U.S. Department of the Treasury

Report to Congress on International Economic and Exchange Rate Policies

For the Period January 1, 2001 through June 30, 2001

THIS REPORT IS REQUIRED UNDER SECTION

3005 OF THE OMNIBUS TRADE AND

COMPETITIVENESS ACT OF 1988 (THE

“ACT”). THIS REPORT REVIEWS

DEVELOPMENTS IN U.S. INTERNATIONAL

ECONOMIC POLICY, INCLUDING EXCHANGE

RATE POLICY, DURING THE PERIOD OF

JANUARY 1, 2001 THROUGH JUNE 30, 2001.

Summary

Major Findings

• The pace of U.S. economic growth continued to slow over the period of

January 1, 2001 through June 30, 2001. Real investment in equipment and

software dropped sharply. Unemployment edged upward. Productivity,

however, rebounded strongly in the second quarter, providing evidence of

continuing long run strength.

• Global growth also continued to slow, leading to a contraction of U.S.

exports in the first half of 2001. U.S. import growth, however, declined at a

more rapid pace than exports and the current account deficit fell in both quarters

of the reporting period.

• U.S. acquisition of foreign assets and foreign acquisition of U.S. assets both

declined markedly in the second quarter of 2001 after surging in the first.

• Treasury determined that no major trading partners of the United States

manipulated exchange rates under the terms of Section 3004 of the Act

during the period under consideration. We continue to monitor the exchange

rate practices of major U.S. trading partners and encourage their taking further

steps toward more flexible exchange rate regimes where appropriate.

Policy Priorities

• Pursue sound economic and financial policies in the United States. The

Administation’s tax relief program and planned fiscal actions, along with

Federal Reserve actions this year, represent significant steps toward

revitalizing the domestic economy. Economic fundamentals and growth

potential remain strong.

• Encourage policies abroad that promote strong global growth. A healthy

global economy requires that economies raise productivity and perform at

their full potential.

• Pursue efforts to expand world trade, which is critical to U.S. economic

success.

• Encourage closer monitoring of economic and financial developments,

and prompt policy action to prevent financial crises.

• Combat money laundering and terrorist financing. Strengthened efforts

are critical to cut off terrorists’ access to financing and to strengthen the integrity of the international monetary system.

EMBARGOED:

FOR RELEASE AT 4:30 P.M., EDT,

OCTOBER 24, 2001

Table of Contents

Summary . . . . . . . . . . . . . . . . . 1

U.S. Economy . . . . . . . . . . . . . 2-4

Other Major Economies . . . . . . 5-6

Emerging Market Economies . . 7-9

Exchange Rate Regimes 

Assessed . . . . . . . . . . . . . . . 10-11
U.S. Department of the Treasury

Report to Congress on International Economic and Exchange Rate Policies

Reporting Period: For the Period January 1, 2001 through June 30, 2001

Page 2

U.S. Economy

Overview of the U.S. Economy

The U.S. economy has been slowing since the third quarter of

2000 and managed only a 1.3 percent annual rate of growth in

the first quarter of 2001 and a 0.3 percent rate in the second,

the slowest pace since the first quarter of 1993. Capital

spending, particularly in the high-tech sector, has been one of

the primary factors that has held growth down. Real investment in equipment and software dropped sharply in the second

quarter for the third quarterly decline in a row, and investment

in new structures fell as well.

The household sector has provided the main support to the

economy. Consumer spending continued to rise in the second

quarter, up at a favorable 2.5 percent annual rate (saar), and

housing demand remained high due to low mortgage interest

rates. Advanced tax refunds pumped roughly $40 billion into

the economy in the third quarter.

The weakness in the economy since the middle of last year has

translated into reductions in employment. Private sector payroll jobs have declined by 150,000 through the first six months

of the year, and the unemployment rate rose from 4.0 percent

in December 2000, to 4.5 percent in June 2001. Manufacturing has borne the brunt of the employment decline, losing

592,000 jobs through the first six months of this year and

nearly 800,000 since a recent peak in July 2000.

Core consumer inflation (excluding food and energy) rose at a

3.1 percent annual rate over the reporting period, and energy

prices 11.3 percent. Energy prices have fallen in recent months

and 12 month increases in core inflation have leveled off

around a 2-3/4 percent rate. Productivity rebounded in the

second quarter to a strong 2.1 percent rate, however, suggesting that despite cyclical influences, structural productivity is

very sound. That increase was only slightly below the 2.4

percent trend rate of growth since 1995, a remarkable performance since productivity usually declines when business

slows.

The Federal Reserve responded to the weakening economy,

reducing interest rates six times in the first six months of this

year, bringing the target for the federal funds rate down from

6.5 percent at the end of last year to 3.75 percent at the end of

this reporting period.

2%

3%

4%

5%

6%

1/98 7/98 1/99 7/99 1/00 7/00 1/01

0%

1%

2%

3%

4%

Unemployment (left axis)

Inflation

Core Inflation (ex. food and energy)

U.S. Civilan Unemployment Rate and Inflation Rate

Unemployment (left axis); Inflation (y/y % change in prices, right axis)

Source: Bureau of Labor Statistics

4%

5%

6%

7%

8%

1/98 7/98 1/99 7/99 1/00 7/00 1/01

U.S. Interest Rates

% (10 year Treasury, constant maturity)

Source: U.S. Treasury

0%

2%

4%

6%

8%

10%

1Q/97 1Q/98 1Q/99 1Q/00 1Q/01

U.S. Real Gross Domestic Product. 1997-2000

% change over previous quarter, SAAR

Source: Bureau of Economic Analysis (BEA)

-1%

0%

1%

2%

3%

4%

5%

6%

1Q/97 1Q/98 1Q/99 1Q/00 1Q/01

16%

17%

18%

19%

20%

21%

Personal

Government

National (right axis)

U.S. National Saving and Selected Components 

% of GDP (personal/gov't on left axis; national on right axis)

Source: BEA
U.S. Department of the Treasury

Report to Congress on International Economic and Exchange Rate Policies

Reporting Period: For the Period January 1, 2001 through June 30, 2001

Page 3

The Current Account

The deceleration in the U.S. economy has sharply curtailed

imports, particularly that of capital goods, with a resulting

reduction in the current account deficit. The current account

deficit fell to $447 billion (saar), or 4.4% of GDP, in the first

quarter of 2001 and to $426 billion, or 4.2 % of GDP, in the

second quarter, compared with a deficit of $465 billion, or 4.6

percent of GDP, in the fourth quarter of 2000. The decline

was more than accounted for by the decline of the merchandise trade deficit from $474 billion (saar) in the final quarter

of 2000 to $450 billion in the first quarter and $431 billion in

the second quarter of 2001.

The slowing global economy reduced U.S. exports over the

first half of 2001 even as U.S. imports declined. Exports of

goods and services (saar) were 3.5% lower, while imports

were 5.4% lower, in the second quarter of 2001 than the final

quarter of 2000. Imports of capital goods excluding automobiles (sa) declined 16.1 % from the final quarter of 2000 to the

second quarter of 2001 while exports declined 9%.

U.S. net investment income payments (sa), $3.7 billion in the

first quarter of 2001 and $4.2 billion in the second, are much

smaller than the size of the U.S. net international investment

position might suggest. This results from the higher rate of

return that U.S. investors secure on their foreign assets relative

to what foreigners secure on their U.S. assets. In particular,

the net income on foreign direct investment is significantly

positive even though the value of foreigners’ direct investment

in the United States exceeds that of U.S. residents abroad. In

the first two quarters of 2001 the net income on direct investment (sa), at $22.7 billion and $23.1 billion, was significantly

greater than it was in comparable quarters of 2000. This

800

900

1000

1100

1200

1300

1400

1500

1600

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

Imports

Exports

U.S. Trade in Goods and Services

Billion of U.S. $, SAAR (BOP Basis, trade balances in bold)

Source: Bureau of Economic Analysis, Bureau of the Census

-166 -181 -253 -305 -355 -397

U.S. Trade in Goods and Services

Billions of U.S. $ (BOP basis, SAAR)

Level Change Level Change

1Q/99 925.3 -8.7% 1,136.8 5.1%

2Q/99 936.7 5.0% 1,188.2 19.4%

3Q/99 966.4 13.3% 1,250.9 22.9%

4Q/99 1,001.1 15.2% 1,300.9 17.0%

1Q/00 1,029.0 11.6% 1,378.3 26.0%

2Q/00 1,063.3 14.0% 1,426.4 14.7%

3Q/00 1,090.0 10.4% 1,479.3 15.7%

4Q/00 1,080.5 -3.4% 1,481.7 0.6%

1Q/01 1,077.2 -1.2% 1,457.3 -6.4%

2Q/01 1,042.3 -12.3% 1,401.8 -14.4%

Source: Bureau of the Census

 Exports Imports 

U.S. Bilateral Merchandise Trade Balances

Billions of U.S. $ (nsa, Census basis) South

China Japan Canada Mexico America EU

1Q/99 -13.6 -16.3 -6.8 -5.7 1.1 -5.6

2Q/99 -15.7 -17.2 -6.8 -6.5 -.3 -10.6

3Q/99 -20.1 -19.4 -9.4 -6.3 -2.5 -13.8

4Q/99 -19.3 -20.4 -9.4 -4.2 -1.7 -13.3

1Q/00 -16.7 -19.1 -10.8 -5.5 -3.9 -12.3

2Q/00 -19.4 -20.7 -12.2 -6.3 -3.5 -13.0

3Q/00 -25.0 -20.3 -13.8 -6.3 -3.6 -14.8

4Q/00 -22.8 -21.5 -15.2 -6.5 -3.1 -14.9

1Q/01 -18.0 -18.2 -14.6 -6.4 -3.4 -13.3

2Q/01 -19.0 -16.2 -13.9 -8.1 -1.8 -14.8

Source: Bureau of Economic Analysis, Bureau of the Census 

-500

-400

-300

-200

-100

0

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

Current Account Balance

Goods and Services Balance

U.S. External Balances

Billions of U.S. $, SAAR (Balance of Payments, BOP, Basis)

Source: Bureau of Economic Analysis, Bureau of the Census
U.S. Department of the Treasury

Report to Congress on International Economic and Exchange Rate Policies

Reporting Period: For the Period January 1, 2001 through June 30, 2001

Page 4

nearly offsets the net payments to foreign residents on U.S.

Government assets (s.a.), which totaled $26.1 billion in the

first quarter of 2001 and $25.6 billion in the second quarter.

Financial Flows:

U.S. residents’ acquisition of foreign assets, and foreign investors’ acquisition of U.S. assets declined markedly in the

second quarter of 2001 after surging in the first quarter. Foreign direct investment flows (sa) to the United States fell to

$120 billion compared to $127 billion in the first half and

$161 billion in the second half of 2000. Net U.S. foreign direct investment flows abroad (sa) were $77 billion in the first

half of 2001 compared to $72 billion in the first half and $81

billion in the second half of 2000.

After modest, $0.7 billion, net purchases of Treasuries in the

first quarter of 2001, non-official foreigners resumed their net

sales to US residents in the second. Net sales, on the other

hand, of non-Treasury securities remained very strong, nonofficial foreigners purchasing $148.8 billion in the first quarter

and $132.7 billion in the second. These levels are significantly

above the levels of corresponding quarters of 2000.

U.S. Exchange Rate Developments

The January 1 - June 30, 2001 reporting period was characterized by sustained foreign investment flows into U.S. assets,

notably corporate debt securities. This demand for U.S. assets

was evident in an appreciation of the dollar against most other

major currencies. The yen depreciated from around ¥115 per

dollar at the start of the period to over ¥120 at the end of it,

and the euro depreciated from $0.94 to $0.83. There was no

foreign exchange market intervention in the major currencies

during the period.

The Federal Reserve Board staff’s broad nominal dollar index

indicated that the dollar appreciated 3.5% on a trade-weighted

basis during the period covered by this report, after a 3.6%

appreciation in the second half of 2000. The real dollar

appreciated 4.5% during the first half of 2001, after a 3.0%

appreciation during the second half of 2000. Dollar

movements have reflected continued foreign interest in

investing in the United States, despite slowing economic

activity.

During the reporting period, January 1, 2001 through June 30,

2001, G-7 Finance Ministers and Central Bank Governors

referred to exchange rates among the major currencies in two

communiqués (February 22, 2001 and April 28, 2001), each

time stating:

“We discussed developments in our exchange and financial

markets. We reiterated our view that exchange rates among

major currencies should reflect economic fundamentals. We

will continue to monitor developments closely and to cooperate in exchange markets as appropriate.”

U.S. Financial Flows

Millions of U.S. $ s.a.* , Q2/99 Q3/99 Q4/99 Q1/00 Q2/00 Q3/00 Q4/00 Q1/01 Q2/01

Net Financial Flows................................................... 106,573 55,923 119,771 59,358 154,986 114,613 115,542 103,329 126,784

Net Portfolio Flows................................................... -1,371 57,678 108,664 124,897 36,560 100,258 98,114 194,696 35,909

U.S. acquisition of foreign assets**.............................. -98,984 -55,970 -29,610 -102,802 -69,130 -47,714 -69,135 -92,602 -34,807

Foreign acquisition of U.S. assets.............................. 97,613 113,648 138,274 227,699 105,690 147,972 167,249 287,298 70,716

Foreign Official............................................. -736 12,721 27,402 22,498 6,447 12,247 -3,573 4,898 -22,430

Private***...................................................... 98,349 100,927 110,872 205,201 99,243 135,725 170,822 282,400 93,146

Net Banking Flows...................................................... -6,936 -2,808 -21,890 -63,659 61,378 -20,057 -28,209 -102,899 59,314

Assets............................................................... -36,016 -10,476 -52,808 -56,234 7,455 -18,147 -71,574 -109,789 9,191

Liabilties............................................................ 29,080 7,668 30,918 -7,425 53,923 -1,910 43,365 6,890 50,123

Net Direct Investment................................................ 114,880 1,053 32,997 -1,880 57,048 34,412 45,637 11,532 31,561

U.S. direct investment abroad.................................... -36,474 -49,750 -30,631 -38,388 -33,346 -41,634 -39,070 -40,940 -35,602

Foreign direct investment in the United States............... 151,354 50,803 63,628 36,508 90,394 76,046 84,707 52,472 67,163

Source: Bureau of Economic Analysis

* Details may not add to totals due to rounding.

** Net private claims on foreigners by nonbanks plus net private U.S. purchases of foreign securities.

***Net purchases of U.S. Treasury securities, net nonbank liabilities to foreigners, net purchases of gov't non-Treasury securities, and net U.S. currency flows.

100

110

120

130

140

150

1/99 7/99 1/00 7/00 1/01

Currency Movements: United States

Federal Reserve Board Staff Nominal Broad Dollar Index, 1/97=100
U.S. Department of the Treasury

Report to Congress on International Economic and Exchange Rate Policies

Reporting Period: For the Period January 1, 2001 through June 30, 2001

Page 5

Economic and Currency Market

Developments in Other Major

Economies

Overview of Other Major Economies

Economic activity in the major industrial countries weakened

perceptibly in the first half of 2001, influenced by the slowdown in the U.S. economy, which began in the second half of

2000. The slowdown also reflected the continued weakness in

Japan. In Europe, which experienced the best growth rate in a

decade in 2000, the pace of activity slowed far more than expected and to a considerable degree in view of more potent

global transmission effects than anticipated. On balance no

major economy escaped the synchronous slowdown in the first

half of 2001. Recent data indicate further weakening across

all the major countries. With the slowing of activity, inflation

pressures appeared to be contained in the major economies

and indeed waned over the period, while deflationary pressures remained firmly entrenched in Japan. These developments permitted an overall easing of monetary conditions in

the major countries led by the vigorous actions of the Federal

Reserve. Foreign interest in acquiring U.S. assets remained

strong throughout the period, reflecting the relative attraction

of investment in the United States and major currencies depreciated modestly against the dollar.

Euro Zone Countries. Euroland’s 3.4% growth last year was

the best in 10 years. This year, aggregate growth will probably fall below 2%. Early confidence that the Euro Zone could

withstand the effects of economic slowing in the rest of the

world now seems overly optimistic. GDP growth was only

0.2% (saar) in the second quarter: Germany, Italy, and Belgium had negative growth; France and Spain had positive, but

sharply lower, growth. The area-wide unemployment rate has

reached 8.3%, a ten-year low, but slowing growth will likely

reverse this in the second half of this year. Headline inflation

spiked above 3% in the late spring from a combination of food

price increases and continued high oil prices. Core price inflation edged just above 2%.

The expectation of relatively stronger growth in the Euro Area

compared to the United States buoyed demand for the euro in

the fourth quarter of 2000. This advance, however, peaked in

the first two weeks of January and the euro experienced a general depreciation throughout the first two quarters of this year,

as evidence accumulated of European vulnerability to the

global slowdown. Last year, rising domestic demand and increasing oil prices generally offset the effect of a decline in the

trade-weighted value of the euro, causing a deterioration of the

current account. In the first half of 2001, however, falling

import demand and lower oil prices offset weak exports and

the current account recovered from –0.9% of GDP in the

fourth quarter of 2000 to -0.4% of GDP in the second quarter

of 2001.

The European Central Bank cut rates by 25 basis points in

May. Euro Zone stock markets declined in the first half. The

German DAX declined almost 6% and the French CAC almost

12%.

United Kingdom. U.K. growth is also slowing but was, in the

second quarter of 2001, the strongest in the G-7 – at 1.8%

(saar) after 2.6% in the first. Growth has been sustained by

strong consumption, while the relative strength of sterling

hampered the competitive position of the manufacturing sector. The current account deficit (sa) fell to 0.6% and 1.6% of

GDP in the first and second quarters of 2001 from its 1.9%

and 2.1% levels of the third and fourth quarter of 2000.

Labor market conditions remained generally tight during the

period, particularly for skilled workers. The unemployment

rate fell to 3.2% in June 2001, reaching at that time a 26-year

low.

The benchmark inflation rate (retail prices excluding mortgage

interest rates) was 2.4% y/y in June, up from December’s

2.1% rate, but below the Bank of England’s 2.5% target rate.

In the first half of 2001, the BOE's Monetary Policy Committee made three 25 basis point reductions in its benchmark interest rate. This was due to greater concern about slowing

growth and reduced concern about inflation.

0.80

0.90

1.00

1.10

1.20

1/99 7/99 1/00 7/00 1/01

Currency Movements: Euro-zone

Euros per Dollar (inverted scale)

0.50

0.55

0.60

0.65

0.70

0.75

1/99 7/99 1/00 7/00 1/01

Currency Movements: United Kingdom

Pounds per Dollar (inverted scale)
U.S. Department of the Treasury

Report to Congress on International Economic and Exchange Rate Policies

Reporting Period: For the Period January 1, 2001 through June 30, 2001

Page 6

Sterling depreciated 5.9% against the dollar in the first half of

2001, following a 1.2% depreciation in the second half of

2000. In contrast to the movement against the dollar, sterling

appreciated 4.2% in terms of the euro in the first half of 2001,

following a 0.7% appreciation in the second half of 2000. The

real trade-weighted value of the pound depreciated 0.6% in the

first half of 2001 following a 0.9% appreciation in the second

half of 2000.

Japan. The Japanese economy weakened in the first half of

2001, as the gradual recovery from the 1997-98 recession ran

out of steam. Real GDP for the period was flat compared to

the second half of 2000, as modest growth in real consumption

spending was offset by declining net exports and weakening

business investment. Recent data suggest that the economic

weakness has deepened in the second half of the year:

industrial production in July-August 2001 was down 3-1/2%

from its level in the second quarter, and data on producers'

inventories suggest the inventory adjustment cycle could put

further downward pressure on production in coming months.

Deflationary pressures remained entrenched, with core

consumer prices (excluding perishables) down 0.9% y/y in

June 2001.

Japan needs continued progress in market-opening

deregulation and structural reforms, especially in the financial

sector, to raise its potential growth rate. The declining size of

the work force due to Japan's aging population implies that

rapid productivity gains will be needed in coming years to

avoid a decline in living standards.

The yen depreciated by 7.4% against the dollar in nominal

terms, 10.4% in real terms, and 6.1% in real trade-weighted

terms, from December to June. Japan's current account

surplus fell from a seasonally-adjusted ¥5.9 trillion ($54

billion, or 2.3% of GDP) in the second half of 2000, to ¥5.1

trillion ($42.0 billion, or 2.0% of GDP) in the first half of

2001. Japanese investors increased their holdings of foreign

assets in the January-June period, recording net outflows of

¥5.1 trillion ($42.7 billion), while foreign investors reduced

their holdings of Japanese assets by ¥320 billion ($2.7 billion).

Japan's foreign exchange holdings increased by $1.4 billion in

the first half of 2001 after posting a $17.3 billion increase in

the second half of 2000.

Canada. Real GDP grew 1.5% (saar) during the first six

months of 2001, slowing from 3.1% in the second half of

2000. The unemployment rate was 7.0%, up from 6.8% in

December 2000, but still at a 24-year low. Consumer prices

were up 3.3% through June 2001 compared with 3.2% in

December. Short-term government bond rates have fallen

while long-term government bond rates have been relatively

flat during the six-month period. Because of reduced concerns

about inflation and to support flagging growth, the Bank of

Canada cut its benchmark policy rate 4 times for a total of 125

basis points in the first half of 2001.

The Canadian dollar depreciated 1.2% against the U.S. dollar

during the first half of 2001 following a 1.3% depreciation in

the second half of 2000. The real trade weighted index of the

Canadian dollar appreciated mildly in the twelve months to

June 2001, falling 1.2% over the second half of 2000 and rising 1.7% over the first half of 2001.

Canada’s overall current account surplus for the first half of

2001 was $15.2 billion (sa) or 4.3% of GDP, up from 2.9% in

the second half and 2.2% in the first half of 2000. Canada's

surplus of goods and services with the United States fell

slightly to $32.2 billion in the first half of 2001 from $32.8

billion in the second half of 2000.

90

100

110

120

130

1/99 7/99 1/00 7/00 1/01

Currency Movements: Japan

Yen per Dollar (inverted scale)

1.20

1.30

1.40

1.50

1.60

1.70

1.80

1/99 7/99 1/00 7/00 1/01

Currency Movements: Canada

Canadian Dollars per Dollar (inverted scale)
U.S. Department of the Treasury

Report to Congress on International Economic and Exchange Rate Policies

Reporting Period: For the Period January 1, 2001 through June 30, 2001

Page 7

Economic and Currency Market

Developments in Emerging Market

Economies

Overview of Key Emerging Markets

Credit and liquidity spreads in the first half of 2001 continued

a rise that began in the second half of 2000, although at a

slower pace. Spreads rose as concerns over global growth

began to materialize and the potential for credit events within

emerging markets increased. The yield spread over U.S.

Treasuries of JP Morgan’s Emerging Market Bond Index Plus

(EMBI+), after reaching 784 basis points at the end of the first

quarter, remained 10 basis points higher at the end of 2Q/2001

compared to 4Q/2000. This increase was due, in part, to continued concerns about the sustainability of Argentina’s public

debt (roughly 20% of the EMBI+ total market capitalization)

and the February crisis in Turkey.

As judged by issuance, emerging market financing strength

was mixed. Bond issuance recovered strongly in 1Q and

2Q/2001. As a result, large emerging market borrowers such

as Brazil and Mexico were able to cover over 90% of their

financing needs for the entire year. On the other hand, equity

and syndicated loan issuances were well off their respective

2000 levels and closer to 1998 levels, which were abnormally

low due to the Asian and Russian crises.

On a positive note, emerging markets in Asia, Emerging

Europe and the Middle East made progress in reducing their

vulnerability to external shocks in 2001. Short-term debt declined by roughly $40 billion to$380 billion by the end of

2000. Meanwhile, reserves declined only $20 billion to $760

billion. Notably, Latin American emerging markets increased

short-term debt $10 billion to $150 billion, while reserves remained constant at $135 billion. This is largely attributable to

Argentina and Brazil, whose end-2000 debt to reserve ratios

increased from 180% to 190% and 120% to 130%, respectively.

Growth in much of the Latin America weakened during the

first half of 2001, due to negative external and domestic

shocks. Argentina experienced negative growth in the first

half of the year and Brazil and Mexico’s economies slowed

considerably, the former due in part to its domestic energy

crisis. The U.S. and global slowdown reduced demand for

exports, particularly in Mexico, and uncertainty emanating

from Argentina and elsewhere reduced investor appetite for

risk, raising fears about reduced capital inflows. The current

account deficit for the Latin American region widened as exports slowed and interest rates rose (though lower import demand mitigated this trend). Due to concerns about the economic outlook, investment inflows have declined. New Latin

American emerging market issues in the first six months of

2001 were $29 billion (not including the Argentine bond

swap), down from $38 billion in the first half of 2000, according to the IMF. External bond spreads, as measured by

the Latin America EMBI+ index, widened 97 bps to 803 bps

during the first half of the year. Weaker exports and capital

inflows have put pressure on exchange rates for those countries with floating exchange rate regimes and on international

reserves for countries with fixed regimes.

Source: IMF, World Bank, OECD, BIS External Debt Tables

Tale of Two EMBI+ Spreads, 2000-2001

Basis point spreads over U.S. bonds (Source: JP Morgan)

200

400

600

800

1000

1200

1400

Jun-00

Jul-00

Aug-00

Sep-00

Oct-00

Nov-00

Dec-00

Jan-01

Feb-01

Mar-01

Apr-01

May-01

Jun-01

EMBI+

Turkey

Argentina

Financial Developments in Emerging Markets

1999 2000 3Q/00 4Q/00 1Q/01 2Q/01

Issuance (US$ bil.) 163.6 216.4 50.3 50.3 42.2 48.1

 Bonds 82.4 80.5 21.1 9.4 26.8 27.7

 Equities 23.2 41.7 8.8 12.4 2.3 5.3

 Loans 58.1 94.2 20.4 28.5 13.1 15.2

Secondary Bond Markets (bps)

 EMBI+ 703 756 677 756 784 766

 Asia 221 489 423 489 450 397

 Latin America 597 706 634 706 763 803

 Em. Europe 1,762 988 852 988 957 766

Stock Market Returns (%)

MSCI EM Free 6.4 -31.8 -13.4 -13.5 -6.2 3.1

 Asia 67.6 -42.5 -22.3 -17.3 -0.1 -1.6

 Latin America 55.5 -18.4 -6 -8.5 -3.5 7.1

 Em. Eur./M. East 76.7 -23.4 -3.9 -14.3 -22 4.5

Emerging Markets Short Term Debt to Reserves 

(S-T external debt as a percentage of gross FX reserves)

0%

40%

80%

120%

160%

200%

1990 1992 1994 1996 1998 2000

All Asia

Latin America Em. Europe and Middle East
U.S. Department of the Treasury

Report to Congress on International Economic and Exchange Rate Policies

Reporting Period: For the Period January 1, 2001 through June 30, 2001

Page 8

Weakening global demand, particularly for high tech goods,

caused real GDP in Emerging Asia (outside of China) to decline by an average rate of negative 0.8% (saar) during the

first two quarters of this year, compared to annual growth of

6.8% last year. While output slowed in China as well, it remained a regional engine of growth. Given the decline in

growth and relatively low inflation rates, most countries

sought to boost domestic demand through accommodative

monetary and fiscal policies. In some countries, undercapitalized banking systems and over-leveraged corporate

sectors hampered the transmission of monetary stimulus.

However, due to the drop in external demand and supportive

macroeconomic policies, current account surpluses and bilateral trade surpluses with the U.S. declined in most countries

during the reporting period. Along with lower current account surpluses, a decline in capital inflows due to the weaker

outlook and continued capital outflows put downward pressure

on most currencies and/or holdings of international reserves.

Overview of Selected Countries

Argentina. The Argentine economy contracted 0.7% q/q

(saar) in the first quarter of 2001 and grew 1.1% q/q (saar) in

the second quarter, after contracting 0.5% in 2000. Unemployment rose to 16% by May 2001, up from 14.4% in October 2000. Consumer prices continued to fall on the back of

depressed aggregate demand, registering a deflation rate of

0.7% y/y in the first half of 2001. On the plus side, exports

grew 0.6% y/y in the first half of the year, with real exports

growing at a 4% rate over the same period. Weak domestic

demand resulted in import compression of 12.3% y/y in first

half of 2001. Export growth together with a sharp import

contraction led to a narrowing of $0.7 billion in the current

account deficit between 1H/2000 and 1H/2001.

Argentina maintains a currency board arrangement, with the

Argentine peso pegged to the U.S. dollar at parity. Argentina’s real effective exchange rate (REER) appreciated 4.8%

during the first half of the year, due in large part to the decline

of the Brazilian real. In the face of slippage on IMF targets,

political turmoil and subsequent reshuffling at the Ministry of

Economy, investors’ confidence in the sustainability of public

finances and government polices fell, increasing capital outflows. The spread on Argentina's component of the EMBI+

index widened 250 bps during the first half of the year to 1025

bps over U.S. Treasuries. Central Bank foreign exchange reserves fell $4 billion during the same period, while bank deposits fell $3 billion, or 3.5%.

Brazil. In the first half of 2001, the Brazilian economy

slowed amid weak consumer demand, energy rationing, and

continuing uncertainty about neighboring Argentina. Real

GDP growth in 1Q/2001 was 0.4% q/q (saar) and 0.1% in

2Q/2001, vs. 3.6% q/q (saar) in 4Q01. The trade balance in the

first half of 2001 recorded a surplus of $70 million as strong

export performance was counterbalanced by substantial capital

imports related to the emerging energy crisis. The current

account deficit was $13.3 billion in the first half of 2001, vs.

80

90

100

110

120

130

140

150

1/99 7/99 1/00 7/00 1/01

Brazil

Colombia

Mexico

Venezuela

Currency Movements: Latin America

Domestic Units per Dollar (inverted scale, 1/99=100)

75

85

95

105

115

125

135

1/99 7/99 1/00 7/00 1/01

Indonesia

Philippines

Thailand

Currency Movements: Selected ASEAN Countries

Domestic Currency Units per Dollar (inverted scale, 1/99=100)

75

85

95

105

115

125

135

1/99 7/99 1/00 7/00 1/01

Korea

Singapore

Taiwan

Currency Movements: NIEs (ex. Hong Kong)

Domestic Currency Units per Dollar (inverted scale, 

90

100

110

120

130

140

1/99 7/99 1/00 7/00 1/01

Nigeria

Poland

Russia

South Africa

Currency Movements in Other Emerging Markets

Domestic Currency Units per Dollar (inverted scale; 1/99=100)
U.S. Department of the Treasury

Report to Congress on International Economic and Exchange Rate Policies

Reporting Period: For the Period January 1, 2001 through June 30, 2001

Page 9

$11.2 billion during the same period last year. FDI fell to $9.8

billion in the first half of 2001 (74% of the current account),

down from $13.4 billion during the same period in 2000, and

foreign investment was unable to meet Brazil’s current account needs for the first time in several years.

The exchange rate largely floats although the Central Bank of

Brazil (BCB) sporadically intervened to support the real both

in the spot foreign exchange market and through sales of dollar-indexed Brazilian real-denominated debt during the first

half of the year. In addition, in response to a depreciating real

and rising inflationary pressures, the BCB began a gradual

monetary tightening, raising its target overnight interest rate

by 250 bps to 18.25% over the first half of the year. Nevertheless, the real continued to weaken in the first half of the

year, depreciating 16% against the dollar (the REER depreciated 14%) amid concerns about high gross external financing

needs, uncertainty in Argentina, and the domestic energy crisis. Net international reserves (excluding dollar-linked liabilities of the BCB) increased during the first half of the year

by $3 billion to $34.1 billion, and from 56% of short-term

external debt (residual maturity) to 61%. As a percent of M2,

net reserves increased from 21.2% to 27.6% during the same

period.

Mexico. Growth slowed to 1.9% y/y in 1Q/2001 and 0.0%

y/y in 2Q/2001 (compared with 5.2% y/y in 4Q/2000). The

U.S. slowdown lowered demand for Mexican exports during

this period, though the impact on the trade balance was somewhat mitigated on the import side by lower domestic demand

and the large imported component of exports. The current

account deficit was unchanged at 1.3% of GDP in the first half

of the year (vs. 1.3% of GDP in the first half of 2000), with

foreign direct investment of $6.8 billion covering 84% of the

current account deficit. Capital inflows strengthened in the

first half, as Mexico continued to distinguish itself as a safe

haven among emerging market economies. The 2Q/2001 Citigroup purchase of Banamex, in particular, sent a strong positive signal to investors. This helped support the peso, which

appreciated 6.2% against the U.S. dollar during the first half of

this year to 9.04 pesos/$, from 9.75 pesos/$. The authorities let

the exchange rate float relatively freely during this period.

Mexico’s REER appreciated 6.2% over the same period.

Helped by low inflation numbers, the BOM eased monetary

policy somewhat over the first half of 2001 to stimulate the

economy Net international reserves rose $5.2 billion during

the first half of 2001 to $40.8 billion. As a percent of M2, net

reserves increased slightly from 13.8% to 14.3% during this

time.

Indonesia. Growth slowed to 3.4% (year-on-year) during

1H/2001, from 4.8% in the previous half, due to a weakening

of both external and internal demand. On the external side,

lower world prices hurt oil and gas export revenues (down

17% in dollar terms) and weakening global demand hit non-oil

exports (down 7%). Meanwhile, domestic demand weakened

due to political uncertainty and concerns about economic policy. The current account surplus was steady at about 4% of

GDP (comparing 1H/2001 and 1H/2000); the U.S. bilateral

trade deficit with Indonesia expanded slightly from $3.6 billion to $3.8 billion. Reduced export revenues and low real

interest rates, along with concerns about political stability,

economic policy and the investment climate all weighed on

the rupiah, which depreciated 6.4% in real effective terms (and

16% against the dollar in nominal terms) over the reporting

period.

Indonesia maintains a floating, though at times moderately

managed, exchange rate regime. While the central bank raised

short-term interest rates several times during the first half of

2001 to support the rupiah and contain inflation, rising prices

led to a continued decline in real interest rates. During the

first half of 2001, net international reserves increased slightly

from $17.8 billion to $18.3 billion, rising as a percent of M2

from 23% to 26%. As a percent of short-term external debt

(residual maturity), reserves climbed from 57% to about 60%.

During the first half of 2001, to support the rupiah, and limit

short-selling, the central bank tightened controls on capital

outflows, mainly lending rupiah to non-residents. Indonesia

has relatively few controls on capital inflows.

Turkey. Turkey suffered an economic crisis beginning in

February 2001, following the liquidity and banking crises it

experienced in November/December 2000. The economic

crisis, which included a massive drop in foreign exchange

reserves, led the Turkish authorities on February 22 to abandon their "crawling peg" exchange rate mechanism and move

to a float of the Turkish Lira. This crisis and its subsequent

effects have led to a 8.5% contraction in GNP for the first half

of 2001 (compared to 6.1% growth in 2000), with Consumer

Price Index inflation accelerating to 56% for the 12 months

preceding the end of June 2001 (up from 39% for 2000). The

crisis also led to high real interest rates and enormously increased public sector costs for restructuring the banking sector, and in turn the net public sector debt ballooned from 57%

of GNP at end-2000 to an estimated 87% at end-2001. The

Turkish Lira lost 45% of its value in nominal terms from its

float to end-June, and roughly 6% in real terms.

To stabilize the economy and address the causes of the crisis,

the Turkish authorities have implemented a strong program of

macroeconomic and structural measures. To support this effort, the International Monetary Fund approved an augmentation of its financing for Turkey of $8 billion, bringing its total

financing for Turkey for the period 1999-2003 to $19 billion.

Through end-June 2001, nearly $9 billion had been disbursed.

The World Bank also agreed to make available $2 billion in

exceptional financing for Turkey in 2001, of which half had

been disbursed by end-June 2001. These efforts have brought

some greater stability to Turkey's financial markets, setting the

stage for a recovery in output.
U.S. Department of the Treasury

Report to Congress on International Economic and Exchange Rate Policies

Reporting Period: For the Period January 1, 2001 through June 30, 2001

Page 10

Exchange Rate Regimes Assessed

Elements of Manipulation

Section 3004 of the Omnibus Trade and Competitiveness Act

of 1988 requires the Treasury to analyze annually the exchange rate policies of foreign countries, in consultation with

the IMF, and to consider whether countries manipulate the rate

of exchange between their currency and the dollar for purposes of preventing effective balance of payments adjustments

or gaining unfair competitive advantage in international trade.

The Secretary of the Treasury is required to undertake negotiations with those manipulating countries that have material

global current account surpluses and significant bilateral trade

surpluses with the United States, unless there would be a serious detrimental impact on vital national economic and security

interests.

• Treasury undertook a broad review of the performance of major trading partners of the United

Stated and concluded that no major trading partners of the United States manipulated exchange

rates under the terms of Section 3004 of the Act

during the period under consideration.

In evaluating evidence of currency manipulation, Treasury

looks at the following two factors:

• Exchange Restrictions and Capital Controls. Restrictive exchange regimes and capital controls can be

a concern, particularly where the restrictions are designed to maintain a consistently undervalued exchange rate.

• Exchange Rate Movements. Large depreciations of

exchange rates, if induced artificially rather than by

market forces responding to fundamentals, could

suggest an attempt to gain a competitive advantage in

trade. Manipulation could also be reflected in the absence of a significant appreciation of the exchange

rate when justified by fundamentals. Equilibrium

real exchange rates, however, are determined by a

number of factors and are therefore difficult to define.

Assessment

As the law requires, economies were examined as potential

exchange rate manipulators if they had significant global current account surpluses and bilateral surpluses with the United

States and maintained a fixed or actively managed exchange

rate system during the reporting period. Detailed assessments

are not provided for those economies where oil exports, with

prices customarily denominated in dollars, clearly dominate

total exports, and fluctuations in world oil prices produce at

times wide swings in the trade and current account balances.

Five emerging market economies were reviewed in detail:

Taiwan, China, Korea, Russia, and Malaysia.

Taiwan. Economic activity slowed substantially during the

reporting period due to Taiwan’s high reliance on IT exports

and declining investor confidence associated with increasing

signs of domestic banking problems and a continued deterioration in the traditional corporate sector. Real GDP fell 2.4%

during in the second quarter of this year on a year-over-year

basis, the first time real GDP fell over a 12-month period since

1975. During the reporting period Taiwan implemented increasingly accommodative monetary and fiscal policies to

support domestic demand. Due to the sharp drop in domestic

demand, the current account surplus rose to 5% of GDP during

the reporting period compared to 1.6% during the same period

last year. However, due to the sharp drop in exports to the

United States, over the same period, Taiwan’s bilateral trade

surplus with the United States declined by $0.7 billion to $4.8

billion.

Taiwan maintains a floating, though heavily managed, exchange rate policy. During the reporting period, Taiwanese

authorities, in the face of the sharp decline in growth and inflation, adopted a more accommodative monetary policy,

showing less resistant to downward market pressures on the

exchange rate. During the reporting period, the New Taiwan

Dollar depreciated 4% against the U.S. dollar and 5.5% in real

effective terms. Gross foreign exchange reserves rose by $2.4

billion during the reporting period to $109 billion, compared

to a decline of $7.1 billion in reserves during the last reporting

period. As a percentage of M2, reserves rose from 18.7% to

19.6%. Reserves to short-term debt rose from about 425% to

470% during the reporting period. Taiwan maintains pervasive controls on both capital outflows and inflows.

China. China’s real GDP growth in 1H/2001 was 7.9% y/y,

virtually unchanged from 7.8% in 2H/2000 in spite of continued weakening of 1H/2001 export growth to 8.8% y/y due

largely to the slowdown in global demand. Domestic demand

strengthened as fixed capital investment and urban household

incomes both showed accelerated growth supported by accommodative fiscal policies. As a result, the current account

surplus for 2001 is expected to decline moderately from its

level of 1.9% of GDP ($20.5 billion) in 2000. China’s merchandise trade surplus was $8 billion in 1H/2001, down 34%

y/y as imports continued to grow faster than exports. China’s

bilateral trade surplus with the United States was $37 billion

in 1H/2001, little changed from $36 billion in 1H/2000 but

down from $47 billion in 2H/2000.

China implements a de facto currency peg to the dollar, which

it has maintained within a tight band since 1995. However,

given the strengthening dollar in 1H/2001, the Renminbi appreciated vis-à-vis the Japanese Yen and most other regional

currencies. In real effective terms, the Renminbi showed virtually no change from August 2000 to February 2001. Gross

foreign exchange reserves reached $180 billion by June 2001,

about 7 times short-term external debt on a residual maturity
U.S. Department of the Treasury

Report to Congress on International Economic and Exchange Rate Policies

Reporting Period: For the Period January 1, 2001 through June 30, 2001

Page 11

basis, only slightly higher than at end 2000. Reserves were

10% of M2 at end-June, unchanged from end-2000. Reserve

growth during 1H/2001 can be accounted for largely by the

resurgence in FDI inflows associated with China’s imminent

WTO accession. China continues to maintain wide-ranging

controls on both capital outflows and inflows.

Korea. Real GDP growth was sluggish in the first half of

2001, posting 1.2% growth in the first quarter and 2.0%

growth in the second quarter (saar) as investment along with

global export demand weakened. Korea’s current account

surplus as a percent of GDP rose to 31⁄2 % in the reporting period compared to 2% for the first half of 2000 as imports declined more rapidly than exports due largely to the sharp drop

in investment. Similarly, Korea’s bilateral trade in goods and

services surplus with the United States rose to $3.8 billion in

the first half of 2001, up from $2.4 billion in the first half of

2000, as imports from the United States declined 20% while

exports declined only 9% over the period.

Korea generally maintains a floating exchange rate regime,

intervening only occasionally to curb what it views as excessive volatility. During the reporting period the won weakened

by 61⁄2 % against the U.S. dollar and 11⁄2 % on a real effective

basis. The Bank of Korea delayed loosening monetary policy

out of concern that inflation was running above the 4% upper

limit of the target band. Gross reserves dropped by about $2

billion in the reporting period to $94 billion, due in part to

Korea’s decision to repay IMF loans ahead of schedule. By

March 2001, gross reserves stood at 224% of short-term external liabilities (residual maturity) compared to 227% in at

the end of 2000. As a percent of M2, gross reserves were little

changed at 28% in June 2001 compared to 28.3% at end-2000.

Korea has relatively few restrictions on capital flows.

Russia. Russia’s GDP rose 5% in the first half of 2001

compared to the first half of 2000, reflecting continued robust

industrial output growth and a recovery in domestic demand.

Federal revenue collections rose to 17.5% of GDP from 15.5%

of GDP in the second half of 2000, while the primary surplus

rose to 6.5% of GDP from 3.5% of GDP. The current account

surplus slipped slightly to 15% of GDP ($21.1 billion) in the

first half of 2001 compared to 18% of GDP (23.5 billion) in

the second half of 2000, primarily due to the steady real

appreciation of the ruble and increases in household incomes.

Imports continued to rise rapidly in the first half of 2001, up

20% compared to the first half of 2000. Russia’s bilateral

trade surplus with the United States reached $2.3 billion in the

first half of 2001.

Russia operates a managed floating exchange rate. The ruble

was under strong pressure to appreciate in the first half of

2001, but the Central Bank of Russia (CBR) intervened to

modestly depreciate the ruble, in nominal terms, from 28.2R/$

at the beginning of 2001 to 29.1R/$ at the end of June 2001.

The ruble appreciated 15% (in real terms against the U.S.

Dollar) in the first half of 2001 due to high Russian inflation.

By intervening, the CBR has taken advantage of Russia’s

favorable balance-of-payments position to rebuild reserves

from their low levels following the 1998 financial crisis. In the

first half of 2001, Russia’s foreign exchange reserves rose

from $28 billion to $35 billion, while the ratio of Russia’s

short-term debt to reserves fell to 30%. Accumulation of

reserves continues to fuel the growth of base money, which

increased 47% year-on-year in the first half of 2001, while

inflation was 23%.

Malaysia. Malaysia entered a technical recession in 1H/2001,

with 2Q/2001 real GDP contracting 6.3% q/q (seasonally

adjusted annualized rate) following 1Q/2001’s 0.6% decline

due largely to a sharp drop in exports, particularly of high-tech

goods to the United States. Expansionary fiscal policy helped

to mitigate the impact of the global slowdown on domestic

demand. With exports stagnating, the current account surplus

shrank to 10.0% of GDP ($8.2 billion) in 1Q/2001 (latest data

available) from 12.9% in the first quarter of 2000. Malaysia’s

bilateral trade surplus with the United States fell to $2.6

billion in the first half of 2001 from $3.1 billion over the same

period in 2000.

Malaysia has maintained a fixed peg to the dollar since

September 1998, when it also imposed capital controls.

Controls have since been relaxed, but offshore trading of the

ringgit remains prohibited and foreign investments by

residents continues to be restricted. To limit short-selling,

ringgit borrowing by non-residents is also restricted.

Substantial capital outflows, which intensified over 2H00,

continued into 2001, raising concerns about the sustainability

of the ringgit peg. Reserves fell to a low of $26 billion from a

peak of $34.7 billion last May, but later stabilized as interest

rate differentials with the United States narrowed (due to the

Federal Reserve’s easing), speculation of a devaluation

subsided, and some portfolio investment returned. As a

percent of short-term external debt (residual maturity),

reserves fell from 344% at the end of 2000 to 299% by June

2001. As a percent of M2, reserves fell from 32% to 28%

during this time. Due to the strengthening of the U.S. dollar,

in real effective terms, the ringgit appreciated 5.4 percent over

the reporting period.