 8.9 13.0

Balance on capital and financial account 550.5 446.3 17.8 27.9 137.1 40.4 73.1

Memo Items

Statistical discrepancy** -92.8 -5.9 92.7 78.8 -34.7 64.5 25.8

Change in foreign official assets in the United States 253.8 393.9 57.4 107.7 84.4 126.9 -9.7

Current Account Detail: Trade in Goods

Exports of goods

 Agricultural products 126.2 132.8 32.8 36.7 33.3 33.1 29.9

 Industrial supplies and materials (including petroleum) 518.8 518.9 131.6 126.5 128.6 131.2 129.1

 Capital goods except autos 493.3 527.7 131.7 133.0 131.6 130.9 135.0

 Automotive products 132.8 146.1 37.1 36.5 36.2 36.6 38.4

 Consumer goods except autos and food 175.0 181.7 45.7 45.6 46.0 45.7 49.0

 Other goods 49.8 54.0 13.0 13.2 14.7 13.2 13.3

Total exports of goods 1,495.9 1,561.2 391.9 391.5 390.3 390.7 394.7

Imports of goods

 Agricultural products 108.3 111.1 27.6 27.7 27.9 28.7 29.2

 Industrial supplies and materials (including petroleum) 782.0 752.3 189.6 182.1 183.2 181.8 173.2

 Capital goods except autos 513.5 551.7 139.3 137.1 137.7 137.2 137.4

 Automotive products 255.2 298.5 74.3 75.7 75.3 73.0 77.0

 Consumer goods except autos and food 517.5 519.6 129.9 130.2 131.7 131.8 134.4

 Other goods 63.6 69.5 17.6 17.5 17.0 17.7 19.1

Total imports of goods 2,240.0 2,302.7 578.4 570.5 572.7 570.2 570.4

Balance of trade in goods -744.1 -741.5 -186.5 -179.0 -182.4 -179.5 -175.7

Source: Bureau of Economic Analysis (BEA) via Haver Analytics.

Notes: *Latest quarter calculated by inference; this line contains items with a longer reporting lag than other lines.

 **Amount needed to make the current account balance with the capital and financial account; by definition,

 current account + capital and financial account + statistical discrepancy = 0.

-7.0

-6.0

-5.0

-4.0

-3.0

-2.0

-1.0

0.0

U.S. Current Account Balance as Percent of GDP

Oil Non-Oil
13

The Dollar in Foreign Exchange Markets

Through September, the trade-weighted value of the U.S. dollar has appreciated by 2.1 percent in 

2013. The dollar has risen by 2.8 percent against advanced economy currencies and by 1.9 

percent against emerging market currencies. By quarter, the dollar appreciated 1.4 percent in the 

first quarter of 2013, 2.0 percent in the second quarter, and depreciated by 0.1 percent in the 

quarter ending September 30. The real trade-weighted value of the dollar is 3.2 percent below its 

20-year average, though it was judged by the IMF in the July 2013 U.S. Article IV report to be 

mildly overvalued. 

Analyses of Individual Economies

Asia

China

After a broad-based slowdown in the first half of 2013, China’s economy has recently shown 

signs of stabilizing, with GDP growth rising to 7.8 percent in Q3, from 7.5 percent in Q2. In 

2012, GDP growth declined to 7.7 percent – China’s lowest rate in more than a decade.2 

Investment continued to drive output in Q3, reflecting an increase in project approvals by the 

central government and rapid growth in infrastructure spending. External demand this summer

was also stronger than expected, leading to a moderate recovery in export growth. However, 

recent high frequency indicators, such as industrial production and fixed asset investment, have 

begun to slow on sequential basis, suggesting that any growth recovery is likely to be limited. 

Consensus forecasts project real GDP growth of 7.6 percent in 2013 and 7.4 percent in 2014. 

China’s current account surplus was 2.5 percent of GDP in the first half of this year, essentially

unchanged from 2.3 percent of GDP in 2012. This represents a significant decline since 2007 

when the current account surplus was more than 10 percent of GDP. However, China’s basic 

balance (the sum of its current account balance and net FDI inflows) was still elevated at 4.3 

percent of GDP in the first half of 2013. According to IMF projections, without continued 

currency appreciation and further structural reform, China’s current account surplus will more 

than double as a share of global GDP by 2018. 

The fall in China’s external imbalance has come largely through a sharp increase in domestic 

investment rather than a greater emphasis on consumption, leading to a worsening of internal

imbalances. In 2012, China’s investment share of GDP was 48 percent, essentially unchanged 

from record highs in 2011 and 2010. Meanwhile, the household consumption share has 

remained near record lows, at 35 percent of GDP. There are currently few signs that this pattern 

will reverse this year despite an increased policy focus on China’s internal imbalances. While 

the pace of investment growth has slowed in the first half of 2013, consumption growth may 

have slowed even further. China’s household survey data suggests that household income 

 

2

In September 2013, China revised 2012 GDP growth to 7.7 percent, from 7.8 percent initially. Seven to eight 

percent annual growth may in fact be China’s current potential growth rate as labor force expansion slows and the 

economy rebalances towards more sustainable sources of long-term growth.
14

growth continued to trail GDP growth in the first half of this year, implying a further 

deterioration in household consumption’s share of GDP. 

Heavy reliance on credit and investment to maintain growth since the global financial crisis has 

led to significant vulnerabilities in the Chinese economy, including weaknesses in the financial 

system, rising local government debt, and an overheated housing market. China’s investment 

rate is extremely high by historical standards and international experience suggests that sharp 

increases in credit and investment are often followed by financial sector problems and a sharp 

correction in growth. Unwinding China’s massive internal imbalances will not be easy, but 

delaying structural adjustment would allow for the further build-up of risk in the system and 

could lead to sharp correction to growth in the future. In the short run, China still has the policy 

tools needed to support growth as it shifts to more balanced growth, including substantial fiscal 

space to increase social spending. 

While China’s leadership has made progress in some specific areas, it will need to pursue far 

more decisive structural policies to promote internal rebalancing and to ensure that the reduction 

in the current account surplus is durable. To support household consumption, it is essential for 

China to pursue policies that increase household incomes and purchasing power. Strengthening 

China’s social safety net will improve household income security and reduce the need for 

households to accumulate large amounts of precautionary savings. Also critical is removing 

distortions that lead to the under-pricing of factor inputs – such as energy, water, land, labor, and 

capital– which tilt the balance of investment toward capital intensive industries and 

manufacturing, and away from the more labor-intensive services sector. Finally, interest rate and 

exchange rate reform are essential for improving the purchasing power of households and the 

development of a more market-based financial system. China’s policy of controlled interest rates 

has been a major driver behind China’s unbalanced pattern of growth. For households, 

administratively-set interest rates have led to lower financial income from bank savings and 

therefore reduced consumption. Since low deposit rates feed into low interest rates on loans, 

these interest rate controls encourage investment in projects with lower expected returns. They 

have also shifted a greater share of credit toward manufacturing and tradable goods, and away 

from non-tradable services and the more dynamic private sector. Controls that keep real returns 

on bank deposits low also introduce financial sector risks, as they encourage investment in 

riskier assets with higher yields, such as property and less regulated ―wealth management‖ 

financial products. 

China’s new leaders have signaled their desire for a more balanced economy that can deliver 

more sustainable growth in the long run, and has taken a number of potentially important steps 

toward this objective. In February 2013, the State Council released its long-delayed income 

distribution reform plan, which lays out a comprehensive framework to improve income 

distribution and double household income by 2020. The plan also recommends important 

structural policies, such as liberalizing interest rates, raising dividend payments of SOEs, and 

increasing social spending. In March this year, the government began the process of energy 

price reform, adjusting oil prices more regularly to better reflect international prices, and in July 

it raised the wholesale price of natural gas by 15 percent. 
15

There has also been renewed momentum for interest rate reform. In July 2013, the PBOC 

announced the end of administrative controls on bank lending rates. While this measure is 

unlikely to influence lending behavior in the short run because very little lending takes place 

below the benchmark rate, it is an important sign that China remains committed to financial 

reform. In September, the PBOC said it will introduce a market-based prime lending rate and 

will allow commercial banks to launch certificates of deposit with market-determined pricing.

At the Fifth U.S.-China Strategic and Economic Dialogue (S&ED) in July 2013, China 

reaffirmed its commitment to rebalance its economy and outlined several measures to promote 

greater domestic demand. In particular, authorities committed to reduce the tax burden on 

services firms by extending its VAT-for-Business tax pilot program beyond Shanghai to cover 

the entire country and to cover additional sectors in 2014.3 Once the pilot program is rolled out 

nationwide, the value added tax (VAT) applied to the services sector should lower taxation on 

services firms to rates comparable to those of manufacturing and other industries, removing a 

major policy distortion that raises the profitability of the tradable goods sector relative to 

services. China also committed to increase the dividends paid by its SOEs and to increase the 

SOE dividend revenue transferred to the central government budget for social welfare spending. 

This should lower earnings retained within the SOE sector and increase the resources available to 

support social welfare and other programs for households. The IMF estimates that China’s 

central government SOEs earned RMB 917 billion in profits in 2011, but paid only RMB 77 

billion in dividends, of which just RMB 4 billion went to the budget. In addition, China pledged 

to increase social security and employment spending; ensure that enterprises of all forms of 

ownership have equal access to production inputs; and develop a market-based mechanism for 

determining the price of those inputs. 

Renminbi (RMB) appreciation is consistent with China’s goals of rebalancing and financial 

reform. A stronger RMB can help support domestic consumption by increasing the purchasing 

power of households. This would help reduce distortions that promote investment in tradable 

goods rather than domestically-oriented production. Reducing intervention in the foreign 

exchange markets and allowing the value of the RMB to be determined more by supply and 

demand would also give Chinese authorities greater control over liquidity creation and domestic 

monetary policy, making it easier for authorities to meet their inflation objectives and more 

effectively target potential asset bubbles. 

Chinese authorities have a stated commitment to further reform of the exchange rate

mechanism. At the July 2013 S&ED, China pledged to ―continue exchange rate reform, 

increase flexibility of the RMB exchange rate, and let [the] market play a more fundamental role 

in exchange rate formation.‖ At the February 2013 G-20 Finance Ministers and Central Bank 

Governors Meeting in Moscow, China joined other G-20 members in pledging ―not to target 

exchange rates for competitive purposes,‖ and reaffirmed its commitment‖ to move more rapidly 

toward more market-determined exchange rate systems and exchange rate flexibility to reflect 

underlying fundamentals, and avoid persistent exchange rate misalignments.‖ China also

committed at the 2012 G-20 Leaders Summit in Los Cabos, Mexico, to reduce the pace of

 

3 The VAT-for-Business tax pilot program was first launched in Shanghai. Chinese authorities announced plans to 

expand the program to nine additional provinces and cities, including Beijing and Guangdong, in July 2012. 
16

reserve accumulation and increase the transparency of its exchange rate policy. At the 

National People’s Congress in March 2013, China’s new leadership pledged to ―steadily carry 

out reforms to make interest rates and the RMB exchange rate more market-based.‖ The State 

Council reiterated these commitments to financial reform in May 2013, underlining that ―[t]he 

RMB exchange rate regime should be optimized to let market supply and demand play a basic 

role in the formation of the exchange rate.‖ 

Regulators have taken further steps this year to loosen China’s extensive capital controls and 

gradually free up channels for cross-border capital and investment. In March, regulators 

announced that its RMB Qualified Foreign Institutional Investor (R-QFII) scheme – which 

initially allowed only Hong Kong-based companies to purchase RMB offshore and invest in 

Mainland securities markets – would be opened to all foreign financial firms domiciled in Hong 

Kong, expanding the program beyond Mainland Chinese firms for the first time. As 

significantly, authorities removed constraints on asset allocation under R-QFII, giving managers 

greater flexibility to design and launch products in response to market demand. In July, 

regulators again increased the amount that foreigners can invest in China’s stock and bond 

markets under the original QFII program, increasing the quota to $150 billion. Also this year, 

China established new RMB clearing arrangements with Taiwan and Singapore, and expanded 

the R-QFII scheme to Singapore and London. These policies represent steps in the direction of 

greater opening of China’s financial sector, though significant restrictions still remain in place.

In May 2013, the government announced it will publish an ―operational plan‖ within the year for 

capital account liberalization, including the creation of a system that will allow domestic Chinese 

investors to invest overseas. Finally, in July 2013, the State Council approved the establishment 

of the Shanghai Free-Trade Zone (SFTZ). The SFTZ is expected to offer a testing ground for 

financial sector reform, with plans to allow trials of liberalized interest rates, capital account 

opening, currency convertibility, and lower entry barriers for financial institutions within the 

zone. Though the details of the SFTZ are still to be clarified, if successful, the program could 

speed up China’s financial reforms and provide a model for policies that could be eventually 

implemented nationwide. 

Widening the RMB’s trading band would be an important sign of China’s commitment to 

market-based exchange rate reform. Chinese authorities have publicly indicated their intention 

to widen the RMB’s +/- 1 percent trading band against the dollar in the near future. Conditions 

for such a move have improved as global markets have stabilized. A wider band should promote 

the two-way foreign exchange flows Chinese authorities have long desired. By contrast, if China 

does not allow greater flexibility and expectations of stability are allowed to develop, it will be 

difficult to spur Chinese firms to develop and expand the use of hedging instruments. A wider 

band that allows larger intra-day fluctuations around the fix would allow the spot rate to better 

reflect market conditions. Moreover, allowing the market to clear within a wider band without 

ongoing intervention would help China’s transition to increased flexibility. 

The RMB is appreciating on a trade-weighted basis, but not as fast or by as much as is needed, 

and intervention has resumed. RMB appreciation is not only good for the U.S. economy, but 

good for the economies of China, broader Asia, and the world. China has allowed the RMB 

exchange rate to partially adjust over the last several years. This is reflected in the real 
17

appreciation of the RMB and the decline of the current account surplus. Through mid-October 

2013, the RMB has appreciated by a total of 12 percent against the dollar and 16 percent on a 

real, inflation-adjusted basis from June 2010, when China moved off its peg against the dollar,

and has appreciated about 45 percent in inflation-adjusted terms since China initiated currency

reform in 2005. China’s real effective exchange rate (REER) – a measure of its overall costcompetitiveness relative to its trading partners – has appreciated about 15 percent since June 

2010 and 38 percent since July 2005. 

In the first nine months of the year, the RMB has appreciated 6.3 percent on a nominal effective 

basis, and 6.6 on a real effective basis, taking into account differences in inflation. This, in 

considerable part, reflects the yen’s depreciation against the dollar and weakness in many EM 

currencies. The pace of nominal RMB appreciation (2.2 percent year-to-date as of October 18, 

2013) has been more modest, with very little appreciation for several months. Still, the RMB’s 

relative stability over recent months stands in sharp contrast to the depreciation of many other 

emerging market currencies this year, and the RMB has appreciated on a broad basis in 2013.

From late 2011 through early 2012, official intervention fell as concerns about a slowdown in

China and the financial crisis in the euro 

area lowered capital inflows into China. 

As these concerns receded in late 2012 and 

in the first half of 2013, official 

intervention resumed at a large scale. 

Official Chinese data show that the PBOC

and Chinese financial institutions

collectively purchased a record $110

billion in foreign exchange alone in both 

January a n d S e p t e m b e r 2013, more 

than it accumulated in all of 2012. It also 

added $53 billion to the People’s Bank of 

China’s (PBOC) ―other foreign assets‖, 

which can be viewed as another form of 

intervention. China slowed the pace of 

reserve accumulation to $47 billion in Q2 of 

this year, with the vast majority of 

intervention concentrated in April. 

Several factors contributed to the slowdown in foreign exchange inflows in the second quarter: 

(1) the government began clamping down on the false invoicing of trade used to channel ―hot 

money‖ onshore for speculation, and regulators introduced new rules that set minimum 

requirements on the net open foreign exchange positions of domestic banks; (2) continued signs 

of weakness in China’s activity indicators over the summer tempered expectations that GDP 

growth would rebound later in the year; and (3) for several weeks in June the PBOC set stronger 

daily fixing rates, despite weaker trading in the spot, creating more upside room in the band and 

reducing the need for foreign exchange intervention. Complete data for the third quarter is not 

yet available, but China’s headline foreign exchange reserves data suggests that authorities 

engaged in significant intervention in Q3. The quarterly increase of $166 billion was three times 
18

the Q2 increase, and the largest in over two years. After adjusting for valuation effects, China’s 

Q3 intervention was likely well over $100 billion. The PBOC’s monthly breakdown of reserve 

changes in Q3 suggests that China intervened most heavily in September, with reserves 

increasing about $110 billion as noted above. 

There are strong indications that the RMB adjustment process has substantially further to run 

before it reaches equilibrium. China's current account remains in surplus and China continues to 

attract net inflows of foreign direct investment. China’s GDP growth remains stronger than in 

the advanced economies, and its equilibrium interest rate is higher. The PBOC continues to 

accumulate reserves and to intervene in the market to prevent appreciation, though the scale of 

the needed intervention varies from month to month in response to the scale of market flows. 

Moreover, if the future pace of appreciation does not keep pace with China’s rapid productivity 

growth, there is a risk that the degree of undervaluation could increase, resulting to another 

widening of external imbalances. The IMF concluded in its recent Article IV consultation with 

China, that the RMB was ―moderately undervalued‖ against a broad basket of currencies, and the 

IMF’s 2013 Pilot External Sector Report shows the RMB was undervalued by about 5 to 10 

percent on a real effective basis.

The PBOC holdings of $3.66 trillion in total reserves is equivalent to 44 percent of China’s GDP

in 2012, or about $2,704 for every Chinese citizen.4 This is an exceptionally large amount 

compared to those of other economies, and well beyond established benchmarks of reserve 

adequacy. China’s stock of reserves is almost as large as the total amount of foreign exchange 

reserves held by all advanced economies combined, and accounts for nearly half of all of the 

foreign exchange reserves held by emerging and developing economies. The evidence that 

China resumed large-scale purchases of foreign exchange this year, despite having accumulated 

$3.6 trillion in reserves, which are more than sufficient by any measure, is suggestive of actions 

that are impeding market determination and a currency that is significantly undervalued. 

China still does not provide transparent disclosure of its foreign exchange activities. As a result, 

market participants and other observers must resort to estimating Chinese intervention using 

published reserve levels. It is one of only two G-20 members that do not report reserves under 

the IMF’s Special Data Dissemination Standard (SDDS) template, the international standard for 

public reporting of reserves data. Many of the largest emerging market countries – including 

India, Russia, and Brazil – disclose their monthly intervention in the foreign exchange market as 

well as reporting their reserves data in the SDDS template. Greater disclosure of its activities in 

the currency market through participation in the SDDS and the IMF’s aggregate Currency 

Composition of Foreign Exchange Reserves (COFER) database would be consistent with 

China’s commitment at the 2012 G-20 Los Cabos Summit to increase the transparency of its 

exchange rate policy. China stated at the 2013 S&ED that it is ―actively considering‖ 

subscription to the SDDS. In line with the practice of most other G-20 nations, China should

 

4

In addition, China has transferred (or swapped) some of its accumulated foreign exchange reserves to commercial 

banks, as well as capitalizing the China Investment Corporation (CIC), its sovereign wealth fund. China’s state 

sector as a whole – including the PBOC, state-owned banks, and CIC – holds roughly $4 trillion in foreign currency 

assets.
19

disclose foreign exchange market intervention regularly to increase the credibility of its 

monetary policy framework and to promote exchange rate and financial market transparency. 

Japan

The yen foreign exchange market is one of the largest and most liquid in the world, accounting 

for about 23 percent of the roughly $5 trillion in daily global foreign exchange transactions, 

according to surveys by the Bank for International Settlements (BIS).5 Japan maintains a 

floating exchange rate regime. 

Japan has not intervened in the foreign exchange markets in almost two years, although the 

authorities issued numerous public statements regarding their desire to ―correct the excessively 

strong yen‖ in the weeks following Prime Minister Abe’s election on December 16, 2012. 

Shortly thereafter, the Japanese government joined the G-7 statement of February 2013, 

affirming that economic policies would be based on domestic objectives using domestic 

instruments and would not target exchange rates. Since then, Japanese officials have clearly 

ruled out purchases of foreign assets as a monetary policy tool and have largely refrained from 

public comment on the desired level of the exchange rate. Japan was also part of the subsequent 

G-20 consensus and statement at the February 2013 Finance Ministers and Central Bank 

Governors Meeting in Moscow that countries would not target exchange rates for competitive 

purposes. This commitment was affirmed by G-20 Leaders in September 2013 at the St.

Petersburg Summit. It is important that these commitments be maintained by all G-7 and G-20 

members.

The yen started to depreciate against the dollar in October 2012 as market expectations built for 

more aggressive monetary easing by the Bank of Japan. After the April 4, 2013, announcement 

of ―Quantitative and Qualitative Easing‖ in which the Bank of Japan committed to double the 

monetary base to achieve a 2 percent inflation target, the yen depreciated as far as ¥/$ 103.2 on 

May 17. This represented a 32 percent depreciation from the beginning of October 2012. The 

yen has since traded in the ¥/$ 96 – 100 range. On a real trade-weighted basis, the yen has 

depreciated by 22.4 percent since the beginning of October 2012 as of September 2013.

In its latest Article IV Consultation Report for Japan (August 2013), the IMF assessed the yen’s 

real effective exchange rate to be moderately undervalued, while noting the very large 

uncertainty about its assessment given the major changes to Japan’s economic framework. Since 

September 2012, Japan’s foreign currency reserves have increased by $8.2 billion on valuation 

changes. As of September 2013, reserves were $1.2 trillion, the second-largest stock of reserves 

in the world.

Gradual but persistent deflation has plagued Japan for the last 15 years. As of August 2013, core 

consumer prices (excluding food and energy) were flat year-over-year, but headline consumer 

prices were up 0.8 percent, driven by increased energy costs stemming from the weaker yen. 

 

5 The 2013 BIS Triennial Central Bank Survey, released in September, showed that a significant expansion in yen 

trading between October 2012 and April 2013, was driven by expectation of a regime shift in Japanese monetary 

policy. In the last triennial BIS Central Bank Survey of Foreign Exchange Turnover, the yen foreign exchange 

market accounted for 19 percent of the roughly $4 trillion in daily global foreign exchange transactions.
20

The Japanese economy continues to recover from the earthquake and tsunami of March 2011, 

and has been supported in the short term by Prime Minister Abe’s ―three arrow‖ economic 

policy, which combines monetary stimulus, an initial fiscal easing following by a large 

consolidation, and planned structural reforms. The IMF projects that GDP growth will be 2.0 

percent in 2013, slowing to 1.2 percent in 2014 as fiscal consolidation kicks in. Japanese Q2 

quarter-on-quarter annualized growth was 3.8 percent, with final domestic demand contributing

3.8 percentage points thanks to strong private consumption and government spending from 

tsunami reconstruction and fiscal stimulus, a 0.7 percentage point offset from inventory 

destocking and a 0.7 percentage point contribution from net exports. In the first half of 2013, net 

exports contributed 1.2 percentage points to growth and domestic demand contributed 2.6 

percentage points. 

In 2011, Japan’s goods trade balance fell into deficit for the first time since 1980 as exports 

slowed following production disruptions stemming from the March 2011 disaster, while imports 

increased due to higher commodity prices and rising demand for reconstruction materials. 

Japan’s nominal trade deficit continued to rise in 2012 and 2013, due in large part to the rise in 

import prices driven by the weaker yen and increased demand for fossil fuel imports due to the 

ongoing shutdown of most of Japan’s nuclear power generators. The nominal trade deficit 

reached 2.2 percent of GDP in the first half of 2013. However, as Japan’s terms of trade have 

deteriorated with the weaker yen, the evolution of Japan’s nominal and real trade balance has 

diverged, with the real trade balance improving as a result of rising export volumes even as the 

nominal deficit increased. During the first and second quarters of 2013, real exports grew by 1.5 

and 3.6 percent, respectively, on a quarterly basis. 

The current account remains in surplus due to positive net income flows, but it has narrowed 

substantially from almost 4 percent in 2010 to 1.2 percent for the first half of 2013. Japan’s 

bilateral trade surplus with the United States totaled $43.2 billion during the seven months 

ending on July 2013, down slightly from $45.9 billion during the same period in 2012. 

Going forward, it is critically important for the global economy that Japan’s economic policies 

(―Abenomics‖) work primarily through an increase in domestic demand. In particular, the 

planned shift toward fiscal consolidation in 2014 needs to be carefully calibrated so as to 

preserve the underlying momentum of internal demand growth. Sustaining growth in demand 

will depend on a rise in business investment, housing investment and especially growth in 

nominal wages. In Japan’s revised data for second quarter GDP, business investment increased 

for the first time in six quarters, by 5.1 percent on a seasonally-adjusted basis. However, 

scheduled cash earnings, a key gauge of the underlying trend in earnings, continued to fall 

through July, although bonus payments and overtime pay have started to increase.

The Japanese authorities have affirmed their commitment to returning Japan’s public finances to 

more sustainable footing. The Abe fiscal stimulus, which centered on reconstruction and 

disaster-preparedness spending, would maintain the deficit at roughly 10 percent of GDP in 

2013, unchanged from 2012. In August, the IMF projected that Japan’s general government 

gross debt will reach 247 percent of GDP – the highest among advanced economies – in 2013.

As a result, medium-term fiscal consolidation remains a key priority for the Japanese authorities. 

However, Japan also needs to take care that its deficit-reduction strategy does not result in too
21

rapid a consolidation that stalls Japanese growth and prevents escape from deflation. If Japan 

proceeds on schedule with the legislated 3 percentage point increase in the consumption tax, it is 

important that its short-term negative impact be moderated through temporary, high multiplier

fiscal measures to support demand. 

In March 2013, Prime Minister Abe announced Japan’s intention to join the Trans-Pacific 

Partnership (TPP) trade negotiations, and Japan joined the negotiations in July 2013. The 

announcement has been interpreted as launching the third arrow of Mr. Abe’s economic reform 

strategy, in so far as joining the TPP would lead to internal reforms such as deregulation in areas 

like agriculture and medical services. Additionally, the Abe Administration has begun to unveil 

a growth strategy, to focus on industrial competitiveness, regulatory reform, and science and 

technology policy. An outline on implementation was presented by Abe in June with assurances 

of deeper and more specifically detailed reforms to come after the Japanese Upper House 

election this past July.

We will continue to closely monitor Japan's policies and the extent to which they support the 

growth of domestic demand. In order to support a stronger economic recovery and increase 

potential growth, it is important that Japan calibrate the pace of fiscal consolidation to the 

recovery in domestic demand and take ambitious and effective steps to increase domestic 

demand, including by easing regulations that unduly deter competition and labor force 

participation in its domestic economy. Monetary policy cannot offset excessive fiscal 

consolidation or be a substitute for structural reform that raises trend growth and domestic 

demand. We will continue to stress the importance of Japan’s continued adherence to the 

commitments made in the G-7 and G-20, to remain oriented towards meeting respective 

domestic objectives using domestic instruments and to refrain from competitive devaluation and 

targeting its exchange rate for competitive purposes. 

South Korea

South Korea officially maintains a market-determined exchange rate, and its authorities intervene 

with the stated objective of smoothing won volatility. The Korean won has remained relatively 

stable in the recent market turbulence despite the sharp depreciation of a number of emerging 

market currencies. The won’s relative strength can be credited to a combination of factors, 

including: a high and growing current account surplus, low levels of short-term external debt, a 

strong fundamental fiscal position, and favorable terms of trade. 

 

The won’s nominal trade-weighted value depreciated moderately in the first half of 2013, but 

strengthened in July and again in August as global investors increasingly differentiated among 

emerging market economies and net portfolio flows to Korea increased. From its 2013 low of 

1161 won per dollar on June 24, the won appreciated 7.6 percent by end September. As of end 

September, the won was 1 percent below its level at the beginning of the year. Although the 

Korean won depreciated at a moderate pace against the U.S. dollar in the first half of 2013, the 

IMF’s July 2013 Pilot External Sector Report finds that Korea's real effective exchange rate 

remains undervalued in a range of roughly 2 to 8 percent. 

In its September 2012 Article IV Consultation Report on Korea, the IMF noted that foreign 

exchange reserves were adequate and that there was ―no need for further reserve accumulation 
22

beyond what would be needed to keep pace with rising foreign liabilities over time.‖ Korea’s 

foreign exchange reserves were $326 billion at the end of September. Korea does not publicly 

report foreign exchange market intervention, although the Administration has encouraged them 

to do so. Instead, market participants derive estimated intervention from changes in Korean 

foreign exchange reserves and forward positions. During the first half of 2013 the Korean 

authorities are believed to have intervened on both sides of the market. Many market 

participants speculate that the Korean authorities intervened in early 2013 to limit the pace of 

won appreciation as the Japanese yen weakened, then subsequently to limit won depreciation. It 

is generally believed that Korea has resumed intervention to limit the won’s appreciation. In 

January 2013, foreign exchange reserves increased $1.9 billion. From January to June, reserves 

declined $3.3 billion. And since June, reserves have increased $10.5 billion through September. 

Korea’s net forward position also has increased to $44.6 billion. 

In early 2013, following eight months of won appreciation, the Korean authorities publicly 

warned they were contemplating further tightening of macroprudential measures on foreign 

exchange exposure of the banking system. The Korean banking system relies heavily on 

wholesale funding, much of it external. This leaves Korea vulnerable to external funding risk, as 

both the Asian financial crisis of 1997-98 and the 2008-9 global financial crisis 

revealed. However, the timing of the potential strengthened macroprudential measures and 

official commentary fed widespread speculation that the intent was to limit won appreciation. 

As the won depreciated, no additional macroprudential measures were signaled or introduced. 

GDP growth in Korea has rebounded this year, with first and second quarter GDP rising by 3.4 

and 4.4 percent, respectively, on an annual basis. Growth has been driven by buoyant exports, 

front-loaded government spending, and fiscal stimulus of 1.3 percent of GDP, delivered in April. 

Personal consumption has lagged overall GDP growth this year, and investment slowed 

significantly in the second quarter. Korean household debt – currently at an OECD high of 136 

percent of disposable income – weighs on spending.6 The IMF projects Korean GDP growth 

will be 2.8 percent in 2013 and 3.7 percent in 2014.

After exceeding the Bank of Korea’s target range of 2-4 percent in 2011, headline price inflation 

subsided to 1.4 percent in 2012 and 1.5 percent on a year-on-year basis as of August 2013. 

Citing the slow recovery in the global economy, the Bank of Korea lowered its policy rate in 

May, to 2.5 percent from 2.75 percent in May 2013. The policy rate has remained unchanged 

since May.

 

Korea has benefited from improved terms of trade this year on falling commodity prices, and 

energy imports constitute around 40 percent of Korean imports. Korea’s trade surplus widened 

during the first half of 2013 relative to the same period in 2012 as export growth outpaced 

imports. Goods and services exports totaled $339 billion in the first half of 2013, 2 percent more

than the same period in 2012, while imports – at $306 billion – were down 3 percent from 2012. 

Korea’s current account surplus as a share of GDP rose sharply to 3.7 percent of GDP in 2012 

compared to 2.3 percent in 2011, and the surplus has continued to rise this year. Private analysts 

 

6 Korean households borrow to support very large expenditure on college-preparatory education and an apartmentrental system that involves large, interest-free loans from renter to landlord, among other reasons.
23

forecast that the surplus will reach 5 percent of GDP this year, the highest since 1999. In 

February 2013, Korea joined the rest of the G-20 in committing to refrain from competitive 

devaluation and resolving not to target its exchange rate for competitive purposes. 

We will continue to encourage Korean authorities to limit foreign exchange intervention to 

the exceptional circumstances of disorderly market conditions. In addition, in line with the 

practice of most other G-20 countries, Korea should disclose foreign exchange market 

intervention shortly after it takes place, similar to Japan and emerging markets such as Brazil, 

India, and Russia. We will continue to press Korean authorities to ensure that macroprudential 

measures are clearly directed to reducing financial sector risks – in design, timing, and 

description – rather than aimed at limiting capital inflows or reducing upward pressure on the 

exchange rate. We are concerned at reports Korea is intervening in the market to resist 

appreciation in the context of a large and widening current account surplus. More generally, we 

will strongly urge Korea to take bold measures to reduce reliance on net exports as an engine of 

growth. 

Taiwan

Taiwan maintains a managed float exchange rate regime, and the central bank states that the New 

Taiwan Dollar (NTD) exchange rate is determined by the market, except when the market is 

disrupted by seasonal or irregular factors. Taiwan’s foreign exchange reserves grew by $9.4

billion (2.3 percent) in the first nine months of 2013 and stood at $412.6 billion at as of endSeptember 2013. Taiwan’s foreign exchange reserves are equivalent to 85 percent of GDP, 18 

months of imports, and 3.2 times the economy’s short-term external debt. 

Taiwan has been relatively little affected by recent capital outflows from emerging markets, with 

positive net foreign equity inflows in July and August. The NTD depreciated 4.2 percent against 

the dollar in the first half of 2013, followed by a 1.1 percent appreciation during July and 

August. The real and nominal effective exchange rates appreciated by just 0.3 percent in the first 

half of 2013, then appreciated 0.6 percent and 0.8 percent, respectively, over July and August. 

Market participants indicated that the Taiwan authorities intervened regularly to resist NTD 

appreciation in foreign exchange markets during the year so far. Taiwan does not publish 

official intervention data, nor does it subscribe to the IMF’s SDDS template for international 

reserves. The SDDS template would help publicly clarify the extent to which the authorities take 

positions in the forward market, if at all. Taiwan already uses the SDDS framework for many of 

its other financial and external accounts. 

Taiwan’s real GDP growth remained little changed in the first half of 2013 from 1.3 percent in 

2012. Stronger contributions from net export and investment will likely lift GDP growth 

moderately in the second half of 2013. The IMF is projecting growth of 2.1 percent in 2013 and 

3.8 percent in 2014. Taiwan’s year-on-year inflation has fallen steadily since February due to 

base effects, and was -0.8 percent in August. The central bank has kept its target rediscount rate 

on hold at 1.875 percent since June 2011.

Taiwan’s current account surplus remained remarkably high in the first half of 2013 at 10.3 

percent of GDP on a strong trade surplus, compared to 10.4 percent of GDP in 2012 and 8.9 

percent in 2011. The second quarter current account surplus of $14 billion is the second highest 
24

in absolute terms historically and, apart from the post-crisis boom in 2009, the highest as a 

percent of GDP since 1988. Taiwan’s goods and services trade surplus totaled $19 billion in the 

first half of 2013, up 32 percent from the same period last year, as exports to other Asian 

economies increased and import prices declined along with global commodity prices. At the 

same time, the income surplus declined on reduced investment income from foreign exchange 

assets and non-resident equity dividend payments. 

Taiwan has a largely open capital account, but maintains some restrictions to avoid large inflows 

or outflows of capital, including measures to discourage foreign investors from holding local 

currency deposits. The financial account showed a net outflow of $19 billion in the first half of 

2013, reflecting greater investment abroad by insurance companies and an increase in lending by 

off-shore banking units.

We will continue to press the Taiwan authorities to limit their foreign exchange interventions to 

the exceptional circumstances of disorderly market conditions and to commit to greater foreign 

exchange market transparency through the publication of intervention data and by reporting 

foreign exchange reserve data using the SDDS template.

Europe

Euro Area

The exchange rate of the euro is freely determined in the foreign exchange market. The euro has 

experienced large fluctuations since the financial crisis resulting from ebbs and flows in risk 

aversion associated with financial stresses in the euro area. In the first half of 2013, the euro 

depreciated by 1.3 percent against the dollar but subsequently appreciated by 4.4 percent through 

the end of September. On a real effective basis, the euro appreciated by 2.7 percent in the first 

half of 2013 and by a further 0.6 percent in the third quarter of 2013.

The euro area economy expanded by 1.2 percent, on a seasonally adjusted, annualized basis 

(saar), in the second quarter of 2013, marking the first expansion of economic activity in the euro 

area in seven quarters. Expansion was supported by domestic demand growth in Germany -

though growth in Germany still continues to rely on positive net exports, which continues to 

delay the euro area’s external adjustment process – and on domestic demand in France. 

Economic conditions across the euro area remain uneven with the countries in the periphery 

remaining in recession overall. Ireland and Portugal expanded on a quarter-on-quarter saar basis 

in the second quarter, but this may have been the result of transitory factors such as weather, and 

the economies of Greece, Italy, and Spain continued to contract during the same period, albeit at 

a more moderate pace.

The euro area’s recovery has substantially lagged other developed countries, leaving economic 

activity at a low level. Euro area GDP still remains 3 percent below its peak in the first quarter 

of 2008, private demand is almost 6 percent below pre-crisis levels, unemployment is running at 

12.0 percent, and the periphery remains in recession overall. While euro area leaders have put in 

place important measures to stabilize the economy, significant macroeconomic and financial 

headwinds remain. The fiscal impulse in 2013, albeit more moderate than 2012, remains 

negative. Private consumption, by far the largest component of domestic demand, could 
25

continue to be constrained as real disposable incomes remain under pressure from elevated 

unemployment, low real wage growth, and higher taxes. Meanwhile investment, which has 

made a significant contribution to weak domestic demand, is showing nascent signs of recovery 

but remains weak overall. Further, while financial fragmentation has eased on the back of ECB 

actions, lending conditions remain tight in many countries and, together with deleveraging, will 

act as drags on growth. Both the European Commission (EC) and IMF forecast that the euro 

area economy will contract in 2013 by 0.4 percent, with GDP expected to grow at the slow pace

of 1 percent in 2014. 

Euro area deficit countries have sharply reduced their current account deficits, but euro area 

surplus countries have not reduced their current account surpluses. The euro area's overall 

current account swung into surplus in 2012, and the surplus has increased further in the first half 

of 2013 to almost 2.3 percent of GDP. The Netherlands and Germany have continued to run 

substantial current account surpluses since 2011, while the current accounts deficits of Italy and 

Spain and the smaller economies in the periphery have contracted significantly, primarily as a 

result of a collapse of domestic demand and falling wages. Ireland, Italy and Spain have run 

surpluses in recent quarters, and Portugal moved into surplus in the second quarter of 2013. 

Germany’s current account surplus, meanwhile, rose above 7 percent of GDP in the first half of 

2013, with net exports still accounting for a significant portion (one-third) of total growth in the 

second quarter, suggesting that rebalancing is not yet occurring domestically. To ease the 

adjustment process within the euro area, countries with large and persistent surplus need to take 

action to boost domestic demand growth and shrink their surpluses. Germany has maintained a 

large current account surplus throughout the euro area financial crisis, and in 2012, Germany’s 

nominal current account surplus was larger than that of China. Germany’s anemic pace of 

domestic demand growth and dependence on exports have hampered rebalancing at a time when 

many other euro-area countries have been under severe pressure to curb demand and compress 

imports in order to promote adjustment. The net result has been a deflationary bias for the euro

area, as well as for the world economy. Stronger domestic demand growth in surplus European 

economies, particularly in Germany, would help to facilitate a durable rebalancing of imbalances 

in the euro area. The EU’s annual Macroeconomic Imbalances Procedure, developed as part of 

the EU’s increased focus on surveillance, should help signal building external and internal 

imbalances; however, the procedure remains somewhat asymmetric and does not give sufficient 

attention to countries with large and sustained external surpluses like Germany.

In 2012, the euro area, in aggregate, undertook one of the most aggressive fiscal consolidations 

of the advanced economies despite having the smallest cyclically-adjusted fiscal deficit and weak 

growth prospects. While the pace of consolidation has moderated somewhat this year, the euro 

area structural fiscal deficit is expected to decrease by another 0.9 percent of GDP in 2013. 

Under the Excessive Deficit Procedure, most of the major euro area economies initially had 

committed to reducing their general government budget deficits to less than 3.0 percent of GDP 

by 2013. The EC, however, has adopted some flexibility in enforcing country targets, focusing 

on a country’s structural effort even if annual headline targets are not met due to weaker than 

expected growth. Germany met the 3 percent target in 2011 and achieved a small surplus in 

2012. Ireland, Greece, and Portugal have been given more time under their reform programs, 

and recently, Spain and France were given two more years (Spain through 2016 and France 

through 2015) and the Netherlands an additional year to meet this 3 percent target. Nonetheless, 
26

we remain concerned about the appropriate pace of consolidation and the need to provide room 

for countercyclical policy responses while ensuring credible paths to fiscal sustainability over a 

time frame that is sensitive to cyclical developments.

In 2013, the European Central Bank (ECB) has continued to take both conventional as well as 

unconventional policy actions to support activity and improve monetary policy transmission. 

The ECB eased monetary policy by reducing its main refinancing rate by 25 basis points to 0.5 

percent in May 2013. The ECB also employed forward guidance in July 2013 to provide greater 

clarity about the expected path of policy, noting that ECB interest rates would remain at or below 

current levels for an extended period of time. The ECB continues to provide full allotments of 

liquidity against eligible collateral to euro area financial institutions. The announcement of the 

Outright Monetary Transactions (OMT) developed by the ECB in September 2012 has 

dramatically lowered financial stress and funding costs within the currency area.7 

The ECB’s provision of over €1 trillion in three-year funding via longer-term refinancing 

operations (LTRO) in December 2011 and February 2012 helped to alleviate funding pressures 

in the banking sector over the course of 2012. Repayment by financial institutions of over onethird of the three-year LTROs, however, has resulted in reduced excess liquidity, which could 

place upward pressure on interest rates.

Overall, recent policy actions and commitments undertaken by the ECB and euro area 

governments have reduced concerns about a euro area systemic event and eased severe market 

pressures, providing additional time for the difficult multiyear adjustment at the country and 

regional levels. But risks of policy setbacks in addressing the underlying vulnerabilities of 

peripheral economies and the institutional structure of the euro area and EU remain 

significant. Further stresses could emerge from political uncertainty, adjustment fatigue, and 

disagreement within the euro area on how to address new challenges to the currency union. Over 

the medium term, delays in financial, economic, and fiscal integration could entrench the large 

economic disparities that have developed across the euro area, leaving the region vulnerable to 

new shocks. A key priority for the euro area is to solidify and accelerate the recovery in growth, 

which will support a reduction of heavy debt burdens, lower high unemployment rates, and help 

maintain political support for the adjustment process within the core and periphery. The 

European Commission forecasts a contraction of 0.4 percent across the euro area in 2013, and 

headwinds to growth include substantial fiscal drag, private sector deleveraging, and a weak 

external environment. The periphery faces greater uncertainty over medium-term trend growth, 

given continued fiscal consolidation, banking sector deleveraging, and mixed efforts to date to 

address challenges to competiveness and productivity.

 

7 Under the OMT the ECB will stand ready to buy sovereign bonds, potentially in unlimited amounts, of countries 

that request support from the European Financial Stability Fund or the European Stability Mechanism and adhere to 

agreed conditions. 
27

Switzerland

In September 2011, in an environment of significant market concerns about tail risks in the euro 

area, the Swiss National Bank (SNB) established a minimum exchange rate (―floor‖) of 1.20 

Swiss francs per euro, temporarily changing the exchange rate regime from a floating to a 

managed rate. Through 2012 the SNB intervened repeatedly to prevent the franc from 

appreciating. However, as European authorities implemented measures to reestablish financial 

stability, and concerns about tail risks subsided, pressures on the Swiss franc subsided and SNB 

interventions have ceased. In June 2013, the SNB reaffirmed its commitment to a managed rate, 

noting that it is prepared to buy foreign currency in unlimited quantities and to take further 

(unspecified) measures to enforce the 1.20 exchange rate floor.

Switzerland is a small open economy surrounded by the euro area, and has been 

disproportionally affected by the financial stresses in Europe, resulting in disorderly movements 

in the exchange rate. The Swiss authorities faced a constrained policy environment as external 

forces pushed the economy into deflation and potentially recession in the summer of 2011. The 

exchange rate floor was established after a number of alternate policy measures failed to achieve 

the SNB’s monetary policy objectives. 

Since establishing the exchange rate floor, the SNB’s reserve assets have increased $166 billion 

on a headline basis, and now total $478.2 billion as of September 2013. Most of this change is 

attributable to SNB purchases of reserve assets, while a smaller portion is due to valuation 

changes of reserves. Through September this year, SNB’s reserve assets increased by $10.3

billion on a headline basis in 2013. Given the lack of foreign exchange intervention this year, 

the total change is attributable to valuation effects. While the currency composition of reserves 

fluctuates on a monthly basis as a result of interventions and valuation changes, the SNB 

rebalances its portfolio over time to keep the euro share around 50 percent of reserves and the 

U.S. dollar share between 25 and 30 percent.

After remaining close to the 1.20 exchange rate floor through the end of 2012, the franc has 

depreciated in 2013 against the euro by 1.4 percent (to 1.22) through September 2013. Against 

the U.S. dollar the franc has depreciated by 1.1 percent this year (also through September), and 

on a real trade weighted basis the franc has depreciated 0.5 percent (through August, based on 

BIS data). In 2012, the current account surplus was 13.4 percent of GDP, of which the goods 

surplus was 2.5 percent. The large current account surpluses traditionally run by Switzerland 

must be interpreted with caution. The IMF notes that (a) the activities of international 

commodity trading companies could add up to 4 percent of GDP to the surplus even though 

some have limited operations in Switzerland; (b) Swiss multinationals partly owned by 

foreigners artificially raises the surplus and is estimated to have added 2 percent of GDP to the 

surplus in 2011; and (c) cross-border shopping direct purchases and deliveries may not be 

reflected in import statistics and overstate the current account by non-trivial amounts. Finally, 

Switzerland’s role as an international banking center generates fee and investment income that 

contribute to the overall current account surplus but cannot be attributed to Swiss citizens.

In the IMF’s 2013 Pilot External Sector Report, the Swiss external position is assessed to be 

―moderately stronger than the level consistent with medium-term fundamentals and desirable 
28

policy settings.‖ The real effective exchange rate is assessed to be ―moderately overvalued 

because of safe-haven capital inflows, but the overvaluation is eroding over time given negative 

inflation differentials with trading partners.‖

Economic growth in Switzerland is slowly reviving and deflationary pressures appear to be 

subsiding. The year-on-year economic growth rate has steadily increased from 0.5 percent in the 

second quarter of 2012 to 2.1 in the second quarter of 2013. This compares to flat year-on-year 

growth in European Union in the second quarter of this year. Economic growth in Switzerland 

over the last year (from the second quarter of 2012 to the second quarter of 2013) has been broad 

based, with real net exports contributing 0.9 percentage points of growth and domestic demand 

contributing 1.2 percentage points. The SNB has recently revised up its growth forecast for 2013 

from 1-1.5 percent to 1.2-2.0 percent. Consumer prices on a year-on-year basis were flat in 

August 2013, following a 21-month period of year-on-year deflation. The SNB forecasts a 0.2 

percent decrease in consumer prices this year. With low unemployment (3.2 percent) and high 

capacity utilization (around 80 percent) there appears to be little ―slack‖ in the economy. The 

SNB estimates the output gap in the first quarter of 2013 at around 1 percent of potential GDP. 

United Kingdom

The United Kingdom (UK) has a freely floating exchange rate. The pound appreciated by 4.3 

percent against the U.S. dollar on a nominal basis in 2012. It reversed course in the first half of 

2013, depreciating by 6.5 percent against the dollar, but recovered most of that by the end of 

September, appreciating by 6.4 percent from July through September. On a real effective basis, 

the pound appreciated by 3.5 percent in 2012, reflecting its nominal appreciation against other 

currencies, notably the euro. This trend reversed in 2013, during which the pound depreciated by 

3.3 percent on a real effective basis in the first half of the year. The pound depreciated by an 

additional 1.2 percent in July, but appreciated in August by 1.5 percent.

The UK economy expanded by 0.2 percent in 2012 and has gained momentum in 2013. 

Economic activity expanded by 1.1 percent on a seasonally-adjusted annualized basis in the first 

quarter of 2013, and accelerated to 2.9 percent in the second quarter. 

The fiscal deficit fell from its post-war peak of 11.2 percent of GDP in fiscal year 2009-10 to 7.9 

percent of GDP in 2011-12, primarily resulting from the tax increases and public spending cuts 

announced by the current and previous governments. The headline deficit narrowed to 5.6 

percent of GDP in 2012-13, but most of the consolidation reflected one-off factors. Excluding 

these factors, the underlying fiscal deficit was little changed from 2011-12 at 7.8 percent of 

GDP.

Monetary policy remains accommodative. The Bank of England (BOE) has maintained its 

historically low policy rate at 0.5 percent and, since October 2011, has increased the size of its 

quantitative easing program three times – each time by £50 billion – to reach £375 billion at its 

July 2012 meeting. The Monetary Policy Committee (MPC) of the BOE in its August 1 

statement made the decision of providing explicit guidance regarding the future conduct of 

monetary policy. Specifically, the MPC stated that it intends not to raise the policy rate from its 

current level at least until the unemployment rate has fallen to a threshold of 7 percent, provided 
29

that this does not entail material risks to price stability or financial stability. The unemployment 

rate in August was 7.7 percent, and the MPC does not expect unemployment to fall to the 7 

percent threshold until 2016. Consumer prices peaked at 5.2 percent in September 2011 on yearon-year basis, but have fallen to 2.7 percent as of August 2013. The MPC projects that the rate 

of inflation will decrease to around the target rate of 2.0 percent in approximately two-to-three 

years.

The current account deficit in 2012 widened to 3.8 percent of GDP – the largest deficit since 

1989 (4.6 percent of GDP) – reflecting a widening trade deficit and modest income deficit. On a 

quarterly basis, the current account deficit peaked at 4.6 percent of GDP in the second quarter of 

2012, and then narrowed to 3.9 percent and 3.5 percent in the third and fourth quarters, 

respectively. In the first quarter of 2013, the current account deficit widened to 3.6 percent of 

GDP, reflecting a shift in the income balance from surplus to deficit that outweighed a drop in 

the trade deficit. In the IMF’s 2013 Pilot External Sector Report, the UK’s external position is 

assessed to be ―moderately weaker than implied by medium-term fundamentals and desirable 

policy settings.‖

Western Hemisphere

Brazil

Since 2011, Brazil has experienced only modest growth, despite an aggressive 14-month 

monetary policy easing cycle that brought the official policy rate (SELIC) to an all-time low of 

7.25 percent in October 2012. The accommodative monetary policy during this period also was 

supported by an array of fiscal stimulus measures, especially targeting durable consumer goods 

to boost flagging industrial production. Despite these policy conditions, in 2012 the economy 

grew only 0.9 percent. The country has faced an extended decline in industrial production, 

attributable in part to weak global demand and domestic supply-side constraints, including a high 

unit cost of labor and underdeveloped infrastructure. 

Brazil’s growth in the second quarter of 2013 surprised on the upside, as the economy expanded 

at a 6 percent annualized rate. The forecast for the second half of 2013 is much weaker though, 

resulting in a full-year growth forecast by the IMF of 2.5 percent for 2013. Annual inflation 

reached 5.8 percent in 2012, close to the upper limit of the central bank’s target band of 4.5 

percent ± 2 percent, and accelerated to 6.7 percent year-over-year in the first half of 2013. As a 

result, in April 2013 the Banco Central do Brasil (BCB) once again began to raise interest rates 

to combat inflation, increasing the policy rate 2.25 percentage points to 9.5 percent as of 

October. 

Brazil maintains a floating exchange rate regime, although over the past two years there have 

been, at times, increased official efforts to manage the real. The authorities have used foreign 

exchange market intervention – primarily through foreign exchange derivatives markets – as well 

as verbal guidance and capital flow management measures, to dampen directional movements of 

the currency. On a real effective basis, Brazil’s exchange rate as of September 2013 had 

depreciated 4.0 percent since the beginning of the year. However, Brazil’s real effective 

exchange rate has fluctuated during that period, appreciating during January to March, but 
30

depreciating to an even greater extent during May to August, before appreciating again in 

September. 

From the beginning of 2013 until the end of September the real depreciated on a nominal basis 

against the dollar, weakening by 8.1 percent. In response to sharp depreciation pressures on the 

real, at the end of May the BCB began to provide onshore dollar swaps and started to build up a 

short dollar position in the foreign exchange futures market, as it sought to support the real by 

providing insurance against the risk of further depreciation. This short dollar position continued 

to increase due to regular BCB activity in the futures market, reaching $54 billion by the end of 

September. In addition, from June through September, the BCB sold $7.4 billion in the spot 

market using repurchase contracts.

Following these frequent but unscheduled interventions, on August 22 the BCB announced a 

plan that would provide $60 billion in dollar swaps and repurchase contracts through December 

2013, with a stated objective of providing hedging and liquidity to the foreign exchange 

market. The announced plan includes minimum weekly offerings of $2 billion in dollar swaps 

through the foreign exchange futures market, as well as $1 billion in offerings of dollar 

repurchase contracts in the spot market. The repurchase operations will cause a temporary fall in 

foreign exchange reserves until the operations are reversed, whereas the dollar swaps are settled 

in local currency. Since the August 22 announcement of the BCB’s foreign exchange 

intervention, the real rebounded 9.3 percent against the dollar through end-September. Brazil’s 

headline foreign exchange reserves totaled $368.7 billion as of end-September.

In June 2013, the authorities removed a series of measures which they previously had 

implemented, beginning in 2009, to control capital inflows and limit upward pressures on the 

real. From 2010 through early 2012, the authorities had gradually broadened the scope of a 

financial operations tax (IOF) on capital inflows to include portfolio inflows, short dollar 

positions in the futures market, and medium-duration external borrowing (between two and five 

years). The authorities reduced the measures to some extent later in 2012 as capital inflows 

slowed. Then, in June 2013, the authorities effectively eliminated the IOF on portfolio inflows 

by reducing the taxation rate to zero, as they sought to attract new portfolio inflows amidst 

currency depreciation pressures. The authorities, however, have reserved the option to change 

the IOF rate again in the future if economic conditions change. 

Brazil’s current account deficit reached 4.0 percent of GDP in the first quarter of 2013, its largest 

deficit since 2001—before declining to 3.3 percent in the second quarter. The widening current 

account deficit over the past year has resulted from a declining merchandise trade surplus, 

combined with a rising deficit in services trade and income payments on foreign investment in 

Brazil.

Canada

The IMF expects Canada’s real GDP is expected to grow at 1.6 percent in 2013, roughly the 

same rate as in 2012. Private consumption is relatively weak due to slower disposable income 

growth and sluggish consumer credit growth, as high levels of household debt have induced 

more caution in borrowing. House sales and construction are also moderating, particularly in 
31

large metropolitan areas. Growth is projected by the IMF to increase to 2.2 percent in 2014, 

driven by stronger external demand.

Fiscal policy is aimed towards consolidation as the recovery takes hold. The fiscal deficit was 

3.2 percent of GDP in 2012, and the authorities have indicated they will seek to achieve fiscal 

balance by the 2015-2016 fiscal year. Headline inflation decelerated to 0.8 percent for the first 

half of 2013 on a year-over-year basis, down from 1.1 percent in the second half of 2012, with 

core inflation of 1.2 percent. The government forecasts inflationary pressures to remain 

contained in 2013, with core inflation flat at 1.8 percent and the CPI rising slightly to 1.7 percent 

for the year.

Canada maintains a flexible exchange rate and employs an inflation-targeting monetary policy 

regime. The Canadian dollar fluctuated against the dollar during 2013 but has generally been on 

a depreciating trend for the year. In nominal terms, the Canadian dollar has depreciated by 3.6 

percent against the U.S. dollar year-to-date as of the end of September. On a real effective basis, 

in 2013 the Canadian dollar has depreciated by 3.9 percent year-to-date as of September.

Canada’s current account has moved into deficit in recent years, with the deficit reaching 3.7 

percent of GDP in 2012, driven by weaker external demand and a strong currency. The current 

account deficit is expected to narrow to 3.5 percent of GDP in 2013 and to shrink further in 2014 

as demand for Canada’s exports, particularly from the United States, recovers. 

Mexico

Mexico’s economy posted three years of sustained growth since the 2008-09 global financial 

crisis, but growth has been gradually slowing and the IMF expects only 1.2 percent growth in 

2013. Soft external demand and a fall in domestic investment have been the proximate causes of 

the slowdown. Mexico recorded a 1.9 percent current account deficit in the first half of 2013, up 

from 1.4 percent in 2012. Still, Mexico stands to gain from stronger economic activity in the 

United States, and the implementation of the Mexican government’s reform agenda could lead to 

stronger consumption and investment. As a result, the consensus forecast among private sector 

analysts is for Mexican growth to pick up to about 3.6 percent in 2014; the IMF expects growth 

of 3.0 percent. 

Mexico has a flexible exchange rate and employs an inflation-targeting monetary policy regime. 

Overall, in nominal terms the peso has depreciated by 1.5 percent against the dollar year-to-date 

as of the end of September. After strengthening steadily during the first four months of 2013, the 

peso began to reverse course in May, depreciating by 8.5 percent against the U.S. dollar between 

May 8 and the end of September. On a real effective basis, the peso has depreciated by 0.3 

percent year-to-date as of September. 

In April 2013, the Bank of Mexico suspended its system of daily dollar auctions by which it 

would sell U.S. dollars on days when the peso was weakening significantly. The system had 

been in place since November 2011, and involved an auction of up to $400 million in foreign 

exchange on any day in which the peso depreciated against the dollar by more than 2 percent. 

Although authorities had discontinued the system during a period of peso strength in the first 
32

four months of 2013, authorities did not re-institute the system during the subsequent period of 

peso depreciation.

Mexico’s foreign exchange reserves increased by $3.8 billion in the first half of 2013, reaching a 

total of $157 billion, driven by foreign exchange inflows from the state-owned oil company, 

Pemex. In November 2012, the IMF renewed a precautionary Flexible Credit Line (FCL) 

arrangement for Mexico, equivalent to $73 billion. Mexico’s first FCL arrangement, equivalent 

to $47 billion, was approved in April 2009. It previously was renewed in March 2010, and in 

January 2011 was renewed again with access augmented to its current level. As of September 

2013, Mexico had not drawn on this line. 

The Bank of Mexico has maintained an accommodative monetary policy stance since early 2009. 

At its October 2013 meeting, the Bank of Mexico cut its target interest rate by 25 basis points to 

3.5 percent. Headline inflation has recently moderated to 3.4 percent in September and has 

fallen into the central bank’s target band of 3 percent plus or minus 1 percent. Core inflation 

dropped to 2.9 percent in the first half of 2013 from 3.4 percent in the second half of 2012.
33

Glossary of Key Terms in the Report

Bilateral Real Exchange Rate – The bilateral exchange rate adjusted for inflation in the two 

countries, usually consumer price inflation. 

Exchange Rate– The price at which one currency can be exchanged for another. Also referred 

to as the bilateral exchange rate.

Exchange Rate Regime –The manner or rules under which a country manages the exchange rate 

of its currency, particularly the extent to which it intervenes in the foreign exchange market. 

Exchange rate regimes range from floating to pegged.

Floating (Flexible) Exchange Rate – A regime under which the foreign exchange rate of a 

currency is fully determined by the market with intervention from the government or central 

bank being used sparingly.

International Reserves– Foreign assets held by the central bank that can be used to finance the 

balance of payments and for intervention in the exchange market. Foreign assets consist of gold, 

Special Drawing Rights (SDRs), and foreign currency (most of which is held in short-term 

government securities). The latter are used for intervention in the foreign exchange markets.

Intervention – The purchase or sale of a country’s currency in the foreign exchange market by a

government entity (typically a central bank) in order to influence its exchange rate. Purchases 

involve the exchange of a country’s foreign currency reserves for its own currency, reducing 

foreign currency reserves. Sales involve the exchange of a country’s own currency for a foreign 

currency, increasing its foreign currency reserves. Interventions may be sterilized or 

unsterilized.

Managed Float– A regime under which a country establishes no predetermined path for the 

exchange rate but the central bank frequently intervenes to influence the movement of the 

exchange rate against a particular currency or group of currencies. Some central banks explain 

this as a policy to smooth fluctuations in exchange markets without changing the trend of the 

exchange rate. 

Nominal Effective Exchange Rate (NEER) – A measure of the overall value of a currency 

relative to a set of other currencies. The effective exchange rate is an index calculated as a 

weighted average of bilateral exchange rates. The weight given to each country’s currency in the 

index typically reflects the amount of trade with that country. 

Pegged (Fixed) Exchange Rate – A regime under which a country maintains a fixed rate of 

exchange between its currency and another currency or a basket of currencies. Typically the 

exchange rate is allowed to move within a narrow predetermined (although not always 

announced) band. Pegs are maintained through a variety of measures including capital controls 

and intervention. 
34

Real Effective Exchange Rate (REER) – The effective exchange rate adjusted for relative 

prices, usually consumer prices. 

Sterilized Intervention – An action taken by the central bank to offset the effect of intervention 

on the domestic money supply. Intervention in which the central bank sells domestic currency 

increases the domestic money supply, and is, in essence, expansionary monetary policy. To 

neutralize the effect of the intervention on the money supply, the central bank will sell domestic 

government securities, taking an equivalent amount of domestic currency out of circulation. If 

the intervention involved the purchase of domestic currency, the central bank will buy 

government securities, placing an amount of domestic currency equivalent to the size of the 

intervention back into circulation. An intervention is partially sterilized if the action by the 

central bank does not fully offset the effect on the domestic money supply.

Trade Weighted Exchange Rate – see Nominal Effective Exchange Rate

Unsterilized Intervention –The purchase of domestic currency through intervention in the 

exchange market reduces the domestic money supply, whereas the sale of domestic currency 

through intervention increases the money supply. If the central bank takes no action to offset the 

effects of intervention on the domestic money supply, the intervention is unsterilized.