U.S. Department of the Treasury

Report to Congress on Intemational Economic and Exchange Rate Policies

Period covered’ January 1, 2000 to June 30, 2000

Page 14

Policy Priorities

Sound economic and financial policies in the United
States, including our strong dollar policy, which is in
the interest of the United States.

In particular, sound domestic policies aimed at in-
creasing the level of national savings would ease ad-
justment of U.S. external imbalances. Maintaining a
budget surplus is essential to this important goal

Encourage policies that promote sustained, domestic
demand-led growth in our major industrial trading
partners in order to create more balanced global
growth patterns and, over time, contribute to re-
duced global imbalances,

In particular, encourage Japan to take supportive
macroeconomic policies that foster a self-sustaining
domestic demand led recovery and implement struc-
tural and financial sector reforms. Encourage
Europe to undertake appropriate macroeconomic
policies and intensify structural reforms with a view
to raising private investment and increasing produc-
tive potential. Japan and Europe should both aspire to
achieve a sustained period of growth above what has
recently been considered their potential through en-
couraging the kind of investments that are necessary for
economic expansion

Continue efforts to open foreign markets to U.S, ex-
ports while maintaining the commitment to open
markets that has been so important to our economic
success.

Continue monitoring markets for evidence of cur-
rency manipulation as countries balance the goals of
reserve accumulation to cover foreign lia jes and
appropriate exchange rate adjustment. In econo-
mies with a significant amount of debt denominated in
foreign currencies, or where the currency is fixed to an-
other currency, a sufficient level of foreign reserves is
important However, in the context of a floating ex-
change rate regime, a country can accumulate an exces-
sive level of reserves in an attempt to prevent a cur-
rency appreciation This appreciation can serve an
important element in the adjustment of both trade and
financial flows. Excessive intervention can, in the
long-run, build pressures in an economy



U.S. Department of the Treasury

Report to Congress on International Economic and i:xchange Rate Pohcies

Period covered. January 1, 2000 to June 30, 2000
Page 5

Currency Movements: Latin America
Domestic Currency Units per Dollar. 3:98> 100 (Inverted Scale)
90) ee ee

100 H

10>

120 ~

130 5

0%

1505 —e— Brasil

wor Mexico

170 = Venezuela .

130 fn Colombia... ae
198 H98 1/99 199 100

Currency Values: Selected Latin American Countries
Domestic currency units per Dollar, average mordhly levels

Jan-Jun

199 1/00 6/00___ Change
Brazil (Reais’S) 150 180 181 02%
Mexico (Pesos/S) 1013 949 98 34%
Venezuela (Bolivares/$) 56926524 = 6804 41%
Ecuador (Sucres/S) 71073 24,6950 25,0000 -1 2%
Colombia (Pesos’S) 15694 19290 21245 9.2%

Brazil. Economic recovery strengthened in Brazil during the re-
porting period, with GDP up 3.8% in the first half of 2000 com-
pared to the same period of 1999 For 2000 as a whole, official
and private forecasters estimated that growth would be 4%. The
recovery took place in a favorable broader context: the real was
relatively stable, depreciating only 0.6% through June 30; CPI
inflation fell to 1.6% in the first half of the year (3.3% annual-
ized) The Central Bank cut the overnight interest rate from 19%
to 175% over the period, with six-month and one-year rates
showing larger declines Brazil was on-track to meet its IMF fis-
cal targets with a large margin and to exceed its program floor for
foreign exchange reserves

The current account deficit narrowed slightly, to $11 2 billion in
the first half of 2000, down from $12 2 billion in the same period
of the previous year, and foreign direct investment of $12 3 billion
more than financed that deficit Reflecting its progress in stabi-
lizing its economy and restoring growth, Brazil completed the
repayment of the $95 billion in extraordinary financial support it
received from the BIS; repaid $9 billion of its $10 8 billion in IMF
Joans; and announced that did not intend to draw further resources
from the IMF under its Standby program

Colombia, Despite Colombia's economic recovery and fiscal
adjustment, investor sentiment toward Colombia weakened in the
first six months of 2000, likely reflecting perceptions of a deterio-
rating internal security situation and, to a lesser degree, of discord
between the Pastrana government and the Congress. That can be
seen in the sharp widening of Colombia's EMBI+ spread, from
423 basis points at end-1999 to 722 basis points on June 30, 2000.
Colombia grew 2.9% y/y in the first half of 2000, and analysts
expect about 3% growth for the year, after the 4 5% GDP contrac-
tion in 1999. A core challenge for Colombia is to reduce the pub-

lic sector fiscal deficit from last year’s level of 55% of GDP Its
IMF-backed adjustment plan calls for the deficit to fall to 3 6% of
GDP in 2000 and Colombia was on-track with program fiscal
targets in the first half of 2000 The current account deficit nar-
rowed to $185 million in Q1/00, from $685 million in Q1/99, re-
flecting strong export growth Cumulative inflation in H1/00 was
7% yly, and Colombia appeared on-track to meet its 10% inflation
target for 2000

Ecuador. Ecuador’s economic and political crisis deepened in
early 2000, as the sucre lost 20% of its value against the dollar in
the first week of the year, after shedding two-thirds of its value in
1999, and as political turmoil led to the resignation of President
Mahuad, who was replaced by Vice President Gustavo Noboa. To
help restore stability, Ecuador announced in January that it would
eliminate the sucre and adopt the U.S. dollar as its national cur-
tency. In April, Ecuador agreed with the IMF on a significant re-
form program, including dollarization, privatization, labor reform,
bank restructuring, and a reduction in the fiscal deficit from 7 2%
of GDP in 1999 to 27% of GDP in 2000 Ecuador was broadly
on-track to meet its IMF targets in the first half of the year

Although the banking system remained weak, with non-
performing loan ratios of close to 50%, banking system deposits
rose modestly over the period, indicating some improvement in
confidence. Freely disposable official foreign exchange reserves
rose to $406 million by end-June, $250 million above the IMF
program target, providing some cushion for the authorities to pro-
yide lender-of-last-resort facilities to the banking system. Con-
sumer prices rose 65% in the first six months of the year, reflect-
ing the large real depreciation that occurred in late 1999 and early
2000 However, monthly inflation showed a sharp downward
trend on a month-over-month basis during the period During the
first half of 2000, the Government of Ecuador announced it would
seek to restructure or reschedule its debt to official bilateral and
private creditors, but it had not concluded such agreements by
end-June

Mexico. The Mexican economy grew 7 8% in the first half of
2000 compared to the same period in 1999, and the most recent
Consensus survey of private forecasters projects growth for the
entire year of 6.3%, up from 3.7% last year. Inflation was on a
downward trend and is expected to be near 9% for the year. com~
pared to the 10% official target and the 12 3% recorded in 1999
The peso was relatively stable, closing June 30 at 995/S, down
4.4% from December 3! of last year Mexico was on-track with
its IMF program, including its fiscal deficit targets, during this
period. The current account deficit widened slightly to $8.0 bil-
lion (2.9% of GDP) in the period, up from $6 5 billion (2.7% of
GDP) in the first half of 1999 Foreign direct investment inflows
of $67 billion covered 84% of that deficit. Net international re~
serves rose $2 2 billion. to $29 6 billion on June 30. Reflecting its
strong economic performance and prospects, Moody's upgraded
Mexico's long term foreign currency rating to an investment grade
rating of Baa3


U.S. Department of the Treasury

Report to Congress on International Economic and lixchange Rate Policies

Period covered. January 1. 2000 to June 30, 2000
Page 10

Capital Flows

Capital inflows continued to increase during the period covered
by this report, supporting high levels of business investment in
the United States. Capital inflows help maintain lower interest
rates than would likely be possible otherwise Increased capital
flows and trade deficits, however, increase the potential vulnerabil-
ity of the United States to changes in global financial markets’ per-
ceptions of investment opportunities in the United States

As global demand patterns revert toward historical trends, the
United States will likely experience a moderation in the pace of
capital inflows and a related adjustment in the current ac-
count, It is important that sound domestic policies be in place in
both the United States and our major trading partners to help pre-
vent a disruptive adjustment Policies in our major trading partners
that encourage domestic demand growth and investment, and poli-
cies in the United States that support national saving. such as the
growing federal budget surplus, are important to contain the rise in
imbalances and facilitate their eventual reduction

The stock of U.S. assets owned by foreigners is increasing. The
value of foreign investment in the United States exceeds the
value of U.S, investments in other countries. The US net
international investment position (NIIP) at year end 1999 was a
negative $1,083 billion with direct investment valued at the current
cost of replacing plant, equipment and other tangible assets,
compared to a negative $1,112 billion at year end 1998. Valuation
changes offset the effects of financial capital flows that would have
made the investment position more deeply negative, all else
constant With direct investment valued at the current stock market
value of owner's equity, the US NIIP at year end 1999 and 1998
was a negative $1,474 billion and negative $1,408 billion,

It is vital that the current high level of business investment be
employed productively to support both future repayments to foreign
investors and increased standards of living in the United States In
that regard, it is interesting to note the high level of profits enjoyed
by U.S businesses has been facilitated by accelerating productivity
growth. In fact, labor productivity growth (in the nonfarm business
economy) has averaged 2 8% since the end of 1995 and 4 0% since
the end of 1998

U.S, Net International Investment Position
Billions of US. S

1993 1994 1995 1996-1997 1998-1999
0 - -
200 LL
-400 i
-600
B00
1000} acuren Cos
1400 | OMarket Value
-1600
Source Bureau of Fcanomic Analysis

U.S, National Savings and Investment
Billions of US. §. SAAR

2.200
00 ——

too] gp ee
4—>
4-4

1,800
~~ Gross Domestic Investment

1.700
1,600
1,500

respectively The deeper negative position on this basis primarily 4.400 —®— Gross Savings
reflects the continued large increases in US equity prices that 1300 .
raised the value of foreign holdings here A growing negative US 1Q/98 5098 19/99 30/99 1Qwo
NIIP implies that a larger amount of the return generated by assets Source: Bureau of Economic Analysis
in the United States will be payable to foreigners in the future
Capital Flows in the United States
Billions of US. 8, s.0., details might not equal torals die to rounding 10/98 20/98 30/98 40/98 10/99 20/99 30/99 40/99 10/00 20/00
Net Capital Flows... 18 28 32 76 77 100 70 6 58 148
Net Portfolio Flows, 98 48-20 “17 7 6 45 4 7 #2
US acquisition of foreign assets* -16 66 3 62 -13 97 -69 ~A2 “80-52
Foreign acquisition of U S assets M4 130-16 45 ct) 91 114 116 196 94
Foreign Official ul 10 47 26 4 +t 12 27 2 6
Private** 103 124 30 19 86 92 102 88 174 88
Net Banking FIOWS.......se010 sa sesnaseneeneneneeseseon eae: wren 54 6 47 5 15 5 13 “26 4
Assets 5 -28 0-28 26 28 42 ll AS 560015
Liabilties 49 M4 5 -20 -14 37 25 20 9 49
Net Direct Investment....csncssscsresrescsememersseversesenseee: — “26 +25 4 87 -14 Wl 12 16 6 42
US direct investment abroad 48 45 19 34 “al “33 Gaal 33 430037
Foreign direct investment in the United States, . 22 20 24 121 27 144 56 49 49___80

Sineve Blovan of Economic Anahsis

"Net private claims on foreigners by nonburks plus net private US purchases of foreign sewurities.

** Net purchases cf U.S Tressuy securtion, net nonibnk iabilities to foreigners net purchases of gov't noneTreasun securities. and nct LS. currency fon,


U.S, Department of the Treasury

Report to Congress on International Economic and xchange Rate Policies

Period covered) January 1, 2000 to June 30, 2000
Page 7

Developments in other Economies

Russia. GDP rose 7 5% y/y in the first half of 2000, reflecting
robust industrial output growth and a recovery in domestic de-
mand Strong growth helped federal revenues collections to
increase to 17% of GDP in the first half of 2000, with a primary
surplus of 6% of GDP The current account surplus increased to
18% of GDP in the first half. from 11% of GDP in 1999, pri-
marily due to higher energy prices. Imports have not recovered
significantly since the August 1998 crisis (they remained at
roughly 60% of pre-crisis levels) despite increases in household
income and some real appreciation of the ruble during 2000

By end-June, the ruble (in real terms) was still 30% below its
pre-August 1998 level The Central Bank of Russia's foreign
exchange reserves ($21 billion as of end-June) rose $8 5 billion
from the start of the year and were at their highest level since
August 1998 Accumulation of reserves is fueling growth of
base money, which increased 23% in the first half of 2000 In-
creased money demand due to strong economic growth and re-
monetization of the economy partly reflects the money supply
growth. Windfall tax revenues currently held at the Central
Bank of Russia (CBR) have also effectively sterilized some of
the CBR’s foreign reserve purchases

South Africa. GDP prew a weaker than expected 15% SAAR
in the first half of 2000, as a result of massive floods, over-
capacity in the mining sector, and uncertainty over the situation
in Zimbabwe GDP is now predicted to increase only 2 7% in
2000, down from easlier expectations of 3% to 35% High oil
and food prices and a depreciating rand caused the South Africa
Reserve Bank's (SARB) targeted inflation measure to increase
from 6 9% for 1999 to 9.2% for the first half of 2000 These
shocks have largely been absorbed into the economy and the rate
of inflation is expected to fall to below 8% by end-2000 Asa
result, the SARB has resisted tightening monetary policy Due
to higher-than-expected revenues, the budget deficit for
FY 1999/2000 was lower than expected, at 26% of GDP This
trend is continuing in FY 2000/2001 and the budget deficit is
forecast to fall to 2% of GDP

An increase in merchandise exports and a rising price of gold
caused the current account balance to go from -0 4% of GDP in
1999 to +0 1% of GDP for the first half of 2000 However.
negative sentiment towards sub-Saharan Africa, as well as
emerging markets in general, has caused capital flows to fall
from +2 6% of GDP in 1999 to -0.3% of GDP in the first half of
2000. It has also led to a 6 6% depreciation in the rand trade-
weighted exchange rate in the first half of 2000 and a 9 8% de-
preciation of the rand against the dollar over the same period
The reversal of capital flows has made increasing foreign ex-
change reserves much more difficult, Nevertheless. the SARB
reduced its net open forward position (NOFP) from $13 billion
at end 1999 to $101 billion in June 2000 and is working to
eliminate the NOFP

Nigeria. Growth is projected to expand in 2000 to 3 4% from
1% in 1999 almost entirely on account of higher oil prices; oil
accounts for roughly 95% of all exports and 80% of budgetary
revenues Nigeria Bonny Light crude averaged $27 11 in the six
months to June 30 as compared to $22.47 in the previous six
months, As a result, the external current account balance showed
a marked improvement from -11 0% of GDP in 1999 to a pro-
grammed 02% of GDP in 2000; this improvement differs
sharply from the non-oil curent account deficit projected at a
negative 27 6% of GDP in 2000 In contrast to Nigeria’s experi-
ence in past oil price cycles, the current increase in oil prices has
not been reflected in an appreciation of the naira In fact, the
naira depreciated moderately in the six-month period to June 30
partly as a result of the substantial liberalization of the foreign
exchange regime in late 1999 The Central Bank of Nigeria
demonstrated a willingness to allow the naira to depreciate but
used government sales of treasury bills through open market
operations to prevent a greater depreciation

Outside of oil prices, the other dominating economic develop-
ment during Q! and Q2 of 2000 was the inability to reach
agreement on the budget due to outstanding differences between
the executive and legislative branches of the government The
National Assembly, in its first year of operation since the return
to democracy, sought to benefit from current oil prices by pass-
ing a law providing for approving unsustainable spending levels
in order to demonstrate a “democracy dividend” to the people of
Nigeria As a result, approval of the IMF's one-year $1} billion
precautionary program was delayed until after the end of the
reporting period

Currency Movements in Other Emerging Markets
Domestic currency untts-dollar, 3°97 = 100 (Russia is on right scale)
40 ~ ees a ~ oe 90

~ 180

- 270

— 540

QQ) fe nee pe eeqeningennen
V7 797198 7/98 1997/99. 100


U.S. Department of the Treasury

Report to Congress on International Economic and Exchange Rate Policies

Period covered January 1. 2000 to June 30, 2000
Page 6

Emerging Asia

According to the Consensus survey of private forecasters,
growth in Emerging Asia (outside of China) is expected to in-
crease from 2 5% in 1999 to 7% in 2000 All countries in the
region, posted positive growth in 1999, ranging from 0.5 % in
Indonesia to as high as 105 % in South Korea. Growth was
boosted by continued strong demand from the United States,
strong global demand for high technology goods, and resurgent
intra-regional trade With export growth strong and imports still
recovering from the sharp decline in domestic demand (primar-
ily a collapse in investment) in 1997-98, all countries in the re-
gion recorded current account surpluses in 1999, though the
rebalancing of growth toward domestic demand has led to
stronger import growth and a further reduction of external sur-
pluses in 2000

With the exception of China, Hong Kong, and Malaysia, most of
the large countries in the region maintained managed floating
exchange rate regimes While most central banks intervened in
the foreign exchange markets, they did so primarily to rebuild
foreign exchange reserves, which were severely depleted during
the crisis, rather than to affect the value of the exchange rate
This reserve accumulation, with the ratio of reserves as a percent
of short-term debt increasing across the region in 1999, has al-
lowed most countries to reduce significantly their vulnerability
to external shocks. In most countries, reserves had reached a
high enough level that only Indonesia and the Philippines re-
mained in need of balance of payments support from interna-
tional financial institutions.

Indonesian GDP growth in 1999 was the lowest in the region at
0.5%, but due to strong export growth so far, the 2000 Consen-
sus forecast for real GDP growth has risen to 4%. Indonesia
maintains a floating exchange rate regime On several occasions
during the reporting period, Indonesian monetary authorities
intervened in the foreign exchange market and raised short-term
interest rates to support the rupiah Nevertheless, the rupiah
depreciated 16% in real effective terms (and 21% against the
dollar in nominal terms) over the reporting period, largely as a
result of political uncertainty and doubts about the Indonesian
government's willingness and capacity to follow through on its
economic reform program The weak rupiah helped boost Indo-
nesian exports of non-oil merchandise and kept a lid on imports

Currency Movements: NIEs (ex. Hong Kong)
Domestic currency units per dollar. Mar 1997 = 100

90 ~ ——
104 wes See eee eewerene’

Sanne
130 vad
isa! . Sr
170 ‘orea

< Singapore

190° Taiwan

197 197 198 TOR 19 199 1/00

Net oil exports also benefited from higher world oil prices In-
vestment remain subdued due to excess capacity and political
uncertainty As a result. the current account surplus in the first
half of 2000 increased to 4% of GDP compared to 3 5 % in the
first half of 1999. During the reporting period, net international
reserves rose from 70% to 80% of short-term external debt.

Thailand. GDP grew 4% in 1999 supported by accommodative
monetary and fiscal policies Due largely to stronger private
domestic demand, the Consensus forecast is for 2000 real GDP
growth to have risen to 5% The current account surplus fell to
7% of GDP for the first half of 2000 from 9% of GDP in 1999
due to higher oil prices and an increase in imports of capital and
consumer goods Thailand maintains a floating exchange rate
regime During the reporting period, the Thai baht fell 2%
against the dollar and in real effective terms. Net international
reserves decreased by $3 billion over the period. but they in-
creased relative to the stock of short-term debt ~ by 21 percent-
age points, to 168%

Philippines. Real GDP grew 3 5 % in 1999. Due to strong, al-
beit falling. export growth, particularly in the electronics sector,
and weakening foreign and domestic investor confidence, the
Consensus forecast projects real GDP growth to remain rela-
tively unchanged for 2000 The current account surplus for the
first quarter of 2000 (first half data is not yet available) shrank to

'% of GDP, compared to 9% a year earlier. as imports grew,
particularly for consumer and intermediate goods The Philip-
pines maintains a managed floating regime On several occa-
sions during the reporting period, the Philippine monetary
authorities intervened in the foreign exchange market and raised
short-term interest rates to support the peso Nevertheless. the
Philippine peso fell 5% against the dollar and 1% on a real ef-
fective basis, largely a result of the continued decline in investor
confidence in the face of a deteriorating fiscal deficit, failure by
the government to advance important structural reforms, con-
cerns about governance. and increased violence and hostage
taking activity in the southern island of Mindanao Gross inter-
national reserves were roughly unchanged between the begin-
ning and end of the reporting period at $15 billion and 109% of
short-term debt

Currency Movements: Selected ASEAN Countries
Domestic currency units per dollar. Mar. 1997 = 100
90 ee .

Malaysia
Philippines
= TM "Thailand

97 797 198 798 199 799 1/00



U.S. Department of the Treasury

Report to Congress on International Economic and Exchange Rate Policies

Period covered January 1, 2000 to June 30. 2000
Page 9

Trade Flows

The disparity in growth between the U.S. and our major
trading partners continued in the first half of 2000, This
growth differential, along with the recent increases in the
Price of oil, helped to drive significant expansions of both
the trade and current account deficits. The increase in the
trade deficit occurred despite strong export growth in the first
half of 2000 The US. economic expansion actually acceler~
ated in the last two quarters of 1999 and continued into 2000
at a strong pace By the second quarter of 2000, real US
GDP was 6.1% above the previous year's second quarter
level. This growth was considerably faster than most other
economies

The current account deficit rose from $305 billion SAAR in the
4" quarter of 1999 to $424 billion SAAR in the second qu
2000. Over the same period, the goods and services deficit
creased from $305 billion SAAR to $357 billion SAAR

US. exports of goods and services increased 12.2% in the first
half of 2000 over the same period in 1999. While export growth
has recently been strong, exports still have not fully recovered
from the global financial crises of recent years. Average monthly
exports of goods during the first half of 2000 to the crisis-Asian
economies (Indonesia, Philippines, South Korea, and Thailand)
and other Asian emerging markets (Singapore, Hong Kong,
Taiwan, and Malaysia) totaled $8 9 billion. This level of exports
is still below the peak of $9 4 billion for the monthly average of
the six months to August 1997 Goods exports to South America

U.S. External Balances
Billions of US. §. SAAR Balance of Pavments, BOP. Basis)

19/99 19/99 1Qv00
0 TTT T
-100 FL ATE
200 TE g
-300
Ocurrent Account
400} OGoods and Services Account
-500

Source: Bureau of Economic Analysis. Bureau of the Census

U,S, Trade in Goods and Services
Billion of US. S, SAAR (BOP Basis. trade balances in bald)

1300

ue ae
100 en el 357
. 185 au 201 a0

1000

900
800

—#—Impons —*— Exports

1999 3Q99 1Q/99 3Q/99
Source Bureau of Economic Analysis. Buren of the Census

19/00

U.S. Trade in Goods and Services
Billions of US $ (BOP basis SAARS

Export Import:

Level Change Level Change

1994 703 4 94% 8005 125%
1995 7951 13.0% 8910 113%
1996 8521 72% 9542 71%
1997 9369 100% 10429 93%
1998 9330 04% 10999 55%
1999 956 2 25% 1221.2 11%
1H/2000* 1042.2 12.2% 1391.0 19.8%

tal SAAR increase or 199, source. BEAL Brean of tue Census
U.S, Bilateral Merchandise Trade Balances
Billions of US. § (asa. Census basis

China_ _Japan_ Canada _Mexico __SA EU
1Q/98 “HS “153 +30 27 34 “21
20/98 -136 -156 -33 “45 3 -70
3Q/98 “173 155 “53 44 28 86
4Q/9B 45 176 -53 42 35 97
1Q'99 136 -163 68 57 rH -56
29/99 157 “172 -68 65 -03 106
3Q'99 -201 -194 -94 63 -25 138
AQ'99 -19.3 -206 91 43 -16 134
1Q/00 167 191 -108 57 41 “131
220. 2194 6 S62 34.

Source Bureens of Ecamomic cinahysis. Burven of the Census
Quarterly non-seaonsally adjusted (rsa) data can bw volatile

and the EU remain weak, growing only 32% and 49%
(respectively) from the first half of 2000 over the same period in
1999. In contrast, goods exports to the NAFTA countries, Japan,
and China showed more impressive gains, growing 11 9%, 11 5%,
and 14.4% (respectively) over the same period

Strong economic growth in the United States generated robust
demand for imports Furthermore. high oil prices have increased
the nominal value of U.S. imports dramatically, with petroleum
import prices at the highest level since November 1990 (during
the Gulf War) Indeed, the rise in the price of oil has helped to
increase the monthly value of petroleum imports by 49 3% ($3.5
billion) since the beginning of 2000; in contrast, the value of all
other poods imports increased only 7 8% ($6.7 billion)

Trends in Petroleum Imports and Import Prices
(imports-left axis, in billions of $. sa, price index-right axis, 1995 = 100)
_ oo a 180
160
140
120
100
—> 80
=F 60
40
= 20

1B

price index, 1995100

197 7/97 198 798 1/99 7199 1/00
Source Census Department (imports) and BLS (price index)


U.S. Department of the Treasury

Report to Congress on International Economic and Exchange Rate Policies

Covers the period January 1. 2000 to June 30, 2000

Real Value of the Dollar, Euro, and Yen
Trade-weighted currencies. 1997-2000 (3:97 100)
Source FRB (Broad Real Index). ECB (Broad Real CPI-
weighted Euro). .JP Morgan (Yen Broad Real)

130

125
120
15
110
105
100

95

90 4 .

85 ———US Dollar
errs Euro
80 Yen

75

197
197
1/98
T98
99
799
00

This report reviews developments
in U.S. international economic pol-
icy, including exchange rate policy,
during the period from January 1,
2000 through June 30, 2000. This
report is required under Section
3005 of the Omnibus Trade and
Competitiveness Act of 1988 (the
“Act”),

EMBARGOED FOR RELEASE
UNTIL:

4:30 p.m, January 18, 2000

Table of Contents

Summary ]
Analysis of Currency Market 2-6
Developments
US. Economy 7-9
U.S. Exchange Rate Policies 10
Emerging Market Exchange 11-12
Policy Priorities 13-14
Appendix 15-16

« The U.S. economy continued its record-breaking expansion over the
period January 1, 2000 to June 30, 2000. The US economy continued to
experience a combination of strong, private investment-led output growth, low
inflation, and low unemployment

Continued, high U.S. growth relative to foreign economies, and the higher
price of oil, helped to spur a renewed acceleration of U.S. imports over the
first half of 2000, Export growth picked up noticeably as foreign domestic
demand increased, but import growth was even faster than export growth;
as a result, the U.S. trade deficit worsened in the first half of 2000.

Strong capital inflows continued in the first half of 2000, more than ac-
commodating the current account deficit. These inflows, together with ris-
ing total national saving, helped sustain a high level of domestic investment
National saving rose, despite a decline in the personal saving rate, as the fed-
eral budget surplus expanded. The strong capital inflows also implied, how-
ever, further deterioration in the U S. net international investment position

Treasury determined that no major trading partners of the United States
manipulated exchange rates under the terms of Section 3004 of the Act
during the period under consideration. We continue to monitor the ex-
change rate practices of our major trading partners and encourage further
steps towards more flexible exchange rate regimes where appropriate.

Policy Priorities

Maintain sound economic and financial policies in the United States, in-
cluding our long-standing strong dollar policy.

Encourage macroeconomic and structural policies supportive of sustained
non-inflationary growth by major trading partners in order to reinforce
the emerging pattern of more balanced and sustainable global growth.

Encourage Japan to implement supportive macroeconomic policies and
structural and financial sector reforms to foster a self-sustaining, domes-
tic demand-led recovery.

In Europe, encourage appropriate macroeconomic policies and an inten-
sification of structural reforms with a view to raising private investment
and increasing the region’s productive potential,

Continue efforts to open foreign markets to U.S. exports while maintain-
ing the commitment to open markets that has been so important to our
economic success,

Continue to monitor the policies and practices of U.S, trading partners
for evidence of currency manipulation as countries balance the goals of
reserve accumulation to cover short-term liabilities and of allowing
exchange rates to find their appropriate level.


U.S. Department of the Treasury

Report to Congress on International Economic and Exchange Rate Policies

Period covered. January 1, 2000 to June 30, 2000
Page 12

Emerging Market Exchange
Rate Regimes

Elements of Manipulation

Section 3004 of the Omnibus Trade and Competitiveness Act of
1988 requires the Treasury to analyze annually the exchange rate
policies of foreign countries, in consultation with the IMF, and
to consider whether countries manipulate the rate of exchange
between their currency and the dollar for purposes of preventing
effective balance of payments adjustments or gaining unfair
competitive advantage in international trade. The Secretary of
the Treasury is required to undertake negotiations with those
manipulating countries that have material global current account
surpluses and significant bilateral trade surpluses with the
United States. unless there would be a serious detrimental im-
pact on vital national economic and security interests

«Treasury undertook a broad review of the perform-
ance of major trading partners of the United Stated
and concluded that no major trading partners of the
United States manipulated exchange rates under the
terms of Section 3004 of the Act during the period
under consideration.

* Treasury officials have urged the Malaysian and
Chinese authorities to move, over time, to a more
flexible exchange rate regime.

In evaluating evidence of currency manipulation, Treasury looks
at the following five factors:

« External Balances. Persistent global current account
surpluses are fundamentally a reflection of an excess of
national savings over national investment, but in some
cases may also reflect efforts to maintain an exchange
rate level that would prevent external adjustment

¢ Exchange Restrictions and Capital Controls. Restric-
tive exchange regimes and capital controls can be a con-
cern, particularly where the restrictions are designed to
maintain a consistently undervalued exchange rate

¢ Exchange Rate Movements. Large depreciations of
exchange rates. if induced artificially rather than by
market forces responding to fundamentals, could sug-
gest an attempt to gain a competitive advantage in
trade Manipulation could also be reflected in the ab-
sence of a significant appreciation of the exchange rate
when justified by fundamentals Equilibrium real ex-
change rates, however, are determined by a number of
factors and are therefore difficult to define.

¢ Changes in International Reserves. Significant and persis-
tent accumulation of foreign exchange reserves could be a
source of concern if it reflects efforts to maintain an exces-
sively competitive exchange rate

* Macroeconomic Trends, When analyzing these economies.
Treasury looks at the macroeconomic policy stance and other
conditions that are important determinants of exchange rates

Assessment

As the law requires, economies were examined as potential ex-
change rate manipulators if they had significant global current
account surpluses and bilateral surpluses with the United States
and maintained a fixed or actively managed exchange rate system
during the period of this report. Four emerging market economies
met this test: Taiwan, China, Korea, and Malaysia

With the exception of China, Hong Kong, and Malaysia, econo-
mies in the region maintained floating exchange rate rezimes

Taiwan, Taiwan's real GDP grew 55 percent in 1999 as a result
of strong external demand for Taiwan's high tech exports and fis-
cal stimulus resulting from earthquake-related reconstruction. The
Consensus forecast is for real GDP growth to have risen to 6 5%
in 2000 as a result of continued robust export growth and invest-
ment in the high tech sector. Despite strong export growth, rising
investment reduced the current account surplus substantially to

5% of GDP in the first half of 2000 from to 3 5% in the same
period in 1999 The bilateral trade surplus with the US. at
around $5 billion in the first half of 2000, was litte changed from
the same period during the previous year

Taiwan operates a managed floating exchange rate policy. Over
the first half of 2000, net foreign exchange reserves expanded by
$75 billion to $115 billion, over 600% of short-term debt. While
reserve adequacy is high by most standards, Taiwan's desire to
accumulate foreign exchange to reduce vulnerability to external
shocks remains driven by its unique lack of access to IMF balance
of payments support. Despite this reserve accumulation, the New
Taiwan Dollar (NTD) nevertheless appreciated by 2 percent
against the dollar. and 5 percent on a real effective basis, over the
Teporting period In addition to accumulating reserves, Taiwan's
central bank also intervened to reduce daily volatility in its cur-
rency and the NTD remains one of the Jeast volatile currencies
among emerging markets with floating exchange rate regimes
US Treasury officials have urged the Taiwanese authorities to
allow market forces to play a greater role in the determination of
the exchange rate and accept a greater amount of volatility to, in-
fer alia, encourage better currency risk management


U.S. Department of the Treasury

Report to Congress an International Economic and Exchange Rate Policies

Period covered) January 1. 2000 to June 30, 2000
Page ll

U.S. Exchange Rate Policies

G-7 Statements on Exchange Rate Policies

During the reporting period, January 1, 2000 to June 30, 2000,
G-7 Finance Ministers and Central Bank Governors reaffirmed
their standing commitment to the importance of progress in a
more balanced pattern of growth among the G-7 economies

« April 15, 2000. “We discussed developments in our
exchange and financial markets In this context, we em-
phasized our view that exchange rates among major
currencies should reflect economic fundamentals We
will continue to monitor developments in exchange
markets and cooperate as appropriate "

Currency Intervention

US monetary authorities did not engage in any intervention for
their own account during the period covered by this report. On
September 22, 2000, at the initiative of the European Central
Bank, the monetary authorities of the United States and Japan
joined with the European Central Bank in concerted intervention
in exchange markets because of their shared concern about the
potential implications of recent movements in the euro for the
world economy

Statement by Secretary Summers

In a press conference immediately afier the G7 Ministerial in
Tokyo, Secretary Summers noted::

« January 22, 2000. “Our policy with respect to the
dollar remains unchanged: a strong dollar is in the
interest of the United States ~


U.S. Department of the Treasury

Report to Congress an International Economic and Exchange Rate Policies

Period covered’ January 1, 2000 to June 30, 2000
Page &

U.S. Economy

Overview of the U.S. Economy

The U.S. economy continued to exhibit strong growth and low
inflation during the period covered by this report, and the
United States is enjoying the longest period of uninterrupted
growth in its history. US GDP expanded 4.8% (SAAR) in the
first quarter of 2000, and 5 6% (SAAR) in the second quarter. but
tecent evidence indicates that the economy is slowing US un-
employment was at 30-year lows during the reporting period; the
unemployment rate in June 2000 was 4 0%, down slightly from
the end of the previous reporting period (4 1% in December
1999) The CPI inflation rate (year over year) reached 3 7% in
June, up from 2.7% in December. largely due to increases in oil
prices. The “core” rate of inflation (excluding food and energy)
was lower, at 2.4% in June, but was up from 1 9% in December
The interest rate on the benchmark 10-year US Treasury note
peaked at 6 7% in January and then fell to 6 1% in June. While
the personal saving rate has continued to fall, the growing federal
budget surplus and strong private business saving has helped to lifi
total national saving

The strong U.S, growth relative to that of its major trading
partners and relatively high U.S, private sector investment gave
rise to an increasing U.S. current account deficit. It is important
that the rest of the world take steps to increase domestic-demand-led
growth in order to sustain a more balanced global expansion, while
the United States strives to increase its national saving

IME Article !V Consultation

The conduct of economic policy by the U.S. Administration
and the Federal Reserve was highly commended by the IMF
staff at the conclusion of the IMF staff's 2000 consultation
with the United States on July 12, 2000 (in accordance with
Article [V of the IMF's Articles of Agreement) The IMF staff
said that “[s]ound monetary and fiscal policies have contributed to
making the current U.S. economic expansion the longest on rec-
ord” The IMF staff also notes the importance of the US expan-
sion to the global economy “The strength of the US economic
expansion played a critical role in supporting world economic
growth during the period of turbulence in 1997-98 ~

However, the IMF staff also took the view that the growth in US
domestic demand in excess of supply and the perceived attractive-
ness of the investment environment have been reflected in a large
and growing current account deficit. In the view of the IMF staff,
appropriate policies in major U.S. trading partners to promote sus-
tained expansion of their economies as well as US policies aimed
at sustaining noninflationary growth are necessary to produce a
smooth rebalancing of global demand Consistent with a broad ef-
fort by the United States to enhance the transparency of the IMF, the
United States is part of a pilot project established by the IMF's Ex-
ecutive Board to allow countries to release to the public the staff
reports on their Article IV reviews The staff report on the US
economy was released on July 28, 2000 on the IMF's web site

U.S. Real Gross Domestic Product
% change over previous quarter. SAAR

%

0%
1097 3Q/97 10/98 30/98 10/99 3099 10/00
Source: Bureau of Economic Analysis (BEA)

U.S, Civitan Unemployment Rate and U.S, Inflation Rate
Unemployment (efi); Inflation (vear-on-vear % change in prices, right)

Core inflation - 5p

97787 9B 7981997991400
Source Bureau of Labor Statisnes

U.S, Interest Rates
%6 (10 wear Treasury: constant maturity)
8%

g

196 796 197 7197 1/98 78 99 7199 1/00
Source US. Treasury

U.S, National Saving and Selected Components
2% of GDP (personal gov't on left axis, total on right axis)

% 21%
3%  daed
gg | tt Personal oot 20%
% 19%
2%

18%
Woe ~~

. 4--Government

0% 17%

10/97 3Q/97, -1QM8_-3Q98
Source BEA

1999 3Q/99 19/00


J.S, Department of the Treasury

Report to Congress on International Economic and Exchange Rate Policies

Period covered: January 1. 2000 10 June 30. 2000
Page 4

Overview of Emerging Markets

Most emerging market economies experienced strong recovery
in the first half of 2000 The recovery was supported by a num-
ber of reform efforts, either underway or completed, in many
crisis-affected countries. These reforms should help contribute
to laying the basis for a stronger, more resilient system of capital
flows to the emerging markets:

« — The level of transparency and disclosure has improved
substantially

* There has been a substantial move toward more resilient
and more flexible exchange rate regimes

* The degree of some types of leverage in the official and
private balance sheets of most post crisis economies has
been reduced: in particular, the ratio of short term debt to
Teserves is now more healthy almost everywhere

* There is greater consensus behind eliminating perverse
incentives that encourage certain types of leverage and
behind advancing debt management practices that leave
governments less vulnerable to liquidity, exchange rate
and interest rate risk

* Insolvency regimes have begun to improve (at the na-
tional level). along with limits on the scope of implicit
government guarantees to the financial system that cre-
ated significant moral hazard concerns

* There have been important improvements in risk man-
agement practices in private financial institutions and in
supervisory policy, both in borrowing countries and in
countries that supply capital

° The repair, recapitalization, and restructuring of banking
systems in the emerging markets are progressing. aided
by much greater support from the intemational financial
institutions and regulatory bodies than existed before

Looking forward, it will be imperative to continue pursuit of
reforms In particular, governments need to:

* Find an appropriate balance between minimizing financing
costs for the public sector and increasing liquidity risk by
avoiding excessive reliance on short-term debt, “bunching”
of external debt payments. and developing an efficient and
liquid market for long-term domestic currency-
denominated government securities

* Continue strengthening financial supervision, regulation,
and disclosure;

¢ Ensure the aggressive disposal of bad assets to restore the
basis for bank lending,

* Ensure that banks have sufficient, high-quality capital, in-
cluding through the conditioned use of public funds where
necessary and appropriate for systemic reasons:

* — Privatize more quickly government shares of intervened
financial institutions and develop deeper capital markets
as an allernative to bank financing; and

* Strengthen bankruptcy regimes to force debtors to rene-
gotiate and implement needed restructuring

Latin America, Overview of Selected Countries

Most of the region experienced economic recovery during the first
half of 2000, as the global financial turbulence and high domestic
interest rates of the previous year receded. Argentina stood out
somewhat due to the weakness of its recovery. with GDP rising
only 0 8% yy in 2000 H1, while Mexico stood out for its strong
growth, with GDP rising 7 8% y/y in the first half Extermal bond
spreads, as measured by the Latin America EMBI+ index. wid-
ened for the region as a whole, as investors digested $29 billion in
new Latin American bond issues in the first six months of 2000,
compared to $24 billion in the first half of 1999

Real GDP Growth: Selected Latin American Countries

°6 change over a war ovo

Mexico Brazil Yenemuela Argentina
1Q/99 18% 04% 93% 30%
2Q/99 31% 01% 8% 53%
3Q/99 43% 03% -5 8% 1%
4Q'99 52% 3% A 5% -0 3%
1Q/00 7% 38% 03% 0%
29/00 76% 3% 26% 0.8%

Source Haver Databave

Argentina. Economic recovery in Argentina proceeded more
slowly than expected from last year’s recession and deflation, with
0.8% yy GDP growth in the first half of 2000 and the latest Con-
sensus Forecast projecting growth of 1 9% and deflation of 0 2%
in 2000 Slow growth contributed to weak public revenues, and
the GOA responded by making additional fiscal cuts to meet fiscal
targets Argentina was on-track with its fiscal deficit targets in the
first half of 2000. Low growth helped foster an increase in the
perception of risk by investors, which contributed to a 140 basis
points widening of Argentina's EMBI+ bond spreads from end-
1999 to June 30, 2000, vs a widening of only 80 basis points for
the overall Latin American EMBI+ index. Investor sentiment and
appetite for Argentine debt is especially important for Argentina.
given its need to issue large amounts of foreign debt each year to
rollover amortizing debt. Exports increased 13% y/y in H1/00 and
imports grew only 2% y/y. which contributed to a narrowing of
the current account deficit from $5 5 billion in H1/99 to an esti-
mated $4 8 billion in H1/00 Confidence in the banking system
seemed to remain strong, however, reflected in steady deposit
growth (6% y/y as of end-June)



U.S. Department of the Treasury

Report to Congress on International Economic and Exchange Rate Policies

Period covered. January 1. 2000 to June 30, 2000
Page 15

Appendix
OMNIBUS TRADE AND COMPETITIVENESS
ACT OF 1988 (H.R. 3)

SEC 3004. INTERNATIONAL NEGOTIATIONS ON
EXCHANGE RATE AND ECONOMIC POLICIES

(a) Multilateral Negotiations -The President shall seek to confer
and negotiate with other countries-

(1) to achieve-

(A) better coordination of macroeconomic policies of
the major industrialized nations; and

(B) more appropriate and sustainable levels of trade
and current account balances. and exchange rates
of the dollar and other currencies consistent with
such balances: and

(2

to develop a program for improving existing mecha-
nisms for coordination and improving the functioning
of the exchange rate system to provide for long-term
exchange rate stability consistent with more appropriate
and sustainable current account balances

(b) Bilateral Negotiations -The Secretary of the Treasury shall
analyze on an annual basis the exchange rate policies of foreign
countries, in consultation with the International Monetary Fund,
and consider whether countries manipulate 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 If
the Secretary considers that such manipulation is occurring with
Tespect to countries that (1) have material global current account
surpluses; and (2) have significant bilateral trade surpluses with
the United States, the Secretary of the Treasury shall take action
to initiate negotiations with such foreign countries on an expe-
dited basis, in the International Monetary Fund or bilaterally, for
the purpose of ensuring that such countries regularly and
promptly adjust the rate of exchange between their currencies
and the United States dollar to permit effective balance of pay-
ments adjustments and to eliminate the unfair advantage The
Secretary shall not be required to initiate negotiations in cases
where such negotiations would have a serious detrimental im-
pact on vital national economic and security interests; in such
cases, the Secretary shall inform the chairman and the ranking
minority member of the Committee on Banking. Housing, and
Urban Affairs of the Senate and of the Committee on Banking,
Finance and Urban Affairs of Representatives of his determina-
ton

SEC 3005 REPORTING REQUIREMENTS

{a) Reports Required -In furtherance of the purpose of this title,
the Secretary, after consultation with the Chairman of the Board,
shall submit to the Committee on Banking. Finance and Urban
Affairs of the House of Representatives and the Committee on
Banking, Housing, and Urban Affairs of the Senate, on or be-
fore October 15 each year, a written report on international eco-
nomic policy, including exchange rate policy. The Secretary
shall provide a written update of developments six months afier
the initial report. In addition, the Secretary shall appear, if re-
quested. before both committees to provide testimony on these
reports

(b) Contents of Report -Each report submitted under subsection
(a) shall contain-

(1) an analysis of currency market developments and the
relationship between the United States dollar and the
currencies of our major trade competitors:

(2) an evaluation of the factors in the United States and
other economies that underline conditions in the cur-
rency markets, including developments in_ bilateral
trade and capital flows:

a description of currency intervention or other actions
undertaken to adjust the actual exchange rate of the
dollar;

(4

an assessment of the impact of the exchange rate of the
United States dollar on

(A) the ability of the United States to maintain a more
appropriate and sustainable balance in its current
account and merchandise trade account:

(B) production, employment, and noninflationary

growth in the United States:

(C) the international competitive performance of
United States industries and the external indebted-
ness of the United States;

(5

recommendations for any changes necessary in Linited
States economic policy to attain a more appropriate
and sustainable balance in the current account;

(6

the results of negotiations conducted pursuant to section
3004;

(7

key issues in United States policies arising from the
most recent consultation requested by the International


U.S. Department of the Treasury

Report to Congress on Inernational Economic and Exchange Rate Policies

Period covered January I, 2000 to June 30. 2000
Page 3

Japan

The yen depreciated modestly (3 0%) against the dollar and in
real trade-weighted terms (1 7%) during the first six months of
2000, while rising (1 9%) against the euro. With prices falling
in Japan during the period, the yen fell in real terms against the
dollar by 58% Japan's current account surplus grew from a
seasonally adjusted ¥5.8 trillion ($54 billion, or 2 1% of GDP) in
the second half of 1999 to ¥7 I trillion (S67 billion, or 2 9% of
GDP) in the first half of 2000 Net private capital outflows
increased to ¥4 2 trillion, compared to ¥1 0 trillion in the second
half of last year, as Japanese firms reduced their overseas
borrowing while the pace slowed on both inward and outward
portfolio investment flows Net foreign exchange reserve
accumulation totaled ¥3.9 trillion ($37 billion) in the first six
months of the year 2000, vs ¥4 7 trillion ($43 billion) in the last
six months of 1999 Reported foreign exchange reserves rose
$57 billion in the first six months of 2000, to $345 billion. The
difference between the change in reported reserves and the BOP
data on reserve accumulation reflects valuation and definitional
differences

Japan's economic recovery appeared to gain strength in the first
half of 2000, as real GDP grew at a 43% annual rate, and
industrial production and other data also showed strong growth
The key questions for Japan's near-term outlook are whether
private consumption will rebound in the face of continued cost-
cutting efforts by Japanese firms seeking to strengthen their
financial positions, and whether private investment will achieve
sustained improvement Over the longer-term, Japan will need
continued progress in market-opening deregulation and other
structural and financial market reforms if it is to raise Japan's
potential growth rate A shrinking labor force due to Japan's
rapidly aging population implies that strong productivity growth
will be needed if Japan is to achieve stronger growth than the
disappointing 1.6% annual GDP growth recorded during the
1990s

Currency Movements: Japan

Yen per Dollar
160
150
140 |
130
120
10
100
90
80

1/98 7198 199 1199 1/00 1400

Canada

The Canadian dollar was essentially stable in real trade-weighted
terms over the first half of 2000, while falling slightly (2 4%)
against the U.S. dollar, reflecting both a strong Canadian cur-
rency (which rose 2 6% against the euro and 0 6% against the
yen) and the rise of the US dollar against other world curren-
cies during the period Canada's current account balance — cus~
tomarily a combination of sizeable trade surpluses and deficits
on investment income - moved into a first half surplus aggre-
gating $5.7 billion in the first half, after a $2.3 billion deficit for
1999 as a whole Exports to the rapidly growing U S. economy
were particularly strong over the period, and Canada gained also
from its net oil exporter status

Overall real GDP growth in Canada was at nearly a 5% annual
rate during the period; in this strong upturn the unemployment
rate averaged 6 7%, a 24-year low. Inflation remains low and
within the 1-3% target of the Bank of Canada's (BOC) Con-
sumer prices were up 2 5% in first half of 2000, mainly because
of energy price increases The CPI excluding energy and food
rose only 1.6% over the same period The BOC raised interest
rates in three 25 basis point increments in the first half of 2000
These increases followed Federal Reserve increases and main-
tained a negative spread with the U S. federal funds rate

Currency Movements: Canada
Canadian Dollars per Dollar
180

170
160 4

13 ONN aa tenens peated
140

130

120

198 798 199 H99 1/00 7100



U.S. Department of the Treasury

Report to Congress on International Economic and Exchange Rate Policies

Period covered January 1. 2000 10 June 30, 2000
Page 2

Economic Policy and Currency
Market Developments in Key
Economies

United States

During the period covered by this report. the Federal Reserve
Board staff's nominal dollar index indicated that the nominal value
of the dollar appreciated 3.3% on a trade-weighted basis, after a
2 0% depreciation in the second half of 1999. During the first half
of 2000. the real effective dollar exchange rate appreciated 4 0%,
afier a 15% depreciation from the second half of 1999. Dollar
movements have reflected the record-setting US expansion and
continuing growth differences between the United States and the
European Union and Japan. During the period of this report. the
Federal Reserve raised interest rates three times, by 25 bps in Feb-
Tuary and March and by 50 bps in May

Currency Movements: United States
Federal Reserve Board Staff Nominal Broad Dollar Index, 1:97 < 100
135

125 4

WS

105

95

85
197 v97 198 TI9® 199 799 1/00

Euro-zone Countries

The euro continued its fall during the first half of 2000, declin-
ing 6.4% against the dollar and 2.4% on a real trade-weighted
basis The Euro-11's aggregate current account deficit deepened
in the first half of 2000, moving from a deficit of €9 3 billion
(not seasonally adjusted. nsa) in the last half of 1999 to €14 4
billion (nsa) in the first half of 2000 Increased oil prices may be
responsible for much of this deterioration, along with stronger
domestic demand growth in the Euro-zone, which has led to
higher import demand

Current estimates are that aggregate real GDP growth in the euro
area will be around 35% in 2000, with a strong first half and
some weakening in the second half of 2000 Unemployment is
declining, especially in Spain and France, and some smaller
countries are close to full employment. The harmonized unem-
ployment rate for the region was down to 91% in June The
still-high unemployment rate suggests that a key issue for the
area will be sustaining growth over the medium term and im-
proving job-creating investment Inflation remains low, with the
yearly core inflation rate at 1.3% in June

Currency Movements: Euro-zone
Euros per Dollar
120

110 Pa

100
090 ]* oH

080

070 |
060

198 798 19 m9 1/00 7100
Note: European Currency Units prior to January 1, 1999

United Kingdom

In the first half of 2000, sterling declined on a real trade-
weighted basis by 2 4% overall During that time period, it fell
by 6.4% against the dollar and by 1.6% against the euro, but it
was still 18% above its 1996 average real trade-weighted rate
and 30% above the 1996 average €/£ rate The United Kingdom
current account balance is customarily the combination of a
goods trade deficit, and surpluses on both the services and in-
vestment income accounts. In the first half of 2000, the current
account deficit totaled $10 3 billion or 1.4% of GDP, following a
deficit of $17 8 billion or 1 2% of GDP for 1999

GDP growth accelerated to 2.9% SAAR (seasonally adjusted
annualized rate) in the first half of 2000. slightly above the 5-
year average growth rate, and up from the 2.2% SAAR rate for
1999. Labor market conditions were generally tight, particularly
for skilled workers, with unemployment at 3 9%, a 25-year low
During the time period, core inflation (retail prices excluding
mortgage interest and indirect taxes) averaged a low 1 8%, well
below the Bank of England's 2 5% target rate However, the
overall consumer price index rose 2.7%. due to rising energy
prices. With low inflation but rising inflationary pressures, the
BOE’s Monetary Policy Committee increased its benchmark rate
by 25 bps to 6% in February 2000. The Bank of England fore-
casts rising inflation for the second half of 2000 and in 2001,
reaching the target rate at end-2001

Currency Movements: United Kingdom
Pounds per Dollar
075

070

065
060

055 4

050
1/98 198 199 799 1/00 700


U.S. Department of the Treasury

Report to Congress on International Economic and Exchange Rate Policies

Period covered January 1. 2000 to June 30, 2000

Page 13

China, Real GDP growth strengthened to 8% y/y in H1/00, up
from 7% in 1999, on strong exports and recovering domestic de-
mand, fuelled by fiscal and monetary stimulus. The Consensus
forecast is for real GDP growth of 8% for the full year China's
current account surplus was 1 5% of GDP in 1999. While data on
China’s current account balance is only released on an annual
basis, China’s trade surplus fell to $12 billion in H1/00 compared
to $29 billion in 1999 (full year) Strong exports were surpassed
by a surge in recorded imports due to increased capital investment
as companies undertake technological upgrades and the continued
effects of a crackdown on smuggling China’s bilateral trade sur-
plus with the U S$ rose to $36 billion in H1/00, compared to $29
billion for the first half of 1999

China maintains a de facto currency peg to the dollar which it has
maintained unchanged within a tight band since 1995 The real
effective exchange rate of the RMB appreciated about 3% during
January - May 2000, reflecting the weakening of the yen and euro
as well as deflation in China. Its gross foreign exchange reserves
were more than six times short-term external debt at end-1999
While the comparable figure for end-June is not available, partial
data indicate the ratio has not changed much: short-term debt to
banks rose modestly during the first quarter and reserves rose
slightly in U.S. dollars during the first half As a percent of M2,
reserves were relatively unchanged at around 11% between end-
1999 and end-June 2000. Reserve growth moderated significantly
relative to 1994-1997 The $3 5 billion increase in reserves during
H1/00 can be accounted for by largely by estimated interest earn-
ings China also continues to maintain wide-ranging controls on
capital account transactions. In bilateral discussions, US Treas-
ury officials have urged the Chinese authorities to move, over
time, to a more flexible exchange rate regime

Korea. Korea also benefited from strong external demand for high
technology goods and stronger domestic private consumption
Real GDP grew 10 5% in 1999 ~ the fastest in the region - but the
Consensus forecast is for it to slow to 8 5% in 2000 Higher oil
prices and strong import demand due to rising investment and
consumption caused Korea’s current account as a percent of GDP
to fall significantly to 2% in the reporting period from 6% in 1999
and 12 5% in 1998 Korea’s bilateral trade surplus with the US
was $5 5 billion in the first half of 2000, little changed from the
first half of 1999

Korea maintains a managed floating exchange rate regime Net
foreign exchange reserves rose by about $16 billion in the report-
ing period to $84 billion, as the government sought to continue
rebuild reserves and compensate for an increase in short-term for-
eign debt By end-June, reserves fell to 177% of short-term exter-
nal liabilities compared to 189% in 1999. Moreover, as a percent
of M2, reserves were relatively unchanged at 26 5% at end-June
compared to 25.5% at end-1999 Despite the reserve accumulation
in U.S dollars during the reporting period, the won still strength-
ened by 1.5 % against the U.S dollar and 4 5 % on a real effective
basis As with Taiwan, US Treasury officials have urged Korean
officials to: 1) allow market forces to play a greater role in the
determination of the exchange, 2) take advantage of upward pres-
sure on the won to contain inflation and reduce the need for higher
interest rates (which retards financial and corporate restructuring),
and 3) accept a greater amount of daily exchange rate volatility

Malaysia. Strong domestic demand and robust export growth
pushed first half growth to over 10% and the Consensus survey of
private forecasters is for real GDP growth to rise to 8 5% in 2000
from 6% in 1999, Despite strong export growth, even stronger
growth in domestic demand led to a large decline in the current
account surplus to about 10 percent of GDP during the first half
compared to 16% of GDP in 1999 The bilateral surplus with the
US increased to $7 billion in the first half of 2000 from $5 5 bil-
lion in the first half of 1999

Malaysia has maintained a fixed peg since September 1998, when
it also imposed capital controls. Since then Malaysia has relaxed
these controls, which are now largely limited to a capital gains tax
on repatriated profits, restrictions on foreign investment by resi-
dents, and a prohibition on offshore trading of the ringgit On a
real trade-weighted basis, the ringgit appreciated 2% from end-
1999 to June 2000 In the first half of 2000, net reserves increased
by S3 billion. and rose as a percent of short-term external debt to
333%, up from 300% at end-1999 Reserves as a percent of M2
increased by a few percentage points to approximately 370 In
bilateral discussion US. Treasury officials have urged the Malay-
sian authorities to move, over time. to a more flexible exchange
rate regime


U.S. Department of the Treasury

Report to Congress on International Economic and Exchange Rate Policies
Period covered) January 1, 2000 to June 30, 2000

Page 16

Monetary Fund under article IV of the Fund's Articles
of Agreement; and

(8) a report on the size and composition of international
capital flows, and the factors contributing to such flows.
including. where possible, an assessment of the impact
of such flows on exchange rates and trade flows

(c) Report by Board of Governors -Section 2A(1) of the Federal
Reserve Act (12 USC 225a(1)) is amended by inserting after
“the Nation” the following:”, including an analysis of the impact
of the exchange rate of the dollar on those trends”

SEC 3006. DEFINITIONS.

As used in this subtitle:

(1) Secretary -The term “Secretary” means the Secretary of the
Treasury

(2) Board -The term “Board” means the Board of Governors of
the Federal Reserve System.