1 

Report to Congress on 

International Economic and Exchange Rate Policies 

June 2007 

This report reviews developments in international economic and exchange rate policies, focusing 

on the second half of 20061

, and is required under the Omnibus Trade and Competitiveness Act 

of 1988 (the “Act”)2,3. 

Major Findings: 

• Global growth remains very robust. It increased to 5.4 percent in 2006, the fastest annual 

rate in over thirty years.4

 The sustained increase in global growth primarily reflects the very 

strong performance in emerging market and developing countries. 

• Global imbalances remain a key issue on the international agenda, and reducing these 

imbalances is a shared responsibility. Some rebalancing is underway and the U.S. current 

account deficit has fallen from its peak, but more needs to be done to rebalance global 

demand in a manner that sustains strong global growth. 

 

• The U.S. economy is contributing to a healthy global economy. Growth is poised to pick up 

over the course of 2007. The fiscal deficit fell to 1.9 percent of GDP in FY2006, down from 

a recent peak of 3.6 percent in FY2004. The U.S. labor market remains healthy and core 

measures of inflation have stabilized or eased. 

• Growth in Europe and Japan has been well above recent five-year averages. To rebalance 

global demand, Europe and Japan will need to implement further structural reforms and 

sustain and boost their respective paces of domestic demand growth. 

• Several oil exporters have accumulated large current account surpluses. These countries can 

help sustain robust global growth by: (1) increasing expenditure on oil production capacity, 

(2) judiciously increasing spending to enhance potential growth and diversify economies, and 

(3) strengthening monetary policy management, where appropriate, by, among other things, 

moving toward more flexible exchange rates. 

• China has achieved exceptionally rapid growth. However, its growth has become severely 

unbalanced - dependent on exports and investment and characterized by very high savings, 

weak consumption, and an inflexible exchange rate. 

 

1

 More recent significant developments are also discussed if information is available. 

2

 The Act states, among other things, that: “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.” 

3

 The Treasury Department has consulted with IMF management and staff in preparing this report. 

4

 See the IMF’s World Economic Outlook, http://www.imf.org/Pubs/FT/weo/2007/01/index.htm. Forecasts of 

aggregate world GDP growth use purchasing power parity (PPP) weights. 
2

• Heavy foreign exchange market intervention by China’s central bank to manage the currency 

tightly has led to excessive accumulation of foreign exchange reserves and a quick increase 

in domestic liquidity. Rapidly expanding domestic liquidity increases the risks of 

overheating, a build-up of new non-performing loans leading to banking sector stress, and 

asset bubbles. These trends clearly increase the risk of a renewed boom-bust cycle, which 

would be quite harmful for the global economy. 

• In addition to economic rebalancing within China, allowing the currency to adjust is a matter 

of international interest and responsibility, with critical implications for the smooth 

functioning of the world’s trading system and the adjustment of global imbalances. 

• China should not hesitate any longer to take far more vigorous action to rebalance its 

economy, promote immediate RMB movement to tackle the currency’s undervaluation, and 

achieve far greater flexibility in the exchange rate regime. 

• At the second session of the U.S.-China Strategic Economic Dialogue (SED) held on May 22 

and 23, Chinese and U.S. officials discussed the Chinese government’s reform agenda. 

Chinese officials emphasized the priority they place on continued implementation of reforms 

to address economic imbalances and to shift growth toward consumption and away from 

investment and exports. They also acknowledged the role of exchange rate reform in that 

process. 

• The Department of the Treasury concluded that, although the Chinese currency is 

undervalued, China did not meet the technical requirements for designation under the terms 

of Section 3004 of the Act during the period under consideration. Treasury was unable to 

determine that China’s exchange rate policy was carried out for the purpose of preventing 

effective balance of payments adjustment or gaining unfair competitive advantage in 

international trade. 

• Even though the Treasury has not designated China pursuant to the Act, Treasury forcefully 

raises the Chinese exchange rate regime with Chinese authorities at every available 

opportunity and will continue to do so. China’s exchange rate has been a prominent feature 

of the SED, G-7 discussions with China, and G20 and IMF Board deliberations. 

• Treasury also concluded that no other major trading partner of the United States met the 

technical requirements for designation under the Act during the period. 
3

U.S. Macroeconomic Trends

U.S. economic growth slowed in 2006 and early 2007, as the economy edged away from an 

unsustainably rapid rate of growth. The labor market remained broadly healthy with a low 

unemployment rate, steady job gains and solid real wage growth. Both headline and core 

measures of inflation stabilized or eased, in large part reflecting declining energy prices in the 

latter part of 2006, although headline inflation increased again as energy costs rose in early 2007. 

The Federal Reserve held its short-term interest rate target unchanged from July 2006 through 

May 2007 after having raised the federal funds rate at every previous policymaking meeting 

since mid-2004. With the economy moderating and inflation stabilizing, yields on longer-term 

securities declined. Most private forecasters predict that real GDP growth will remain below 

trend in 2007, with stable inflation and a modest increase in the unemployment rate. 

Real GDP grew by 3.1 percent over the four quarters of 2006, matching the pace recorded during 

2005. Growth slowed over the second half of 2006, however, to a 2.2 percent annual rate from a 

rapid 4.1 percent pace in the first half of 2006. Economic activity continued to moderate in the 

first quarter of 2007, with real GDP growth easing to 0.6 percent at an annual rate. Residential 

investment dropped sharply in the second half of 2006 and first quarter of 2007, accounting for a 

large portion of the moderation in overall GDP growth. Household consumption remained 

strong, however, rising by 3.8 percent at an annual rate between the second quarter of 2006 and 

first quarter of 2007, matching the pace averaged over the prior three years. Nonresidential 

investment declined at the end of 2006 but turned up slightly in the first quarter of 2007. 

The decline in residential building activity has been holding down overall GDP growth since late 

2005. Over the four quarters of 2006, residential investment fell by nearly 13 percent – the 

largest annual decline since 1990. Most of the drop occurred in the second half of 2006, 

subtracting 1.2 percentage points from annualized GDP growth in both the third and fourth 

quarters. In the first quarter of 2007, the housing sector reduced real GDP growth by nearly a 

full percentage point, slightly less than in the prior two quarters. Recent data suggest that the 

residential sector remains weak, but there are signs that the housing market is stabilizing. 

Housing starts have started to recover from the low levels recorded last fall, and sales of existing 

single-family homes (over 80 percent of the one-family market) edged higher in the first quarter. 

New single-family home sales also appear to have stabilized, but the overhang of all singlefamily homes for sale remains substantial. Private analysts expect that declining housing activity 

will continue to act as a damper on growth through late 2007. 

Nonfarm payroll employment expanded by 88,000 in April 2007. Since the employment trough 

in August 2003, the economy has generated 7.9 million jobs, or 179,000 a month. The 

unemployment rate edged up in April to 4.5 percent but was still among the lowest jobless 

readings since mid-2001. Real hourly earnings for production workers rose by 1.2 percent 

during the twelve months ended in April. Real hourly earnings fell during 2004 and 2005. 

Productivity growth has decelerated, reflecting slower output growth. Output per hour in the 

nonfarm business sector rose 1.7 percent at an annual rate in the first quarter of 2007 and was up 

just 1.1 percent over the past four quarters – notably less than the 2.8 percent pace since the business 

cycle peak in the first quarter of 2001. Growth of unit labor costs slowed to 1.3 percent over the 

latest four quarters from 3.4 percent during 2006.
4

Inflation eased at the end of 2006 as energy prices fell, and underlying price pressures remained 

relatively contained through the first four months of 2007, although energy prices rebounded. 

Headline consumer price inflation rose by 2.6 percent over the twelve months ended in April, 

down from a 3.6 percent gain in the year-earlier period. Energy prices increased 2.9 percent in 

the latest twelve-month period compared the 21 percent average year-over-year increase during 

the first half of 2006. Excluding both energy and food, core consumer prices advanced by 2.4 

percent in the year ending April 2007, slower than the 2.9 percent gain posted over the year 

ending in September 2006. 

At its most recent meeting in May, the Federal Open Market Committee (FOMC) left the federal 

funds target rate unchanged at 5.25 percent. The FOMC has maintained that rate at its current 

level since August 2006, which is the highest since March 2001. The FOMC raised the fed 

funds rate in seventeen straight hikes of 25 basis points each from June 2004 through June 2006. 

Despite monetary tightening during that two-year period, long-term interest rates remained 

relatively stable. The level of the Treasury ten-year yield fluctuated between four and five 

percent from mid-2004 to early 2006. The ten-year rate rose as high as 5.25 percent in late June 

2006 but has since eased to about 4.85 percent as of late May 2007. Mortgage rates have 

generally moved with the 10-year Treasury yield, remaining in a fairly narrow band around 5.8 

percent from 2003 through 2005. Low mortgage rates pushed home sales to record levels in 

2004 and 2005. Mortgage rates jumped sharply between mid-2005 and mid-2006 but have since 

retreated in line with the 10-year Treasury rate. In late May, the average interest rate for a 30-

year fixed-rate mortgage was close to 6.4 percent, down from a recent high of 6.8 percent in July 

2006. 

The federal budget situation has improved notably in the past two years, with the deficit 

shrinking by half of the FY2004 estimate a full three years ahead of the Administration’s 

FY2009 goal. The FY2006 deficit was $248 billion, $70 billion less than in FY2005. As a share 

of GDP, the deficit amounted to 1.9 percent in FY2006, down from a recent peak of 3.6 percent 

in FY2004 and below the 40-year average of 2.3 percent. Strong receipts growth has been largely 

responsible for the improved near-term federal budget situation, with receipts up nearly 12 

percent in FY2006. At the same time, growth in outlays has remained subdued. The FY2008 

budget sees steady improvement in the U.S. government’s fiscal situation over the next five 

years. The deficit is projected to shrink each year through FY2011, averaging 1.1 percent of 

GDP over the FY2007-FY2011 period. A small surplus is projected for FY2012. 

The Administration’s most recent economic forecast, prepared in May 2007, projects moderate 

growth and inflation and continued low unemployment for the remainder of 2007. Real GDP is 

expected to rise by 2.3 percent during the four quarters of 2007, down from 2006, and 0.6 

percentage point below the 2007 growth prediction in last November's forecast. The growth 

reduction for the year reflects the low growth that has already occurred; GDP rose 0.6 percent in 

the first quarter of 2007. Going forward, growth is likely to accelerate back to near-trend rates 

(about three percent). Some recent private forecasts see a sharp rebound in growth in the second 

quarter of 2007. Overall, the Administration projections for growth, inflation, and the 

unemployment rate are very similar to the private consensus. The Administration is projecting 
5

headline consumer price inflation of around 3.2 percent for 2007, a faster pace than predicted last 

November. The higher inflation forecast reflects the rebound in energy costs during the first four 

months of the year. The Administration sees a modest increase in the unemployment rate in 

2008, averaging 4.7 percent for the year. 

World Economic Conditions 

The global economy expanded 5.4 percent in 2006, its fastest annual growth rate in over thirty 

years. The IMF projects strong growth to continue at 4.9 percent in 2007 and 2008.5

 The 

sustained increase in global growth from 2003 to 2006 primarily reflects strong growth in 

emerging market and developing countries, which have grown 4.8 percent faster on average than 

advanced economies over this four-year period. Importantly, growth of output per capita in 

emerging market and developing countries have averaged over six percent per annum the last 

four years, far in excess of the 2.2 percent average growth rate from 1989 to 1998. 

Overall, the growth rate in developing and emerging market economies averaged 7.9 percent in 

2006, fueled by very rapid growth in China and India. However, strong growth has not been 

limited to China and India. In developing Asia, excluding China and India, the IMF expects 

economic growth to average six percent in 2007 and 2008. Moreover, the benefits of healthy 

global economic growth are spread widely across all regions, including Africa, Emerging 

Europe, Latin America, and the Middle East. 

Economic growth in both the Euro-area and Japan is expected to be in the neighborhood of two 

and one-half percent for 2007. For the Euro-area that is double the average pace of growth of the 

five years (2001-05). At 7.3 percent, unemployment is at a 15-year low in the Euro-area. The 

pace of growth in Japan has picked up and, at 2.2 percent in 2006, was nearly one percent faster 

than the 2001-05 average. Unemployment in Japan is at a nine-year low of 3.8 percent in April. 

Lower oil prices in the second half of 2006 helped to alleviate some global inflationary concerns. 

In the early part of 2007, however, oil prices have risen once again to above $60 a barrel. Nonenergy commodity prices also remain at or near all-time highs, with metals prices rising by 41 

percent in the year through May 2007.6

 Short-term financial conditions have tightened over the 

last six months with the European Central Bank (ECB) raising its overnight interest rate by 75 

basis points to 4.00 percent and the Bank of Japan (BoJ) raising its reference rate by 25 basis 

points to 0.50 percent. Recent data suggest market participants expect that both the ECB and the 

BoJ will raise their respective official interest rates at least once more in 2007. Still, both real 

and nominal long-term interest rates in the advanced economies are relatively low, while interest 

rate spreads for riskier markets and assets remain near historic lows. Lower spreads presumably 

reflect less perceived risk due to less overall government debt, higher reserve coverage ratios,7

and improved economic growth in many emerging market economies. The weighted-average 

 

5

 See the IMF’s World Economic Outlook, http://www.imf.org/Pubs/FT/weo/2007/01/index.htm; forecasts of 

aggregate world GDP growth use PPP weights. 

6

 The Commodity Research Bureau (CRB) Metals Index (a sub-index of five markets of the overall CRB commodity 

index, including: copper scrap, lead scrap, steel scrap, tin and zinc). 7

 According to the IMF, the reserves to import ratio will reach 79.1 percent in 2008, after rising from less than 50 

percent at the end of 2001 to 71.4 percent at the end of 2006. See Table 35 on page 269 in the Statistical Annex of 

the IMF’s most recent World Economic Outlook, http://www.imf.org/Pubs/FT/weo/2007/01/pdf/statappx.pdf
6

spread that large emerging market countries pay on their external debt over 10-year U.S. 

Treasuries fell to near 150 basis points in early June 2007 from around 190 basis points in early 

November 2006.8 

An important contributing factor to the low level of spreads on emerging market foreign 

currency debt is the large amounts of foreign exchange reserves that emerging markets, 

especially China and the oil producing countries, have accumulated in recent years. IMF data 

show official reserve holdings of emerging market and developing countries rose from $802.5 

billion at end-2000 to about $3 trillion at end-2006, a nearly four-fold increase in six years (see 

below).9 IMF projections show reserves of these countries rising to $4.3 trillion by end-2008. 

This figure does not include asset holdings of sovereign wealth funds (i.e., government-owned or 

-controlled investment funds that are not part of official reserves). Private sector estimates put 

the size of sovereign wealth funds between $1 and $2.5 trillion at end-2006, and many expect 

that they will grow substantially in size, along with official reserves, over the next few years (see 

Appendix 3). 

International Reserves of Emerging Market and Developing Countries10

(Billions of U.S. Dollars) 

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

5,000

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

China Fuel exporters Non-china, non-fuel

Source: IMF WEO statistical appendix, Spring 2007 

 

8

 As measured by JP Morgan EMBI+ spread. 

9

 See Table 35 on page 269 in the Statistical Annex of the IMF’s spring 2007 World Economic Outlook, 

http://www.imf.org/Pubs/FT/weo/2007/01/pdf/statappx.pdf. Counting advanced economies, total global 

international reserves were about $4.8 trillion at year-end 2006. 

10 This IMF grouping does not include the newly industrialized Asian economies of Hong Kong, South Korea, 

Singapore, and Taiwan. 
7

Global imbalances (i.e., large current account deficits and surpluses) stabilized somewhat in 

2006, with the U.S. current account deficit falling to 5.8 percent of GDP in Q4 2006 versus 7.0 

percent in Q4 2005. A key part of the international strategy to reduce global imbalances is the 

rebalancing of global demand. To some extent there has been some demand rebalancing as 

weaker but more sustainable domestic demand growth in the United States was partially offset 

by stronger domestic demand abroad, especially in the Euro-area. Domestic demand growth in 

the Euro-area was 2.5 percent in 2006 (on a calendar year basis) and 2.3 percent (on a Q4/Q4 

basis). However, both rates were less than GDP growth rates in the Euro-area, suggesting net 

exports continued to supplement overall Euro-area growth. Domestic demand growth also 

strengthened in Japan, but less substantially than in the Euro-area, and recent quarterly patterns 

have been both bullish and bearish. Japan’s Q1 2007 GDP growth number was 3.3 percent 

(annualized), with only 1.4 percent of that coming from domestic demand. 

Further efforts will be needed to rebalance global demand. That more needs to be done can be 

seen from the table below, which shows changes in domestic demand for the United States and 

for that of G-7 partners of the United States. In 2006 the pace of the partners’ demand expansion 

increased by a weighted average of 0.6 percent11 while in the U.S. demand expansion declined 

by 0.2 percent. However, current forecasts for 2007 suggest no growth offset from partners 

despite a further slowing in the U.S. And in 2008, if forecasts are correct, the growth gaps could 

once again widen. Without offsetting demand-driven growth from elsewhere, the goal of 

ensuring sustained overall global economic growth might be in jeopardy. To be sure, other 

countries, including China and other large surplus countries, and not just the United States’ G-7 

partners, need to boost their reliance on domestic demand-driven growth. 

Domestic Demand Growth in U.S. and G7 ex-U.S. 

(Percent Change) 

2006 2007F 2008F 

U.S. Domestic Demand 3.1 1.7 2.7 

Change -0.2 -1.4 +1.0 

G7 ex-U.S. Domestic Demand 2.1 2.1 2.1 

Change +0.6 0.0 0.0 

Source: IMF WEO statistical appendix, Spring 2007 and Treasury calculations 

 

11 PPP weights. 
8

The United States International Accounts12,13

• U.S. Balance of Payments 

The U.S. current account deficit was $850 billion (at a seasonally adjusted annual rate, or 

“saar”), or 6.4 percent of GDP, in the second half of 2006, compared with $863 billion, or 6.6 

percent of GDP, in the first half of 2006. Viewed over a longer period, the U.S. current account 

deficit increased, as a percent of GDP, from around zero in 1991 to over four percent in the 

fourth quarter of 2000. Then, after a cyclically induced narrowing in 2001, it resumed increasing 

to reach 7.0 percent in the fourth quarter of 2005, before easing from this peak in 2006. 

 

12 The IMF annually reviews U.S. economic performance and policies through the IMF Article IV surveillance 

process. The last Article IV surveillance review took place in July 2006. The IMF Article IV Staff Report and the 

results of the IMF Executive Board’s discussion of the U.S. Article IV review can be found at 

http://www.imf.org/external/pubs/ft/scr/2006/cr06279.pdf. In addition, the IMF discusses U.S. economic policies 

and performance in the context of its twice yearly World Economic Outlook reports. These can be found at 

http://www.imf.org/Pubs/FT/weo/2007/01/index.htm. 13 This report was prepared before the June 8, 2007 publication of the annual revisions of U.S. International Trade in 

Goods and Services statistics. These revisions are generally small and do not affect the analysis of the report. 

2005 2006

Q3 Q4 Q1 Q2 Q3 Q4

Current Account:

 Balance on Goods -782.7 -836.0 -198.7 -212.5 -208.2 -210.9 -218.9 -197.9

 Balance on Services 66.0 70.7 17.0 17.7 16.6 17.2 17.5 19.4

 Balance on Income 1/ 11.3 -7.3 7.8 -2.2 -2.6 -2.2 -5.5 3.0

 Net Unilateral Current Transfers -86.1 -84.1 -9.5 -26.2 -19.5 -21.9 -22.5 -20.2

Balance on Current Account -791.5 -856.7 -183.4 -223.1 -213.8 -217.7 -229.4 -195.8

Balance on Current Account as % of GDP -6.4 -6.5 -5.8 -7.0 -6.6 -6.6 -6.9 -5.8

Major Capital Flow Components (financial inflow +)

 Net Bank Flows -8.9 -21.6 -7.0 17.6 -48.4 41.1 -6.0 -8.4

 Net Direct Investment Flows 100.7 -65.3 74.8 52.3 -16.2 -0.6 -3.8 -44.7

 Net Securities Sales 669.2 650.6 186.3 213.8 203.6 116.1 188.4 142.5

 Net Liabilities to Unaffiliated Foreigners by Non-banking Concerns -14.1 132.1 -9.2 -55.1 28.8 -6.1 46.2 63.2

Memoranda:

 Statistical Discrepancy 10.4 141.4 -72.2 -19.1 44.3 65.1 0.2 31.8

 Change in Foreign Official Assets in the United States 199.5 300.5 34.0 71.9 75.7 75.9 78.4 70.5

Trade in Goods 

Balance -782.7 -836.0 -198.7 -212.5 -208.2 -210.9 -218.9 -197.9

Total Exports 894.6 1023.7 224.9 232.9 243.7 252.1 261.3 266.6

 of Which:

 Agricultural Products 64.9 72.8 16.3 16.5 17.2 18.1 18.8 18.7

 Capital Goods Ex Autos 362.7 414.0 90.6 96.1 99.9 102.1 104.0 108.1

 Automotive Products 98.6 107.2 25.2 26.1 26.2 26.0 27.7 27.2

 Consumer Goods Ex Autos and Food 115.7 129.2 29.1 30.0 31.1 31.4 32.8 33.9

 Industrial Supplies and Materials 2/ 233.1 275.8 58.8 59.0 63.8 68.9 71.3 71.7

Total Imports 1677.4 1859.7 423.7 445.4 452.0 462.9 480.2 464.6

 of Which

 Petroleum and Products 251.9 302.6 67.3 73.2 72.3 79.5 84.4 66.4

 Capital Goods ex Autos 379.2 418.4 95.8 97.5 100.9 103.7 107.3 106.6

 Automotive Products 239.5 256.7 60.3 62.6 64.4 64.4 63.3 64.6

 Consumer Goods Ex Autos and Food 407.3 442.9 101.0 103.8 106.0 107.5 112.2 117.1

1/ Including compensation of employees

2/ Including petroleum and petroleum products

Source: BEA, Bureau of Census

U.S. Balance of Payments and Trade

($ billions, seasonally adjusted unless otherwise indicated)

2005 2006
9

Although services constitute around 30 percent of U.S. exports of goods and services and around 

15 percent of U.S. imports of goods and services, the balance of trade in services is relatively 

small, being around a four to eight billion dollars month surplus over the past several years, and 

is relatively stable, showing a slight upward trend. As a consequence, movements in the balance 

of trade in goods and services reflect, in the main, movements in the balance of trade in goods. 

In the second half of 2006, the United States exported $1,056 billion (saar) in goods and 

imported $1,889 billion, with a resulting $834 billion deficit on trade in goods.14 Exports of 

goods increased 6.5 percent in the second half of 2006 compared to the first half of 2006, while 

imports increased 3.3 percent. Imports are sufficiently large relative to exports that the gap 

between imports and exports narrowed only marginally, even with weak growth in imports. 

Non-automotive capital goods constituted 40.2 percent of merchandise exports in the second half 

of 2006. Consumer goods constituted 24.3 percent, and non-automotive capital goods 

constituted 22.6 percent of merchandise imports. Petroleum and petroleum product imports 

accounted for 16.0 percent of merchandise imports. The value of petroleum and petroleum 

product imports as a percent of total merchandise imports has risen from 10.4 percent in the 

second half of 2003. The rise in the U.S. oil bill has been an important factor in the growth in 

the U.S. trade and current account deficits. 

Canada, Mexico, China, Japan, Germany, and the U.K. remain the largest trading partners of the 

United States. Canada purchased 21.4 percent of U.S. exports, Mexico 12.7 percent, Japan 5.8 

percent, China 5.5 percent, and the U.K. 4.2 percent in the second half of 2006. China accounted 

for 16.8 percent of U.S. imports, Canada 15.5 percent, Mexico 10.5 percent, Japan 8.0 percent, 

and Germany 4.7 percent in the second half of 2006. 

Prices of imported goods, not seasonally adjusted or “nsa”, increased 0.9 percent in the year 

through the fourth quarter of 2006. Non-petroleum import prices rose 1.3 percent over this 

 

14 Sums may not be exact due to rounding. 

Country Exports 

Jul06-Dec06 Country Imports Jul06-Dec06

Total, All Countries ($Bil) 531.0 Total, All Countries ($Bil) 953.9

Percent of 

Total

Percent of 

Total

 Canada 21.4 China, Mainland 16.8

 Mexico 12.7 Canada 15.5

 Japan 5.8 Mexico 10.5

 China, Mainland 5.5 Japan 8.0

 United Kingdom 4.2 Germany 4.7

 Germany 4.1 United Kingdom 2.9

 Republic of Korea 3.1 Republic of Korea 2.4

 Netherlands 3.0 Taiwan 2.1

 Singapore 2.5 Malaysia 2.0

 Taiwan 2.2 France 2.0

 France 2.2 Venezuela 1.9

Memo Memo

 Euro-area 14.9 Euro-area 13.1

 OPEC 4.0 OPEC 7.8

Source: Bureau of the Census
10

period, while petroleum import prices decreased 0.4 percent. Export prices rose 3.7 percent over 

this period. The most recent trough in import and export price inflation occurred roughly at the 

beginning of 2002. Since then non-petroleum import prices have risen 9.6 percent and export 

prices 14.8 percent. 

Foreign demand for U.S. financial assets remains strong. A major item financing the U.S. 

current account deficit has been net private foreign purchases of long-term U.S. securities, which 

totaled $950.5 billion in the twelve months ending March 2007. 

Foreign investors owned $2.1 trillion of Treasury securities at the end of 2006, or 51.9 percent of 

the public debt not held in Federal Reserve and U.S. Government accounts. This compares with 

$2.0 trillion, at the end of December 2005. Foreign official institutions held $1.3 trillion in 

Treasury securities at the end of June 2006, as they did at the end of June 2005. There are 

around $20 trillion in U.S. securities of all kinds outstanding. 

• Net International Investment Position 

The U.S. net international investment position (NIIP) widened (with direct investment valued at 

the market value of owner’s equity) to a minus $2.5 trillion (20.4 percent of GDP) at the end of 

2005, the latest date for which data are available, from $2.4 trillion (20.9 percent of GDP) at the 

end of 2004. A $1.1 trillion valuation adjustment, reflecting strong appreciation of foreign 

stocks relative to U.S. equity, offset almost all the $785 billion widening attributable to financial 

flows and the $394 billion widening due to exchange rate changes. The NIIP (with direct 

investment valued at current cost) was a negative $2.7 trillion (21.6 percent of GDP) at the end 

of 2005 compared to a negative $2.4 trillion (20.2 percent of GDP) position at the end of 2004. 

The United States currently earns approximately the same amount on its foreign investments that 

it pays out on foreigners’ investments in the United States, even though the value of foreigners’ 

U.S. assets is around $2.5 trillion greater than the value of the U.S.-owned foreign assets. Net 

earnings on direct investment have been large enough for many years to offset outflows of 

income payments on other forms of international investment, but the difference between the two 

has been narrowing and in 2006 net investment income turned into a marginal outflow. U.S. 

residents earned $0.8 billion less on their investments abroad than they paid out on foreign 

investments in the United States in 2006; in 2005 they earned $18 billion more on their 

investment abroad than they paid out on foreign investments in the United States. 

The NIIP is a critical measurement in analyzing the sustainability of the current account deficit. 

A growing negative NIIP must stabilize as a percent of national output in the long-run, or it will 

become impossible to service the external debt out of current or future production. It is generally 

believed that a stable NIIP as a percentage of GDP requires that the balance on trade in goods 

and services be close to zero.15

 

15 The magnitude of the balance depends, among other things, on relative rates of return. For example, U.S. 

residents earn a higher rate of return on their foreign assets than residents of foreign countries earn on their U.S. 

assets. If this were to remain the case through the indefinite future, then the NIIP could stabilize with the United 

States running a deficit on trade in goods and services. There is, however, no clear reason for this advantage to 
11

• Financial Markets and the U.S. Current Account Balance 

A surplus on the capital and financial accounts is, by balance of payments accounting definition, 

the counterpart of a current account deficit. These flows finance that part of net capital 

formation that is equal to the excess over domestic saving. The growth of the U.S. current 

account deficit over more than a decade has been linked to high levels of domestic U.S. capital 

formation compared to domestic U.S. saving. There are counterpart developments throughout 

the world that are necessarily linked to this process, since the rest of the world must be running 

an aggregate current account surplus, or a deficit on their capital and financial accounts, when 

the United States is running a deficit on its current account. 

A key feature in discussing global imbalances is the emergence, in the last decade, of a global 

saving glut, by which is meant that saving outside the United States has grown relative to 

investment16. Saving rates in many emerging market economies, especially those in Asia, are 

very high compared to investment rates, resulting in correspondingly large current account 

surpluses. These high saving rates, in turn, may be partly associated with the demographic 

consequences of aging and the need to save for retirement in the absence of well developed 

public pension systems, and also with the lack of well developed financial systems allowing 

consumers to diversify and hedge against risks (including through insurance products) or to 

borrow (for example, mortgages). With rising oil prices, large current account surpluses of oil 

exporting countries have reemerged. Ten major oil exporters17 had a combined current account 

surplus of over $400 billion in 2006. 

Investment rates across the globe have been dampened by a range of factors over the last decade, 

including low growth in some economies, the emergence of large service sectors which are less 

capital intensive than many industries, excess capacity after the Asia crisis and the bursting of 

the IT bubble, more efficient financial intermediation, and strong corporate profitability coupled 

with a low propensity to reinvest earnings. 

An increasingly efficient and supportive international financial system permits those countries 

with an excess of saving to place the excess saving profitably in foreign assets, rather than 

forcing adjustments to bring saving and investment into closer equilibrium in individual 

countries. The pronounced tendency, over many years, of investors to prefer to invest in their 

home country has weakened significantly over the past decade.18 

Financial markets have an indirect, but powerful, effect on current account balances. For 

example, if foreign demand for U.S. assets increases suddenly, asset prices – exchange rates, 

interest rates, equity prices, etc. – will change to ensure asset market equilibrium. At that point, 

the current account will not have changed and there will be no increased net transfer of assets to 

 continue indefinitely. The conclusion also depends on a number of technical assumptions, such as the rate of 

nominal growth of GDP being equal to the nominal rate of interest. 

16 Described in Bernanke, Ben S., The Global Saving Glut and the U.S. Current Account Deficit, Remarks at the 

Homer Jones Lecture, St. Louis, Missouri, April 14, 2005. 

17 Iran, Kuwait, Libya, Nigeria, Norway, Qatar, Russia, Saudi Arabia, United Arab Emirates, and Venezuela. 18 As described by former Federal Reserve Board Chairman Alan Greenspan in his speech, Current Account, to the 

Economic Club of New York March 2, 2004. 
12

foreign investors19. However changes in these asset prices will affect imports, exports, saving 

and investment so that the current account balance will be reduced over time20. As a current 

account deficit widens, there will be an increase in the net transfer of assets to foreign investors. 

In practical terms, perceived high rates of return on U.S. assets, based on sustained strong 

productivity growth especially relative to that of the rest of the world, sound U.S. economic 

performance, a welcoming U.S. investment climate, and the deepest and most liquid capital 

markets in the world have all combined to attract foreign investment. In turn, sustained external 

demand for United States assets has allowed the United States to achieve levels of capital 

formation that would have otherwise not been possible, and robust growth in investment has 

been critical to non-inflationary growth of production and employment. 

The U.S. Dollar 

In the second half of 2006, the dollar depreciated vs. the euro by 3.2 percent to $1.32, but 

appreciated vs. the yen by 3.9 percent to ¥ 119. Until late November, the dollar traded in a 

$1.25-1.28 range vs. the euro and gradually appreciated from ¥114 to ¥118. 

The key factors in exchange rate movements in this period were shifts in market views regarding 

the relative outlook for economic growth and the monetary policy cycle in the United States and 

in other countries and a downward adjustment in market expectations regarding returns on U.S. 

assets relative to foreign assets. Capital outflows from Japan weighed on yen exchange rates, as 

did an increase in short-yen positions used to finance risk positions in other currencies and other 

asset classes. Geopolitical tensions were also a factor at times, but this was more evident in oil 

and gold prices than in exchange rates. 

• The Federal Reserve raised the Fed funds target rate to 5.25 percent in June 2006 but did not 

adjust its policy stance further for the rest of 2006 and thus far in 2007. Subsequent U.S. 

economic data releases confirmed, on balance, that U.S. economic activity had moderated 

and that declines in housing construction and some manufacturing were pronounced. After a 

marked depreciation in the fall, the dollar was supported toward the end of the year when 

strong sales and manufacturing data prompted an improvement in investors’ outlook for U.S. 

growth and a reversal of expectations for declines in dollar interest rates. 

• The Bank of Japan (BOJ) raised its official policy rate to 0.25 percent in July 2006. At that 

time and for a while thereafter, Japanese economic data supported a view in the market that 

further rate increases were likely by year-end. However, market expectations regarding the 

extent and timing of BOJ rate hikes changed after several disappointing Japanese economic 

data releases late in the year, and the BOJ did not hike the rate again until February 2007. 

Yields on yen-denominated claims remained quite low relative to yields in other currencies 

and encouraged Japanese investors’ demand for foreign assets. Evidence of increased use of 

short yen positions to finance long positions in other currencies accumulated throughout most 

of the third quarter of 2006. But in subsequent weeks there were signs that such positions 

 

19 Or, if the U.S. current account were in surplus, there would be no decrease in the rate of foreign acquisition of 

U.S. assets. 

20 That is a current account surplus would narrow and a current account deficit would widen. 
13

were being closed out amid reports of foreign central banks’ interest in increasing their yen 

reserves and of increased Japanese official interest in monitoring yen-financed “carry 

trades.”21 

• After a sharp increase in May and June 2006, implied volatilities in major currencies and 

other asset classes eased to or near historical lows in the latter half of the year, and the low 

volatility environment favored risk positions financed in low interest rate currencies, notably 

the yen. Volatilities briefly turned higher in late November and early December before 

settling down again until late February. In late February and early March 2007 they again 

rose sharply as market participants became concerned, inter alia, about the risk of a rapid 

liquidation of yen-financed carry positions. 

• The European Central Bank (ECB) raised its re-financing rate to 3.00 percent in August 2006 

and indicated that further increases would be needed to forestall inflation risks in the Euroarea. There were hikes to 3.25 percent in October 2006, 3.50 percent in December 2006, 

3.75 percent in March 2007, and subsequently 4.00 percent in June 2007. In fall 2006, Euroarea economic data, notably Germany’s IFO business climate survey and Q3 GDP, allayed 

the market’s summertime concern that Germany’s impending corporate and consumer tax 

increases would hurt economic growth. Interest differentials between the United States and 

the Euro-area narrowed substantially throughout the second half of 2006. 

• After mid-summer 2006, a number of other foreign central banks raised their interest rates 

one or more times before the end of 2006 and in some cases continued to do so in 2007. 

These interest rate increases tended to reinforce the market’s sense that the monetary policy 

cycles in the United States and in other countries were diverging. 

 

21 The “carry trade” is roughly the practice of borrowing in low nominal interest currencies to invest in the assets of 

currencies with higher nominal interest rates. 

Nominal Trade Weighted Dollar Feb 25, 2002 = 100

65

70

75

80

85

90

95

100

105

110

F-02M-02A-02N-02J-03A-03J-03O-03D-03M-04J-04S-04N-04F-05M-05A-050-05J-06A-06J-06O-06D-06M-07

Broad

Majors

OITP
14

Country Analyses 

Argentina 

Argentina intervenes frequently in the foreign exchange market to manage the value of the peso 

and build international reserves. Since repaying Argentina’s entire $9.9 billion in IMF 

obligations in January of 2006, the central bank has more than rebuilt its stock of foreign 

reserves. At end-December 2006, reserves stood at $32.0 billion, up $13.5 billion from the postIMF repayment reserve level of $18.5 billion. 

During the second half of 2006, the peso appreciated 0.6 percent in nominal terms, from 3.084 to 

3.066 to the dollar. For the entire 2006 calendar year, the peso depreciated 1.3 percent, from 

3.026 to 3.066 to the dollar. Argentina’s real effective exchange rate depreciated 0.3 percent 

during the second half of 2006, due to depreciation of the peso against its non-U.S. trading 

partners. 

The central bank continues to buy dollars actively in the foreign exchange market. It then 

partially sterilizes these purchases through the issuance of central bank paper. In order to rebuild 

reserves following its large repayment to the IMF, the central bank stepped up intervention in the 

second half of 2006, accumulating $6.5 billion, a 17.7 percent increase, over the last six months 

of 2005. The increased dollar purchases in the second half of 2006 reflect changes in monetary 

policy that give the central bank greater freedom for intervention. In particular, the monetary 

program rules allow the central bank to target M2, instead of the monetary base. Despite the 

central bank’s sterilization measures, M2 growth accelerated to nearly 14 percent in the second 

half of 2006 from just four percent over the first half of last year. Nominal interest rates on 

central bank repo transactions rose by 25 basis points in the second half of 2006 to 8.25 percent 

from 8.0 percent in the first half of 2006, but real interest rates remained negative with inflation 

at 9.8 percent in 2006. 

Argentina’s economy continued its rapid expansion in 2006, driven by strong growth of private 

investment in construction and durable equipment. Real GDP increased at a seasonally adjusted 

annual rate of 8.6 percent during 2006, down slightly from 9.1 percent in 2005. Growth in real 

GDP slowed to 7.5 percent in the fourth quarter of 2006 (saar) from 11.8 percent in the third 

quarter, principally due to a drop in investment in construction near the end of 2006. Strong 

growth and an accommodative monetary policy continued to put upward pressure on annual 

inflation rates, although inflation moderated to 9.8 percent at year-end 2006 compared to 12.3 

percent at year-end 2005. Administrative price controls on 70 percent of the items in the CPI 

basket were the main reason for the decline in inflation. 

Argentina’s trade surplus increased by 7.1 percent in 2006 to $14 billion due to primarily to 

higher world commodity prices and improved terms of trade (up 6.3 percent y/y in the fourth 

quarter of 2006). As a result, Argentina’s current account surplus expanded to $8.1 billion (3.7 

percent of GDP) in 2006, versus $5.6 billion (3.0 percent of GDP) in 2005. Lower interest 

payments on external sovereign debt and higher tourism revenue also contributed to a higher 

current account surplus. On an accumulated basis, foreign direct investment into Argentina fell 

4.0 percent year-on-year to $4.8 billion during 2006. In 2006, the U.S. trade balance with 
15

Argentina shifted into a surplus of $800.7 million, from a deficit of $461.7 million the prior year, 

a net positive change of $1.26 billion. 

Capital controls remain in effect on both local and foreign U.S. dollar inflows. Residents of 

Argentina are limited in the amount of dollars they can bring freely into the country and 

foreigners are required to keep dollar inflows in the country for a minimum of one year, with 30 

percent held on deposit in an interest-free account at the central bank. Foreign direct investment 

is required to remain in Argentina for 365 days. 

Brazil 

Brazil has a flexible exchange rate regime and relies on inflation targeting to guide monetary 

policy. The real continued to strengthen during the second half of 2006, appreciating 1.4 percent 

in nominal terms, from 2.16 to 2.13 reals to the dollar (while the real effective exchange rate 

appreciated 5.1 percent). The real has appreciated by 85 percent relative to the dollar since 

reaching a low in October 2002, likely reflecting the downward overshooting during the 2002 

crisis, structural improvement in export competitiveness, and, more recently, the six percent 

improvement in the terms of trade in the last six months of 2006. 

Brazil’s external accounts have remained remarkably robust considering the strong recovery of 

the real. On a seasonally adjusted basis, Brazil’s current account surplus was $8.8 billion (1.6 

percent of GDP) in the second half of 2006, up from $4.5 billion (0.9 percent of GDP) in the first 

half of the year, while the trade surplus rose from $21.7 billion (4.2 percent of GDP) to $24.4 

billion (4.4 percent of GDP) over the same period. The U.S. trade deficit with Brazil narrowed 

from $3.8 billion in the first half of 2006 to $3.3 billion in the second half of the year. 

The strong real has supported the reduction of inflation in Brazil. The inflation outlook has 

continued to improve over the past year, with year-on-year inflation at 3.3 percent in December 

2006, down from 4.0 percent in June and below the central bank’s 4.5 percent midpoint target for 

2006. The central bank has stated it will maintain its same target range in 2007. Net 

international reserves have increased rapidly since Brazil repaid its $15.5 billion obligation to the 

IMF in December 2005. Gross reserves increased to $85.8 billion by December 2006 from $53.8 

billion a year before, and have continued to accumulate at a rapid pace – reaching $109.5 billion 

in March of 2007 – as the central bank purchased dollars in the spot market. The government’s 

goal of reserve accumulation is to smooth out exchange rate fluctuations and to improve the 

country’s external sovereign position. Gross reserves covered about 50 percent of gross external 

debt in the fourth quarter of 2006, compared to 32 percent in the fourth quarter of 2005. The 

central bank has a broad objective of increasing reserves in the medium run, but has not 

committed to a specific numerical target in terms of a reserve coverage ratio. 

Strong export growth and investment contributed to a recovery of the Brazilian economy during 

the second half of 2006 after a disappointing second quarter. A slowdown in export volumes and 

consumption growth and continued strong growth of imports had resulted in lackluster real GDP 

growth of 3.4 percent at an annualized rate in the first half of 2006 compared to the second half 

of 2005. But a strong resumption of export and consumption growth in the second half of 2006, 

together with continued robust investment growth, resulted in GDP growth of 5.7 percent over 
16

the second half of the year and 3.7 percent growth for all of 2006, compared to 2.9 percent in 

2005. 

 

Brazil took several steps last year to liberalize its foreign exchange market. In July of 2006, 

Brazil loosened its repatriation requirements for exporters, enabling them to keep up to 30 

percent of their export revenue abroad and to hold the rest for up to a year. Previously, exporters 

were required to repatriate all of their foreign currency earnings within seven months of their 

receipt. Brazil now also allows the registration of foreign capital not previously eligible for 

registration. 

Mexico 

Mexico has a flexible exchange rate regime. During the second half of 2006 the Mexican peso 

appreciated 4.5 percent in nominal terms, from 11.4 to 10.9 pesos to the dollar. The broad real 

trade-weighted effective exchange rate appreciated by 5.2 percent during the same period. The 

real appreciation reflected, in part, increased market confidence in the new administration 

following the close presidential elections of July 2, an improved outlook for advancing key 

structural reforms, and relatively contained inflation. 

 

Heavy external debt repayments during the second half of 2006 resulted in an $11.1 billion drop 

in foreign exchange reserves from $78.7 billion at the end of June to $67.7 billion by the end of 

December. Pemex, the state-controlled Mexican oil company, is obligated by law to sell its 

foreign currency earnings to the Bank of Mexico to service the country’s foreign debt. Reserves 

accumulate, therefore, when the foreign currency obtained by the Bank of Mexico is greater than 

foreign debt payments. The Bank of Mexico follows a transparent rule for selling these reserves. 

Every 13 weeks, the Bank of Mexico retains half of the reserves accumulated during that period 

and sells the other half evenly over the ensuing three months. This procedure is designed to 

prevent uncertainty in the financial markets and minimize discretionary actions by the financial 

authorities. 

Mexico’s seasonally adjusted current account deficit was $2.1 billion in the second half of 2006 

compared to a surplus of $368.5 million in the first half of 2006. The $2.5 billion reversal in the 

current account balance reflects the fall in oil prices in the second half of 2006. Mexico’s trade 

surplus with the United States for the second half of 2006 was $32.8 billion, up slightly from 

$31.3 billion in the first half of 2006. Mexico is the second largest supplier of oil to the United 

States. 

Also, the slowdown in the U.S. economy in the second half of the year contributed to a 

deceleration of economic growth to a more moderate pace in the second half of the year. Real 

GDP increased at seasonally adjusted annual rates of 2.7 percent and 1.9 percent during the third 

and fourth quarters, respectively. At the same time, supply shocks on certain key food items 

(mainly corn and tortillas) caused a temporary spike in inflation, resulting in price levels above 

the Bank of Mexico’s three percent target. Year-on-year headline inflation was 4.1 percent in 

December, compared with 3.2 percent in June. 
17

Mexico does not maintain controls against most external capital inflows and outflows. It does, 

however, maintain some restrictions against certain types of foreign investment, such as the 

establishment of foreign bank branches within Mexico. 

Venezuela 

Venezuela maintains a pegged exchange rate. The official nominal exchange rate was 2,147 

bolivars to the dollar at end-December 2006, unchanged since end-December 2005. The J.P. 

Morgan trade-weighted real effective exchange rate appreciated by 4.4 percent during the second 

half of 2006, largely due to Venezuela’s high inflation rate. 

The high inflation rate is largely the result of an accommodative monetary policy stance, with 

real interest rates that are significantly lower than elsewhere in the region. In particular, 

unsterilized reserve accumulation is contributing to monetary expansion and inflationary 

pressures. The stock of central bank reserves increased to $36.6 billion at end-December 2006 

compared to $31.2 billion at end-June 2006 and $29.6 billion at end-2005. The monetary base 

expanded by 67 percent to end-December 2006 from the end-June 2006. Annual inflation 

increased to 16.9 percent year-on-year at end-December 2006 from 11.8 percent year-on-year at 

end-June 2006, significantly above the 90-day deposit rate of 10 percent seen through most of 

2006. The combination of high inflation and a fixed exchange rate, which have contributed to 

real exchange rate appreciation, has eroded Venezuela’s competitiveness as evidenced by strong 

import growth and falling non-oil exports in 2006. 

Venezuela has a large current account surplus, equal to 14.9 percent of GDP in 2006. Higher oil 

prices account for much of the recent strong growth performance, the large current account 

surplus, and foreign reserve accumulation, although oil prices did ease somewhat in late 2006. 

Oil accounts for about one third of Venezuelan GDP, 90 percent of the country’s exports and 

close to half of government revenues. Real GDP rose by 10.3 percent in both 2005 and 2006, 

driven primarily by strong growth in government expenditure exclusive of interest payments 

(about 40 percent real growth) and private consumption (18.8 percent real growth) in 2006 as the 

government sought to disperse the benefits of additional oil revenue. 

The willingness of the government to spend quickly its extra oil revenue led to strong import 

growth in 2006, which caused the current account surplus to shrink as a percent of GDP in 2006. 

The current account surplus did rise in dollar terms to $27.2 billion (14.9 percent of GDP) in 

2006 compared to $25.5 billion (17.6 percent of GDP) in 2005, but this growth did not keep pace 

with nominal GDP growth. Also, while petroleum exports rose by $10.4 billion to $58.4 billion 

in 2006, this increase was largely offset by an $8.5 billion increase in goods imports in 2006. 

The bilateral U.S trade deficit with Venezuela fell to $13.6 billion during the second half of 

2006, down from $14.5 billion in the first half of 2006. The slightly lower bilateral trade deficit 

primarily reflects increased U.S. exports to Venezuela, rather than lower oil prices. 

Venezuela maintains extensive controls on capital inflows and outflows. These controls require 

exporters to surrender their foreign exchange earnings to the government at the official exchange 

rate. 
18

The Euro-area 

The value of the euro is market-determined, and the European Central Bank (ECB) has not 

intervened in the foreign exchange market since November 2000 when it defended the euro 

against further depreciation. The Euro-area’s international reserves increased by $15 billion 

between June 2006 and December 2006 reaching $184 billion. 

Citing inflationary pressure, the ECB has continued to raise its main refinancing rate, currently 

4.00 percent. The ECB’s primary monetary policy target is an annual rate of inflation of less 

than 2.0 percent. In the wake of ECB interest rate hikes and a narrowing of the dollar/euro 

interest rate spread, the euro appreciated 3.3 percent in nominal terms against the dollar during 

the second half of 2006, from $1.28 per euro to $1.32. Over the same period, the euro 

appreciated 1.2 percent in real effective terms22. Thus far in 2007 the euro appreciated a further 

1.8 percent against the dollar, reaching $1.34 on May 24. 

The Euro-area’s current account balance increased to a $8.6 billion surplus (0.2 percent of GDP) 

in the second half of 2006 compared to a $13.2 billion deficit (0.3 percent of GDP) in the first 

half. The Euro-area’s trade surplus with the U.S. declined during the second half of 2006 

compared with the same period in 2005, to $46.2 billion from $48.7 billion. 

CPI-measured inflation reached 1.9 percent (y/y) in March 2007, relatively stable since 

December 2006 despite a three percentage point VAT hike in Germany at the beginning of the 

year. Euro-area growth increased to 2.8 percent in 2006, up from 1.5 percent in 2005. Growth is 

broad-based with net exports, investment and private consumption all making significant 

contributions. Unemployment has been falling since 2004, reaching a 15-year low of 7.3 percent 

in April. Expanding employment should support private consumption in the medium term. 

The ECB has expressed concern about the pace of M3 growth rate (the growth of the threemonth centered moving average, which reached 10 percent in February 2007). This is 

significantly higher than the ECB’s comfort zone of four percent, a fact that underpinned the 

market’s correct expectations of a 25 basis point hike to four percent of the minimum bid for the 

main refinancing rate in June 2007. 

Germany 

Germany’s current account surplus increased from $57.4 billion (or 4.1 percent of GDP) in the 

first half of 2006 to $90.7 billion (or 6.1 percent of GDP) in the second half, largely due to strong 

import demand from Russia and Asia. For all of 2006, Germany’s current account surplus was 

$148.0 billion (5.1 percent of GDP) as real exports of goods and services expanded 13.4 percent 

and real imports of goods and services increased 11.9 percent. Germany ran a $23.3 billion 

bilateral merchandise trade surplus with the United States in the second half of 2006, compared 

to a $26.3 billion bilateral surplus in the second half of 2005. 

 

Strong export growth helped propel strong German annual growth, which for 2006 almost tripled 

to 3.0 percent from 1.1 percent in 2005. While net exports continue to drive growth, economic 

 

22 Source: ECB. The index is based on producer price indices. 
19

expansion did become more broad-based in 2006, with both investment (up five percent from 

one percent in 2005) and private consumption (up 0.9 percent from 0.3 percent in 2005) 

improving. Domestic demand growth increased to 1.5 percent during the second half of 2006 

from 0.8 percent during the same period in 2005. 

Spain 

Although the stronger euro and declining net exports have restrained Spain’s growth rate, it has 

still been reasonably robust. Growth was an annual 3.8 percent in the second half of 2006 after 

expanding at a 4.0 percent rate in the first half of the year. Growth has been driven by domestic 

demand, in particular investment. Annualized consumption and investment growth were 5.1 

percent and 6.3 percent, respectively, in the second half of 2006. Strong growth helped 

unemployment to fall to 8.4 percent in the fourth quarter of 2006, down from 8.6 percent in the 

second quarter of the year. 

Inflation fell to 2.7 percent y/y in December 2006, down from 3.9 percent y/y in June. There are 

concerns about overheating given the concentration of economic activity in the housing sector 

and cost pressures resulting from record-low (for Spain) unemployment. Fiscally, the 

government ran a budget surplus of 1.8 percent of GDP in 2006. 

The principal factor behind Spain’s widening current account deficit has been Spain’s high level 

of investment; gross fixed capital formation was 29.2 percent of GDP in the second half of 2006. 

The current account deficit reached $60.6 billion (9.5 percent of GDP), up from $45.4 billion 

(7.7 percent of GDP) in the first half of the year. Goods imports increased 9.6 percent y/y, while 

goods exports increased 8.4 percent y/y. Spain’s bilateral surplus with the United States on trade 

in goods was $1.3 billion in the second half of 2006, an increase of $366 million over the same 

period in 2005. Spain’s increasing trade surplus with the U.S. is largely related to higher 

exports, in dollar terms, of refined fuel products to the United States. 

The Netherlands 

The Netherlands continues to post large current account surpluses. Its current account surplus 

was $27.1 billion (7.9 percent of GDP) in the second half of 2006, up $6.3 billion from $20.8 

billion (6.8 percent of GDP) during the second half of 2005. The Netherlands has trade and 

services surpluses as well as a surplus on net income flows that more than offset a deficit in 

transfers. Both the trade and income balances are influenced heavily by the large number of 

international companies based in the Netherlands (e.g., Shell, Unilever, Phillips, and Mittal) 

that have transformed the Netherlands into a major processing and trans-shipment point for 

Europe. For the full year in 2006, the current account surplus was 8.7 percent of GDP, up 

from 7.7 percent in 2005. The Netherlands had a bilateral trade deficit with the United States, 

which grew to $6.9 billion in the second half of 2006, up $1.8 billion from the same period in 

2005, due largely to aircraft sales. 

GDP grew 2.9 percent (annualized) over the second half of 2006, driven largely by investment, 

which increased 11.3 percent. Both private and public investment grew rapidly (12.7 percent 

and 4.2 percent, respectively) due to several one-off factors (e.g., updating computer equipment, 
20

vehicle purchases due to changes in subsidies, and airplane purchases). Headline inflation was 

1.7 percent in December (y/y) while core inflation was 1.2 percent. 

Norway 

Norway has a freely floating exchange rate and a monetary framework targeting inflation. The 

Norwegian kroner depreciated 0.3 percent against the dollar during the second half of 2006 while 

the JP Morgan index of the real value of the kroner was unchanged over the period. 

Norway is a major oil and gas exporter and a key player in the oil services industry. Its current 

account surplus during second half of 2006 was $28.5 billion (16.8 percent of GDP), up a 

nominal $5.0 billion from $26.1 billion (17.0 percent of GDP) in the second half of 2005. 

Merchandise exports in the second half of 2006 were up 8.5 percent over the same period in 

2005 while imports increased 14.8 percent. Norway had a bilateral trade surplus of $2.3 billion 

with the United States in the second half of 2006, up $8.4 million from the corresponding period 

in 2005. Foreign exchange reserves grew $7.4 billion to $56.8 billion during the second half of 

2006. 

Norway’s central bank reserves the right to intervene in foreign exchange markets to influence 

the kroner but has not done so since January 1999; however, management of the Government 

Pension Fund (GPF) – the custodian of Norway’s oil and gas wealth portfolio – influences 

currency developments. By investing the GPF’s resources overseas, Norway reduces the 

influence that oil and gas-related earnings inflows might have on the exchange rate. At the end 

of 2006, the GPF’s market value was $284.9 billion (83 percent of total 2006 GDP, or 114 

percent of non-oil and gas GDP) and growing rapidly. By law, the return on the GPF’s 

investments abroad can be used for current government consumption while the principal remains 

as a retirement fund for future generations. However, some of the GPF is already being used to 

service retirement benefits through the current government budget. Oil and gas production is 

expected to peak in 2008 and halve by 2030, and revenue accruing to the GPF is inadequate to 

meet the needs of a rapidly aging population. Consequently, there is increasing pressure to 

reform the pension system to avoid the need to draw down GPF principal. 

GDP increased 3.1 percent (at an annual rate) during the second half of 2006 compared to 

the second half of 2005. Consumption grew by 4.6 percent during the same period while 

fixed investment increased 12 percent, reflecting strong activity in the construction, 

machinery and equipment and oil drilling sectors. Headline inflation was 2.2 percent 

(annualized) during the period while core inflation was 1.1 percent. Monetary policy was 

gradually tightened during the second half of 2006 as the key policy interest rate was raised 

from 2.75 percent to 3.5 percent due to concerns about economic overheating. 

Switzerland 

Switzerland has a freely floating exchange rate and an inflation targeting monetary regime. The 

Swiss franc appreciated one percent against the dollar and depreciated 2.9 percent against the 

euro during the second half of 2006. The JP Morgan index of the real value of the Swiss franc 

depreciated 2.2 percent during the same period. 
21

Switzerland’s large and persistent current account surplus is supported by robust exports, 

services income (mostly banking fees derived from its role as an international banking center) 

and income from overseas investments that support the financial sector. 

According to the Swiss central bank, Switzerland posted a $33 billion current account surplus 

(16.6 percent of GDP) in the second half of 2006, up from $27.1 billion (15 percent of GDP) in 

the same period in 2005. The trade surplus increased $1.8 billion (from $700 million to $2.5 

billion) in the second half of 2006 compared to the corresponding period in 2005, while the 

surpluses in the services and income accounts increased $1.3 billion (to $13 billion) and $1 

billion (to $21.5 billion), respectively, during the same period. The surplus on trade in goods 

accounted for 7.6 percent of the total current account surplus in the second half of 2006 while 

surpluses on services and income accounted for 40 percent and 65 percent, respectively. The net 

transfers balance deficit over the period accounted for -12.7 percent. Goods exports increased by 

14 percent in the second half of 2006 over the corresponding period in 2005, while imports grew 

by 11.4 percent. The U.S. trade surplus vis-à-vis Switzerland was $63.2 million in the second 

half of 2006, up from a deficit of $1.1 billion from the corresponding period in 2005. The 

counterpart to the current account surplus is largely direct investment outflows, which are 

estimated to have been $27.6 billion in the second half of 2006. 

As a small open economy, Swiss economic conditions are heavily influenced by conditions in 

the Euro-area, Switzerland’s largest trading partner. Monetary tightening continued during the 

second half of 2006 with the policy interest rate rising to 2.1 percent at the end of 2006, from 1.4 

percent in June 2006 – which mirrored rate increases by the ECB. Nonetheless, Swiss interest 

rates are low relative to those of other major currency countries including the euro. As a result, 

the Swiss franc continues to be a significant funding source for “carry trades” in the region. This 

tends to place downward pressure on a currency and helps explain the franc’s depreciation 

despite robust fundamentals. At the same time, countervailing forces that have traditionally 

supported the franc have weakened. According to the IMF, the franc’s status as a “safe haven” 

currency has lessened and it has lost market share as an official reserve currency following 

central bank’s gold sales in 2005. Foreign exchange reserves rose from $36.2 billion to $38 

billion during the second half of 2006. 

GDP growth was estimated to be 1.9 percent (annualized) during the second half of 2006. 

Consumption and fixed investment grew 2.1 percent and 5.6 percent, respectively, on an 

annualized basis during the same period, while net exports grew 4.9 percent during the second 

half of 2006 compared to the second half of 2005. During the second half of 2006, headline 

inflation was 0.6 percent y/y, while core inflation was 0.8 percent y/y. 

Russia 

The exchange value of the Russian ruble is managed by the Central Bank of Russia against a 

reference basket of the US dollar and euro. The U.S. dollar’s and euro’s shares in the basket are 

55 percent and 45 percent, respectively. The central bank continues to manage closely the 

exchange rate in an effort simultaneously to meet inflation targets and to limit real exchange rate 

appreciation. The ruble appreciated two percent against the dollar during the second half of 
22

2006. However, as a result of the strength of the euro, the Central Bank’s nominal tradeweighted index of the ruble depreciated 0.5 percent in the second half of 2006 while its real 

trade-weighted index appreciated by 0.5 percent. The ruble has continued to appreciate against 

the dollar since the end of 2006, firming an additional 2.4 percent in 2007. The appreciation of 

the real exchange rate also accelerated to 2.6 percent in the first quarter of 2007 as Russia’s 

inflation rate remains above that of its major trading partners. 

The Central Bank of Russia’s intervention to moderate exchange rate appreciation boosted total 

international reserves to $303 billion at the end of 2006 from $182 billion at the end of 2005. 

Net of valuation changes, Central Bank of Russia reserves rose $107.5 billion during 2006, 

compared with an increase of $61.5 billion during 2005. In addition, the balance of Russia’s oil 

stabilization fund rose to $89 billion at the end of 2006 from $43 billion at the end of 2005. 

A decline in oil prices, coupled with strong growth in imports, resulted in a decline in Russia’s 

current account surplus to $39.5 billion (not seasonally adjusted, or “nsa”), or 7.1 percent of 

GDP, in the second half of 2006 compared to $41.7 billion, or 10.0 percent of GDP, in the 

second half of 2005. Russia’s bilateral trade surplus with the United States increased to $7.6 

billion in the second half of 2006 compared to $5.4 billion in the second half of 2005. The net 

inflow of private sector capital that began in the second half of 2005 continued in the second half 

of 2006, as international bank lending to Russian enterprises helped to compensate partially for a 

year-end fall off in direct and portfolio investment flows. As a result, the financial accounts in 

the balance of payments, exclusive of changes in reserves, posted a surplus of $1.7 billion during 

the second half of 2006 compared to a $3.4 billion surplus in the second half of 2005. 

In addition to Russia’s current and financial account surpluses, declining demand among Russian 

households for foreign exchange, or “de-dollarization”, also contributed to increased demand for 

rubles in the foreign exchange market. Like most of the former Soviet Union, Russia has been 

heavily dollarized and the domestic money supply can be thought of as having, in effect, ruble 

and foreign denominated components. Fluctuations in the exchange value of the dollar can cause 

Russian residents to buy or sell rubles, impacting the ruble-denominated portion of the domestic 

money supply. 

Indeed, “de-dollarization” partially explains the dissimilar behavior of inflation and the growth 

in the large ruble monetary aggregate, M2. The increase in the CPI slowed from 10.9 percent 

y/y in December 2005 to 9.0 percent y/y in December, compared to an end-2006 Central Bank of 

Russia inflation target of 9.0 percent. Growth in M2, by contrast, accelerated to 48.8 percent in 

the 12 months through December compared with growth of 38.6 percent in 2005. While the fall 

in inflation is largely attributable to a sharp deceleration in the growth of administered prices 

which make up approximately 20 percent of Russia’s CPI basket, the acceleration of M2 growth 

over the period can be explained by continued foreign exchange sales by Russian residents, the 

limited effectiveness of Central Bank of Russia sterilization efforts and a strong increase in bank 

credit to the real economy. 

 

Real GDP growth accelerated to 6.7 percent y/y during the first half of 2006, little changed from 

6.4 percent in 2005. Output growth has been supported by strong household spending and fiscal 
23

easing as the government is spending a larger share of oil revenues ahead of the 2007-2008 

election cycle. 

South Africa

The South African Reserve Bank’s overall monetary policy framework is based on inflation 

targeting and a floating exchange rate. It has, nevertheless, been operating in the market, since 

March 2003, to purchase foreign exchange with the aim of building its foreign exchange 

reserves. The Reserve Bank seeks to purchase foreign exchange when the market is active, 

while not explicitly seeking to set any level for the rand, or to resist market movements. All 

purchases of foreign currency for reserves are fully sterilized. 

Although overall the rand appreciated 1.8 percent from end-June to end-December, it 

experienced wide swings over the period, depreciating 11.9 percent from the middle of August to 

the first of October then appreciating 9.7 percent though the end of the year. Commodity price 

fluctuations and shifting investor sentiment pushed the rand to a three-year low at the start of the 

fourth quarter, as they had done during the May-June 2006 period, in which the rand depreciated 

16.3 percent against the dollar. The rand strengthened by end-December with improved 

commodity prices, South African interest rate hikes, and renewed investor interest in emerging 

markets. 

Domestic demand continued to strengthen, supported by an 11 percent increase in private sector 

credit expansion in the second half of 2006, and the current account deficit reached 6.4 percent 

of GDP in 2006 (annualized 5.7 percent in Q3 and 7.8 percent of GDP in Q4). Growing capital 

equipment imports and exceptionally high oil imports23, combined with moderate export levels 

in the final quarter of 2006, widened the deficit. Net financial inflows comfortably financed the 

current account deficit and the central bank continued to increase its foreign reserves, which 

increased seven percent to $25.6 million by end-December from end-June. Reserve levels 

represent about five months import cover. 

Robust demand also contributed to annualized 4.5 and 5.6 percent real GDP growth in Q3 and 

Q4, respectively, and five percent for the year. Responding to perceived inflationary pressure, 

fueled by private sector consumption growth, rising fuel prices, and rand depreciation, the central 

bank raised interest rates 200 basis points to nine percent in the second half of 2006. Although 

the full impact of the interest rate hikes will likely reach into 2007, Q3 and Q4 inflation remained 

within the bank’s official 3-6 percent target band, at five percent,24 while consumer prices were 

4.6 percent higher in 2006 than in 2005. 

South Africa’s imports from the United States increased 15 percent in 2006 over 2005 (to a total 

of $4.5 billion) while South Africa’s exports to the United States were up 28 percent to $7.5 

billion. 

 

23 The South African Reserve Bank attributed the current account deficit spike in 4Q06 to oil import timing, 

predicting that the deficit would return to the five percent range in 2007. 

24 The South African Reserve Bank’s inflation target corresponds to CPIX inflation, which is CPI minus mortgage 

interest. 
24

South Africa ran a small fiscal surplus (0.8 percent of GDP) in FY06/07 (year-ending March 31) 

– the country’s first budget surplus since the 1994 transition. The FY07/08 budget calls for 

another surplus, followed by modest deficits the following two years as the country ramps up 

infrastructure expenditure. Better revenue collection and a favorable economic backdrop fueled 

the fiscal improvement. The budget includes further capital control liberalization, continuing the 

policy of gradually removing capital flow constraints. South African firms may now enter into 

joint ventures outside Africa with a 25 percent stake (previously a 51 percent stake was 

required); and companies may conduct trade dealings through a single foreign currency account 

rather than multiple accounts as before. 

Egypt 

Egypt abandoned its formal peg to the U.S. dollar in 2003 and launched an interbank foreign 

exchange market in late 2004. While Egypt technically allows its currency to move against the 

U.S. dollar, it has maintained a de facto peg against the dollar since January 2005: daily volatility 

has been low, and the pound has only gradually appreciated from 5.9 pounds per dollar, when the 

peg began, to 5.7 pounds per dollar in early 2007. Between December 2005 and December 

2006, the pound appreciated 0.4 percent in nominal terms; however, due to Egypt’s relatively 

high inflation (12.5 percent y/y in December), the real trade weighted effective exchange rate 

appreciated by 4.1 percent. 

The de facto peg serves to dampen exchange rate volatility while the Central Bank of Egypt 

(CBE) lays the groundwork for greater currency flexibility. The CBE has a medium-term goal of 

adopting a formal inflation targeting regime to guide monetary policy. This would require the 

pound to float freely. In the meantime, the CBE is working to increase the transparency of its 

policymaking and improve its ability to monitor prices and economic conditions. 

 

Structural reforms implemented since 2004, along with a robust regional economy, helped 

Egypt’s economy to grow by 6.8 percent in the fiscal year ending in June 2006, with the IMF 

projecting growth of 6.7 percent for the year ending in June 2007. Egypt has also received a 

large influx of foreign capital, driven in part by the government’s ambitious campaign to 

privatize state-owned firms: net foreign direct investment reached a record $6.9 billion in the six 

months ending in December 2006, more than double the $3.0 billion received during the same 

period in 2005. 

 

Rapid economic growth has been accompanied by rising inflation: the CPI rose 12.5 percent y/y 

in December 2006, compared to a three percent increase during the same period in 2005. The 

recent spike in inflation partly reflects the temporary impact of reduced government price 

subsidies for energy and food. The monetary base (M0) grew by 10 percent in the year ending 

December 2006, contributing to 15 percent growth in broad money (M2). 

The current account surplus rose modestly to 2.5 percent of GDP in 2006, compared to 2.2 

percent of GDP in 2005. This surplus came mainly from the strong surplus on the services 

balance, including Suez Canal revenues and tourism, of 8.8 percent of GDP in 2006, and also 

large net transfers of 5.4 percent of GDP in 2006. By contrast, Egypt’s trade deficit was 11.7 

percent of GDP in 2006, while the bilateral trade deficit with the United States reached $1.7 
25

billion, an increase over the $1 billion deficit in 2005. The CBE’s reserves grew by 19 percent 

y/y to $26.1 billion at-end December from $21.9 billion a year earlier. 

Saudi Arabia 

High and rising oil prices over the last few years are the main cause of the country's high growth, 

large current account surplus, and rapidly accumulating net foreign assets, but the government’s 

fiscal policy has also played some role. The Saudi Riyal has been unofficially pegged to the 

dollar since 1986 (officially since 2003), so interest rates largely follow recent increases in the 

United States. The Gulf Cooperation Council has set a goal of establishing a formal monetary 

union by 2010, but it is still unclear how this will affect Saudi Arabia’s exchange rate regime. 

On a real trade-weighted basis, the Riyal depreciated 5.7 percent y/y to December 2006, which 

was largely due to U.S. dollar depreciation and relatively low inflation in Saudi Arabia. 

Saudi Arabia is one of the most oil-dependent economies in the world, with oil accounting for 

around 50 percent of GDP, almost 90 percent of export earnings, and over 80 percent of 

government revenue. With high and rising oil prices over the past few years, real GDP growth 

has averaged close to six percent, with average nominal GDP growth around 12 percent. Despite 

strong economic growth, official CPI inflation was contained to less than one percent y/y on 

average over 2002-2005, but did increase modestly to 2.9 percent y/y in December 2006 on the 

back of strong food price inflation, which posted a 6.6 percent y/y increase to December 2006. 

Saudi Arabia’s current account surplus has soared over the past few years, but strong import 

growth of 26 percent y/y in 2006 caused the overall current account surplus to fall as a percent 

of GDP to 27.4 percent in 2006 compared to 29.3 percent in 2005. While oil export revenues 

increased to $188.6 billion in 2006 from $161 billion in 2005 due largely to higher oil prices, 

imports of goods and services increased by more, rising to $120.2 billion in 2006 from $88.2 

billion in 2005. The bilateral trade surplus with the United States reached $23.9 billion in 2006, 

compared with $20.4 billion in 2005, due largely to higher oil prices. 

The government’s financial position continued to improve as oil revenue caused the budget 

surplus to increase slightly to 20.3 percent of GDP in 2006 from 18.4 percent in 2005. The 

government used much of that surplus to reduce total government debt, which fell to 28 percent 

of GDP in 2006 and is down from 86 percent in 2003. If oil prices are stable, implementing the 

government’s plans to increase expenditure on social and infrastructure projects would reduce 

these surpluses over time. 

Due to the large current account surplus and fixed exchange rate, the net foreign assets of the 

Saudi Arabian Monetary Agency rose to $255 billion in March 2007, providing over two years 

of import cover, from $182 billion in March 2006. However, SAMA official reserves minus 

gold actually fell over the same period from about $28 billion to about $27 billion. 

Singapore

The Monetary Authority of Singapore (MAS) has a mandate to implement monetary policy with 

the objective of maintaining price stability for sustainable economic growth. To achieve its 
26

mandate, the MAS uses the exchange rate as its operational monetary policy tool, managing the 

Singapore dollar (SGD) against an undisclosed basket of currencies of its major trading partners. 

Since April 2004, the MAS has followed a policy of “modest and gradual” nominal appreciation 

against this basket. On April 10, 2007, the MAS reaffirmed its policy stance. 

In the second half of 2006, the SGD appreciated 3.2 percent against the U.S. dollar. (SGD 

appreciation totaled 8.4 percent for 2006.) JP Morgan’s nominal trade-weighted index of the 

SGD appreciated 1.7 percent in the second half of last year. However, the real trade-weighted 

index depreciated 4.8 percent over the same time period, reflecting a significant drop in 

wholesale price inflation in Singapore in the last quarter of the year. Headline CPI inflation was 

just under one percent in 2006. The economy continued to expand briskly, with growth at 7.9 

percent (saar) in the fourth quarter of 2006 following 3.9 percent (SAAR) in the third quarter. 

High and increasing saving rates, accompanied by stable investment rates for Singapore in recent 

years, have resulted in persistently large current account surpluses. For 2006, the current 

account surplus reached 27.5 percent of GDP. Singapore’s gross national saving rate, which has 

exceeded 40 percent of GDP since 2004, is among the world’s highest, and primarily reflects 

extremely high corporate saving and, to a lesser extent, persistent budget surpluses. Meanwhile, 

domestic investment remains around 20 percent of GDP. Corporate profits and government 

savings – including profits from government-linked companies – are often invested overseas. 

Driven by the large current account surplus and the managed exchange rate regime, reserves 

increased by $8 billion in the second half of 2006, or about six percent of GDP. Total official 

reserves were $138 billion at year-end, or just over 100 percent of GDP. In addition, the 

Singapore’s Government Investment Corporation (GIC), which was established in 1981 to 

manage fiscal surpluses and reserves in the face of chronic balance of payments surpluses, also 

likely acquired additional foreign exchange. Singapore continues to run a bilateral trade deficit 

with the United States, amounting to about $4.2 billion in the second half of the year, up from 

$2.5 billion in the same period one year earlier. 

India 

India’s exchange rate arrangement is a managed float. In the second half of 2006, the Reserve 

Bank of India (RBI) made U.S. dollar purchases totaling $5 billion, contributing to an overall 

increase in foreign exchange reserves of $14 billion. In the first half of 2006, the RBI purchased 

$15.6 billion, and foreign exchange reserves increased $25 billion. The rupee appreciated 4.0 

percent against the dollar in the second half of the year. The JP Morgan real effective tradeweighted index of the rupee appreciated by 2.8 percent over the same period. 

The RBI describes its monetary objectives as “maintaining price stability and ensuring adequate 

flows of credit to productive sectors.” These objectives are implemented by adjusting market 

liquidity through repurchase (“repo”) and reverse repo agreements, open market operations, and 

the cash reserve ratio applied to banks. 

India’s economy grew 9.8 percent in the second half of 2006 from the second half of 2005, 

driven by continued strong activity in the manufacturing and services sectors. Robust domestic 
27

demand and increases in food prices put upward pressure on wholesale price inflation, which 

was 5.7 percent y/y in December, up from 4.4 percent y/y one year earlier. In response to 

inflationary pressures, the RBI increased policy rates by 25 basis points twice, in July and 

October, and raised the cash reserve ratio by 25 basis points in December. 

The current account deficit was a seasonally adjusted $2.7 billion (0.7 percent of GDP) in the 

second half of 2006 compared with $7.3 billion (1.9 percent of GDP) in the first half. The U.S. 

bilateral trade deficit with India was $6.0 billion in the second half of 2006, which is slightly 

larger than in the same period one year earlier. 

Capital inflows financed the current account deficit comfortably. Although large overseas 

acquisitions by Indian companies drove up outward FDI, net foreign direct investment and 

portfolio inflows were $10.2 billion in the second half of 2006 compared to $9.3 billion in the 

second half of 2005. Gross FDI inflows in the second half of 2006 were $12.1 billion, $8.5 

billion more than the year before. Higher FDI was driven by the strength of domestic economic 

activity and was focused in the financial services, manufacturing, information technology 

services and construction sectors. There were strong portfolio inflows from foreign institutional 

investors (FIIs)—particularly in equity markets between August and November 2006. During 

December 2006, FIIs registered outflows against the backdrop of global equity market volatility. 

Indian commercial borrowings abroad were valued at $5.5 billion in the second half of 2006, 

$2.4 billion higher than in the same period in 2005. 

Japan 

Japan maintains a floating exchange rate regime. The Yen is widely traded in foreign exchange 

markets, with total average daily volume of $425 billion (dollar equivalent). Japanese authorities 

have not intervened in the foreign exchange market since March 2004. 

Japan’s economic recovery continues, but it has not proved sufficiently robust for the Japanese 

economy to durably exit price deflation. Although the recovery is now in its sixth year, nominal 

GDP still remains below its 1997 peak. Economic growth has accelerated modestly from 0.3 

percent in the first year of the recovery (2002) to 2.2 percent in 2006. Although GDP growth 

increased to a 3.3 annual rate in the first quarter of 2007, domestic demand growth was a more 

subdued 1.4 percent, the same as the average rate for 2006. Growth last year was increasingly 

reliant on business investment and domestic demand (contributing 1.4 percent) but net exports 

also contributed 0.8 percent to overall growth. Private consumption contracted sharply in Q3 

2006, but rebounded in the final quarter of 2006, to move above 2005 levels. Consumer prices, 

which rose 0.5 percent y/y during the second half of 2006, began to decline once again at the 

start of 2007. The CPI fell 0.1 percent y/y in March 2007, while the CPI, excluding fresh food, 

dropped 0.3 percent y/y. 

With the exit from deflation not yet complete, the Bank of Japan (BOJ) continues to maintain an 

accommodative monetary policy stance. On July 14, 2006, the BOJ raised overnight interest 

rates from zero to 0.25 percent. The BOJ took another step on February 21, 2007, raising 

interest rates another 25 basis points to 0.50 percent. 
28

Japan’s trade and current account surpluses increased in the second half of 2006 as falling oil 

prices helped reduce the import bill. As a share of GDP, Japan’s current account surplus stood at 

4.1 percent in the second half of 2006 compared to 3.8 percent in the second half of 2005. Less 

than half of the current account surplus is due to trade in goods and services. Rather, net income 

inflows from Japan’s overseas direct and portfolio investment account for more than half of the 

external surplus. The U.S.’s bilateral deficit with Japan widened by $4.5 billion to $45.4 billion 

in the second half of the year compared with the same period in 2005. 

Gross flows of private capital remained very large in the second half of 2006, although the net 

outflow (the sum of net domestic and foreign outflows) slowed to $47.1 billion in JulyDecember 2006, compared to outflows of $54.4 billion over the first six months of 2006. 

Japanese investor outflows have been supported by household demand for overseas bonds and 

equities. A wide interest rate gap between the U.S. and Japan remains, and investors continue to 

make use of short-term interest carry trades. 

The yen weakened 3.8 percent versus the dollar over the July to December 2006 period, closing 

at ¥119.07 on December 29. The yen has further weakened slightly in 2007, depreciating to 

¥121 by early June. Indexes of the real effective value of the yen have been weakening for some 

years as these indices have been dominated by the differential in inflation between Japan – which 

has experienced persistent deflation since 1998 – and its trading partners. The BOJ index 

indicates that the yen is at its weakest level in roughly 20 years. The BOJ index depreciated 3.3 

percent over the second half of 2006, and was 3.3 percent weaker compared to December 2005. 

It has weakened further over the first five months of 2007. 

Japan’s foreign exchange reserves continue to rise, reflecting interest earned on reserves and 

valuation effects.25. Gold and foreign exchange reserves totaled $895.3 billion at the end of 

December 2006, up from $864.9 billion at end-June and $846.9 billion at end-December 2005. 

Reserves rose further to $908.9 billion at end-March 2007. 

South Korea 

South Korea’s exchange rate has exhibited a high degree of flexibility on both a day-to-day basis 

and over time, although the authorities have carried out intervention operations. Over the past 

two years, the average daily fluctuation of the Korean won26 has been similar to that of the euro 

and the Japanese yen. The won appreciated 3.2 percent against the dollar in the last half of 2006, 

and by more than 10 percent from its December 31, 2005 value. The won appreciated 30.3 

percent against the dollar from February 27, 2002, when the Federal Reserve Board’s Index of 

the dollar’s nominal trade weighted value reached its most recent peak, through May 10, 2007. 

During that period, the dollar depreciated 36.0 percent against the euro, 28.6 percent against the 

pound sterling, and 31.2 percent against the Canadian dollar. The won has also appreciated in 

real effective terms, strengthening 5.7 percent by end-2006 versus end 2005, but has since 

weakened 3.0 percent from the beginning of this year through March 2007. 

 

25 Upward valuation adjustments are the result of increases in the dollar value of non-dollar currencies that Japan 

holds as reserves. 

26 As measured by the average absolute value of the daily percentage change in the closing price of a currency. 
29

Foreign exchange reserves increased $28.4 billion (13.5 percent) in 2006, reaching $238.4 

billion, almost equal to South Korea’s total foreign debt of $263.4 billion. The pace of growth in 

foreign exchange reserves over the second half of the year ($14.4 billion) was slightly less than 

in the first half ($15.3 billion). Over the first three months of 2007, foreign exchange reserves 

have grown $5.0 billion to $243.4 billion. 

South Korea’s economy continues to perform well, with real GDP growth of 5.0 percent in 2006, 

after 4.2 percent growth in 2005. The Bank of Korea (BOK) has used inflation targeting since 

1998, and its current inflation target for the period 2007-2009 has been set as a range of 3.0±0.5 

percent in terms of the three-year average of annual consumer price inflation. The overnight call 

rate is the major monetary policy instrument of the BOK. Consumer price inflation – at 2.2 

percent in March 2007 – is below the central bank’s target range. South Korea’s flexible 

exchange rate regime, under which the won has appreciated steadily since 2003, has contributed 

significantly to containing inflation. Despite substantial nominal and real appreciation of the 

South Korean won over this period, exports grew by close to 15 percent in 2006, after a 12 

percent increase in 2005. 

Rapid growth of imports caused the trade surplus to contract by $6.6 billion in 2006 to $16.6 

billion, with the trade surplus with the U.S. declining by $1.2 billion to $9.5 billion. South 

Korea runs a surplus in merchandise trade, but has a substantial and growing deficit in services. 

Driven by a rising net outflow of tourists and students, the services deficit reached a record $18.8 

billion in 2006. Spurred by declining balances in goods and services trade, Korea’s current 

account surplus fell sharply in 2006 to just $6.1 billion (0.7 percent of GDP), down from $15.0 

billion in 2005 and $28.2 billion in 2004 (when it was 4.1 percent of GDP). Korea depends 

heavily on petroleum imports, and the trade balance is sensitive to world oil prices. While down 

overall in 2006, South Korea’s trade and current account surpluses expanded in the final quarter 

of the year due to a sharp drop in the import bill as oil prices fell. 

China

The Chinese economy continued to grow rapidly during 2006, with GDP growth of 10.7 percent 

for the year. Growth accelerated during the first quarter of 2007, reaching a higher than 

anticipated 11.1 percent. At the same time, internal imbalances within the Chinese economy, 

which are of concern to the Chinese authorities and are the focus of the most recent Five-Year 

Plan, continued to grow more severe. 

Growth continues to rely on net exports and investment. In 2005, net exports and investment 

contributed 26 percent and 38 percent of GDP growth, respectively. Net exports have been 

rising as a share of GDP in recent years, reaching a record 7.3 percent of GDP in 2006. A 

preliminary estimate indicates that net exports contributed about one fifth of GDP growth in 

2006. The expansion of Chinese net exports continued in the first quarter of 2007. The trade 

surplus for the quarter was $46.5 billion, double the surplus in 1Q2006.27 China’s current 

account surplus rose to a record $249.9 billion in 2006 —55 percent above the 2005 level and 

 

27 Special features, e.g. anticipation of lower export tax rebates, may explain some of the rapid growth in the trade 

surplus in the first quarter. 
30

9.0 percent of China’s GDP. China’s current account surplus has been rising as a share of GDP 

since 2001, but the increase has been particularly sharp in the last two years. 

Investment as a share of GDP has risen along with net exports’ share of GDP. China’s 

investment rate rose in each of the five years to 2005, reaching 42.7 percent of GDP. Investment 

maintained this elevated level in 2006. Investment is supported by China’s high national saving 

rate, which was a record 52 percent of GDP in 2005.28 Since the beginning of the reform era, 

most booms and slowdowns in the Chinese economy have been associated with fluctuations in 

investment, and the rising share of investment in GDP increases the potential amplitude of these 

swings. The rapid growth of investment and GDP in the first quarter of 2007 and the 

acceleration of consumer price inflation have raised anew concerns about the possibility of 

overheating, industrial overcapacity, the potential build-up of new non-performing loans, and 

asset bubbles. A rapid unwinding of these conditions could lead to an abrupt slowdown (a “hard 

landing”) in the Chinese economy. 

China’s tightly managed exchange rate regime is a substantial obstacle to the resolution of 

economic imbalances that foster China’s high savings, high investment, and large trade 

surpluses. China maintained a de facto fixed exchange rate against the dollar from 1997 until 

July 2005. On July 21, 2005, the Peoples Bank of China (PBOC) revalued its currency, the 

renminbi, by 2.1 percent and announced the adoption of a new managed floating exchange rate 

regime. Since the initial revaluation, the renminbi has been tightly managed against the U.S. 

dollar, with limited fluctuation on a daily basis. The policy limit on daily movement above or 

below the morning “reference rate” was 0.3 percent until May 18, 2007, when the PBOC 

widened the limit to 0.5 percent. So far, intra-day movements of the RMB exchange rate have 

rarely approached the limits of the original 0.3 percent band. In the first year under the managed 

basket regime (July 22, 2005 to July 22, 2006), the maximum daily movement on either side of 

the reference rate averaged 0.04 percent during the course of trading. The RMB/USD rate has 

has experienced slightly more movement since, averaging 0.1 percent daily divergence from the 

morning reference rate. 

The renminbi appreciated 2.4 percent against the U.S. dollar in the second half of 2006. This 

was the largest half-yearly renminbi appreciation since the new exchange rate regime began in 

July 2005. The renminbi appreciated 6.5 percent against the Japanese yen and depreciated by 0.8 

percent against the euro during this same period as these currencies moved against the US dollar. 

The IMF index of China’s nominal effective exchange rate appreciated by 1.3 percent in the 

latter half of 2006. China’s real effective exchange rate (i.e., the average movement of the 

renminbi against the currencies of China’s trading partners, adjusted for movements in domestic 

prices), gained 2.7 percent in the second half of 2006 on the back of rising domestic inflation. 

By the same indicator, China’s currency appreciated 0.9 percent in real effective terms from July 

2005 to December 2006. 

During the second half of 2006, the People’s Bank of China (PBOC) continued to intervene 

heavily in China’s foreign exchange market. The PBOC’s foreign exchange reserves climbed by 

 

28 With national saving calculated as the sum of investment and the current account balance. 
31

$247.5 billion in 2006 and reached $1.066 trillion at end-2006.29 China’s large trade surplus was 

the primary source of net foreign demand for renminbi, although net foreign direct investment 

also contributed to foreign demand for the currency. China’s foreign exchange reserves 

continued to grow very rapidly in the first part of 2007, with total reserves reaching $1.2 trillion 

by end-March. The reserve increase in the first quarter of 2007 was in part due to the unwinding 

of foreign exchange swap contracts that the PBOC had entered into with Chinese banks as well 

as the rapid growth of the trade surplus.30 

In the 11th Five-Year Plan launched in early 2006, Chinese authorities set forth policy priorities 

aimed at curbing China’s domestic and external economic imbalances. Chief among these policy 

goals was bringing about a shift in the composition of China’s aggregate demand to rely less on 

investment and exports and more on domestic consumption. Despite this high level attention, the 

outcome for 2006 shows that the role of consumption continued to diminish and the shares of 

national saving, investment and net exports in GDP further increased. 

Slow implementation of market-based tools for domestic macroeconomic management is a key 

reason that China’s economy grew more imbalanced in 2006. Typically, in an economy as large 

as China’s, the central bank’s main goals are to maintain domestic growth and price stability. In 

China’s case, the primary task of the PBOC is to manage the exchange rate and absorb the large 

amount of domestic liquidity that results from the net inflow of foreign exchange into China. 

This ample supply of funds has contributed to low interest rates, high credit and investment rates, 

and increased risk of a “boom-bust” cycle. 

An autonomous monetary policy, with greater exchange rate flexibility, would give the PBOC 

better control over domestic credit and investment, and allow the PBOC to further liberalize 

interest rates and develop the monetary policy transmission mechanism, thus enabling improved 

credit allocation and reducing the risks of bubbles in asset prices. More effective monetary 

policy would help rebalance the Chinese economy towards greater household consumption, 

absorbing the impacts of increased government spending on education and social safety nets to 

prevent overheating. (Increases in fiscal outlays, as called for in the 11th Five-Year Plan, will 

help to reduce households’ “precautionary saving” for medical care, education, and retirement—

and bring down excessive national saving.) 

However, with current policy measures and constrained movement of the exchange rate, China’s 

growth grew more unbalanced in 2006. As Premier Wen Jiabao said before the National 

People’s Congress in March of this year, “the biggest problem in China's economy is that the 

growth is unstable, imbalanced, uncoordinated and unsustainable.'' This sentiment was echoed in 

a statement by National Development and Reform Commission (NDRC) Chairman Ma Kai in 

the same month when he said, “transformation of the nation's growth structure is an extremely 

urgent task.” 

 

29 The PBOC has conducted an undisclosed amount of foreign exchange swaps with Chinese commercial banks in 

recent years as a domestic liquidity management measure. One effect of these swaps is that the PBOC’s reported 

currency reserves are smaller than they otherwise would be until the swaps unwind. 

30 According to the 2006 annual reports of Bank of China, China Development Bank, and China Construction Bank, 

currency swaps conducted by these institutions with the PBOC exceeded US$ 70 billion. See in the China Securities 

Journal (Chinese) 王栋琳, 去年“已知”货币掉期达700多亿美元, 中证网: 2007-04-17, at 

<http://www.cs.com.cn/yh/02/200704/t20070417_1087175.htm> 
32

The leadership seems to be cautiously recognizing the benefits of a more flexible exchange rate. 

In January at the National Financial Sector Work Conference, Premier Wen said “a perfect 

exchange rate regime should consider our country's economic situation and the ability of the 

economy and companies to bear such changes and ensure there are no big fluctuations in the 

economy.” And in the same month, a research agency under the Ministry of Commerce, an 

agency historically averse to increased renminbi flexibility, issued a report stating that the 

renminbi was undervalued and that “continued, progressive and moderate appreciation of the 

renminbi would help regulate China’s yawning trade surplus.” 31 However, the report suggested 

that renminbi appreciation would also have negative effects in China, particularly for farmers 

and unskilled laborers and those in the central and western regions. 

China continues to take steps, though at a slow pace, aimed at reforming currency and monetary 

policy to eventually move towards a more freely-tradable and market-determined exchange rate. 

Currency market and financial sector reforms provide needed infrastructure for foreign exchange 

trading and hedging. China has now authorized 22 banks (both foreign and domestic) to act as 

market makers in the foreign exchange market. While in 2005 almost all foreign exchange 

transactions were with the Chinese authorities, now over 80 percent of all spot trades are 

conducted by private parties. The transaction volume in foreign exchange swaps, introduced in 

April 2006, reached $1 billion per day one year later, evidencing a rapid rise in the use of foreign 

exchange hedging. In January 2007, China launched SHIBOR (Shanghai InterBank Offer Rate) 

to create a benchmark yield curve for pricing financial instruments, including foreign exchange 

derivative products, as well as to enable the PBOC to monitor domestic liquidity conditions. In 

an effort to increase two-way capital flows, China announced on May 11, 2007, that QDII 

(Qualified Domestic Institutional Investor) license holders would be allowed to invest half of 

their funds in overseas equities. (QDII’s were previously limited to bonds and other fixed 

income instruments). On May 23, China announced that the quota for QFIIs (Qualified Foreign 

Institutional Investors) would be increased from $10 billion to $30 billion. 

At the second session of the U.S.-China Strategic Economic Dialogue (SED) held in Washington 

on May 22 and 23, Chinese and U.S. officials discussed China’s reform progress in detail. 

Chinese authorities reiterated the priority they place on shifting the composition of economic 

growth towards domestic consumption and correcting imbalances in the economy and the role 

that exchange rate reform plays in that process. 

Despite the progress that China has made and the continued public commitment to reform, 

China’s exchange rate is undervalued against the U.S. dollar, even in the judgment of domestic 

observers. Prolonged, one-way intervention in foreign exchange markets by the central bank, an 

unprecedented amount of foreign exchange reserve accumulation, and a rapidly increasing 

current account surplus are clear indicators of fundamental renminbi undervaluation. While 

China has taken some steps to increase the flexibility of the renminbi, the pace of appreciation 

that the authorities have allowed is much too slow and should be quickened. 

 

31 Website of the Ministry of Commerce (English), 1/17/2007, “Report: RMB Estimated to Keep Gaining This 

Year,” Xinhua. 
33

Although the renminbi is undervalued and market sentiment clearly favors appreciation, 

Treasury concluded that China did not meet the technical requirements for designation under the 

terms of Section 3004 of the Act during the period under consideration. Treasury was unable to 

determine that China’s exchange rate policy was carried out for the purpose of preventing 

effective balance of payments adjustment or gaining unfair competitive advantage in 

international trade. 

Taiwan 

Taiwan operates a managed floating exchange rate regime. According to the central bank’s 

official policy statement, the exchange rate is market-determined except in instances when “the 

market is disrupted by irregular factors” and the central bank intervenes. Throughout the second 

half of 2006, the Taiwan dollar (NT$) remained within the 31-35 NT$/USD trading range in 

which it has fluctuated for more than five years. After ending 2005 at 33.29/USD and 

appreciating 2.6 percent to end the first half of 2006 at 32.44/USD, the NT$ depreciated 0.5 

percent to end the year at 32.59/USD. The NT$ ended March 2007 at 33.06/USD, having 

depreciated another 1.4 percent from its end-2006 value. 

Broad money supply (M2) grew 6.13 percent over 2006. The central bank raised interest rates 

by 50 basis points, with the discount lending rate ending the year at 2.75 percent; required 

reserve ratios remained unchanged over the year. The central bank continued its practice of 

sterilizing nearly all of its interventions. 

Taiwan has experienced sluggish domestic demand growth and low inflation or falling prices 

since a sharp decline in fixed investment spending led to a short recession that began in the 

fourth quarter of 2000. However, strong export growth has allowed Taiwan to achieve annual 

real GDP growth rates between three and six percent since the recession ended. Growth in 

Taiwan has been highly dependent on world market growth and demand for Taiwan’s exports. 

Real GDP growth slowed from 6.3 percent at an annual rate in the last half of 2005 to 3.0 percent 

in the first half of 2006, as net export growth slumped. GDP growth then recovered to 6.2 

percent in the second half of 2006, as net exports recovered and contributed 3.3 percent to GDP 

growth. Taiwan’s exports are heavily concentrated in sales of electronics to China, Japan, and 

the United States, meaning that small fluctuations in either overall demand in these three large 

economies or global demand for electronics can lead to significant fluctuations in Taiwan’s 

income from net exports. 

Inflation also continued to remain very low, with prices falling by some measures, throughout 

2006. Consumer prices, excluding food and energy, rose by 0.5 percent y/y in the second half of 

2006, while Taiwan’s GDP deflator declined by 1.2 percent in the second half of 2006. Prices 

have remained very weak in 2007; consumer prices excluding food and energy were 0.1 percent 

lower at end-March 2007 than at end-2006. 

Taiwan’s current account surplus rose from $10.4 billion (5.9 percent of GDP) in the first half of 

2006 to $14.8 billion (8.2 percent of GDP) in the second half of 2006, reflecting a widening 

surplus in goods trade, a narrowing deficit in services trade, and growth in the income surplus. 
34

Since the second half of 2005, Taiwanese residents have increased their demand for foreign 

assets while foreign investors have eased their demand for Taiwan dollar assets, reducing upward 

pressure on the Taiwan dollar exchange rate. Net accumulation of foreign exchange reserves, 

which averaged nearly $29 billion a year from 2001 to 2005, consequently slowed to $2.7 billion 

in the first half of 2006, and $3.4 billion in the second half of 2006. Total foreign reserves stood 

at $260 billion at mid-year, and $266 billion at year’s end 2006. Total foreign reserves rose by 

just $1 billion in the first quarter of 2007 to reach $267 billion at end-March 2007.

Malaysia

Nearly two years after its move off a fixed U.S. dollar peg, Malaysia is progressing towards a 

more flexible exchange rate regime. Since the initial revaluation on July 21, 2005, the ringgit 

has appreciated steadily against the dollar. Daily exchange rate volatility has increased since 

mid-2006, and Malaysia took further steps to relax foreign exchange controls in April 2007. 

Structural imbalances still persist in the Malaysian economy. The current account surplus 

remains very large, and the level of foreign exchange reserves has increased significantly over 

the past year. Nevertheless, there are signs that private consumption and fixed investment levels 

are rising, which, with a more flexible exchange rate, should lead to more balanced growth in the 

coming years. 

Malaysian authorities have intervened in foreign exchange markets in both directions – buying 

the ringgit to limit depreciation and accumulating foreign reserves to fend off upward pressure. 

Though Malaysia’s authorities have intervened heavily in times of strong pressures on the 

currency, the ringgit has recently been appreciating at a faster pace than in the 14 months 

following the initial revaluation. Since the initial 1.4 percent revaluation in July 2005, the ringgit 

continued to appreciate steadily over the course of 2006, rising by 6.6 percent in nominal terms. 

The average daily fluctuations against the dollar have also increased from 0.05 percent in the 

second half of 2005 to 0.16 percent in the first half of 2006 and 0.18 percent in the second half of 

the year. The ringgit has appreciated by an additional three percent in nominal terms since the 

beginning of 2007, as a result of strong portfolio flows into the local stock market. The 

authorities have stated that they will continue efforts to moderate excessive volatility in the 

exchange rate, but reiterated that long-term fundamentals should drive the value of the ringgit. 

Malaysia continues to relax the capital controls put in place in the aftermath of the Asian crisis in 

1998, and has more recently begun to relax controls that pre-dated the crisis. In March 2007, the 

central bank, Bank Negara Malaysia, announced changes to the foreign exchange rules that 

liberalize capital flows in both directions. The measures, which took effect on April 1, allow 

greater flexibility for onshore banks to engage in foreign exchange activity by abolishing limits 

on net open positions and increasing the scope of allowable activity; provide non-residents with 

greater access to ringgit assets and financial products; and allow residents to engage in foreign 

currency transactions. However, offshore trading of the ringgit remains prohibited. 

Malaysia’s economy has maintained a strong rate of growth, averaging nearly 6.0 percent y/y 

over the past four years. In 2006, despite weaker external demand, real GDP grew 5.9 percent 

y/y, driven by domestic consumption, which contributed 3.5 percentage points of the growth, and 
35

rising investment spending, which added an additional 1.7 percentage points to growth. Private 

sector demand was a key driver, supported by improving business sentiment and rising job 

creation. Inflation rose in the first half of 2006, peaking at 4.8 percent y/y in March, following 

increases in administered fuel prices earlier in the year, but steadily decelerated over the second 

half, ending the year at 3.1 percent y/y. The 3.6 percent inflation rate for 2006 was the highest 

rate since 1998. For the first four months of 2007, inflation declined further to an average of 2.4 

percent. Given relatively low inflationary pressures, the central bank has maintained the 

overnight policy rate at 3.5 percent since April 2006. 

Exports have been a key source of growth, with the export share of GDP exceeding 120 percent, 

greater than the average of its regional peers.32 Electronic exports account for nearly half of 

Malaysia’s total exports, and the United States is Malaysia’s primary export destination for 

electronic goods. (Malaysia is the United States’ 11th largest trading partner.) This closely ties 

Malaysian export performance to economic conditions in the United States. In the second half of 

2006, export growth slowed to 14.1 percent y/y from 23.1 percent in the first half of the year, and 

fell further in the first quarter of 2007 to 7.7 percent y/y due to weak external demand. The 

increase in intermediate imports kept pace with exports given that they make up 70 percent of 

total imports, but demand for other import goods has been relatively robust due to stronger 

domestic demand. 

As a net oil exporter, Malaysia has significantly benefited from recent high oil prices, and the 

rise in oil prices has contributed to further growth of Malaysia’s already large current account 

surplus. In 2006, the current account surplus was $25.6 billion, over 16 percent of GDP, with the 

non-oil current account surplus at 13 percent of GDP. Except for Singapore, Malaysia runs the 

highest current account surplus as a percentage of GDP of emerging market countries in Asia. 

Significant capital outflows, reflecting greater overseas investment by Malaysian firms and debt 

repayments, have, to a large extent, offset the large current account surplus. Nevertheless, 

Malaysia’s external position remains strong, as reserves stood at $82.5 billion at the end of 2006, 

roughly six months of import cover. Reserves increased by $3.7 billion in the second half of 

2006, as compared to $8.3 billion in the first half. Reserves have continued to accumulate in 

2007, and were $88.6 billion as of end-March, a seven percent year-to-date increase. 

Total investment continues to recover from its post-Asian crisis collapse, but has yet to return to 

pre-crisis levels. Private fixed capital investment has increased by 28 percent since 1999 and has 

continued to recover steadily over the past two years. However, investment in Malaysia as a 

share of GDP is still well below what it was in the early 1990s – long before the run-up to the 

Asian financial crisis. In 2006, gross fixed capital formation was 27 percent of GDP compared 

to an average of almost 40 percent over the 1990-1994 period. 

 

32 Malaysia, like many economies in East Asia, imports components for further processing and assembly. This is the 

reason that total exports (but not value-added in export industries) are larger than GDP.