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December 3, 2004
Report to Congress on International Economic and
Exchange Rate Policies
This report reviews developments in international economic policy,
including exchange rate policy, focusing on the first half of
2004. The report is required under the Omnibus Trade
and Competitiveness Act of 1988, which 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."
This report reviews the effects that significant international economic
developments have had on the United
States and foreign economies and
evaluates the factors that underlie those developments.
For the specific purpose of assessing whether an economy is
manipulating the rate of exchange between its currency and the U.S. dollar
according to the terms of the Act, Treasury has traditionally undertaken a
careful review of the trading partner's exchange rates, external balances,
foreign exchange reserve accumulation, macroeconomic trends, monetary and
financial developments, the state of institutional development, and
financial and exchange restrictions. Attention is
given to both the changes and interactions of significant
variables. Isolated developments in
any one area do not typically provide sufficient grounds to conclude that
exchange rates are being manipulated under the terms of the
Act. A combination of factors, on the other hand, can
and has in the past led Treasury to find that certain countries had
satisfied the terms of the Act.
After reviewing developments in the
States, the report examines exchange rate
policies in major economies across five regions of the world: (1) the
Western Hemisphere, (2)
Europe and Eurasia, (3)
Sub-Saharan Africa, (4) North Africa, the
Middle East and South Asia,
and (5) East Asia. To summarize,
the report finds that:
Economies around the world continue to follow a
variety of exchange rate policies, ranging from a flexible exchange rate
with little or no intervention to currency unions and full
dollarization. For example,
follows a flexible exchange rate regime with no intervention, twelve
countries are members of the European Monetary Union, and
use the U.S. dollar as their "domestic" currency.
A notable trend observed over the past several years
is the move by many economies to adopt flexible exchange rates, combined
with clear price stability goals and a transparent system for adjusting
monetary policy instruments.
The report finds that no major trading partner of the
States met the technical requirements for
designation under the Omnibus Trade and Competitiveness Act of 1988 during
the first half of 2004. The report notes that while a
number of economies continue to use pegged exchange rates and/or intervene
in foreign exchange markets, a peg or intervention does not in and of
itself satisfy the statutory test.
Treasury has consulted with the IMF
management and staff, as required by the statute, and they concur with our
conclusions. The Administration
strongly believes that a system of flexible, market-based exchange rates
is best for major trading partners of the
Treasury is continuing to engage actively with
economies and to encourage, in both bilateral and multilateral
discussions, policies for large economies that promote a flexible
market-based exchange rate combined with a clear price stability goal and
a transparent system for adjusting policy instruments.
In this light, the communiqués of the G-7 Finance Ministers and
Central Bank Governors in February, April and October of this year stated:
"…that more flexibility in exchange rates is desirable for major
countries or economic areas that lack such flexibility to promote smooth
and widespread adjustments in the international financial system, based on
States International Accounts
The current account deficit is conceptually equal to the gap between
investment and saving as a matter of international accounting.
When investment in the United
States is higher than domestic saving,
foreigners make up the difference, and the
States has a current account
deficit. In contrast, if saving exceeds investment in a
country, then that country has a current account surplus as its people
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. Perceived high rates of return
assets, based on sustained strong productivity growth relative to the rest
of the world, attract foreign investment.
In the first half of 2004, for example, the
current account deficit was $594 billion (at a seasonally adjusted annual
rate and on a national income and product accounting, or NIPA, basis) or
5.1 percent of GDP. This $594 billion deficit equaled
the gap between $2,246 billion in investment and $1,652 billion in
domestic investment was $594 billion more than domestic saving with net
foreign investment making up the difference.
Overall, rapid growth in real GDP over the latter part of 2003 extended
into the first quarter of 2004 when real GDP rose at a strong 4.5 percent
annual rate. That was followed by a softening in the
second quarter, with real GDP rising at a 3.3 percent pace, leaving growth
in the first half, however, at a solid 3.9 percent annual
rate. The second-quarter slowdown was concentrated in
personal consumption expenditures, inventory investment and net
exports. In contrast, business fixed investment
strengthened considerably in the second quarter, rising at a 12.5 percent
pace following a 4.2 percent increase in the first quarter, supported by
growing profits and a profit margin that has been holding near a six-year
The current account was $627 billion in deficit (at a
seasonally adjusted annual rate and on a balance of payments basis)
in the first half of 2004. A major item financing the
current account deficit has been net private foreign purchases of
securities, which reached an annualized $503 billion in the first half of
2004. (Included in these were net private foreign
purchases of U.S. Treasury securities amounting to $202
billion.) In addition, foreign official institutions
assets by $403 billion.
Viewed over a longer period, the
current account balance declined, as a percent of GDP, from a 1 percent
surplus in the first quarter of 1991 to a 4 percent deficit in the fourth
quarter of 2000, to a 5 percent deficit in the first half of 2004.
Due to the current account deficit the net investment position of the
United States (with direct investment valued at the current stock market
value of owners' equity) fell to a negative $2.7 trillion as of December
31, 2003, the latest date for which data are available, from a negative
$2.6 trillion at the end of 2002. A $398 billion
valuation adjustment due to exchange rate changes offset much of 2003's
financial outflow. Despite a large negative position,
residents earned $39 billion more on their foreign investments in 2003
than foreigners earned on their
investments. These positive net income receipts are the result of large
net inflows of income from direct investment offsetting net outflows of
income on portfolio investment.
current account deficit is the counterpart of the aggregate surplus of
other economies in the world. The policies of all
countries affect the global pattern of current account
balances. It is important that policies that the
States follows to reduce
global imbalances keep the
States and the world economy
strong. There are three types of economic
policies that the Bush Administration is pursuing and will continue to
pursue which relate directly to the current account.
First are policies aimed at increasing saving of the public sector
and the private sector as the
economy continues to expand. A second group of
economic policies are those that will raise global growth. A third area of
policy relates to exchange rate flexibility for certain Asian economies
that lack such flexibility.
The U.S. Dollar
The Federal Reserve Board's "broad" nominal dollar index increased 2.2
percent during the first half of 2004. The dollar rose
2.9 percent against the "major" foreign currencies (seven other
industrialized economy currencies) while rising 1.4 percent against "other
important trading partners" (largely currencies of emerging market
economies). The broad index declined 11.0 percent from
February 27, 2002,
when it reached its recent peak, through June 30, 2004. Over this latter
period the dollar depreciated 22.6 percent against the major currencies
while appreciating 5.8 percent against the currencies of other important
Over the year ending in June 2004, the consumer price
index rose 3.3 percent, the largest 12-month increase since
mid-2001. Energy prices were a primary factor, up 17.0
percent over the year ending in June. The core CPI (excluding food and
energy) increased 1.9 percent over the twelve months through June 2004
compared to 1.1 percent in the twelve months through December 2003, the
latter being the smallest increase in core consumer prices since
1966. The Fed increased the federal funds target
rate by 25 basis points to 1.25 percent at the end of June from the 1
percent where it had been held for the preceding 12 months. There were
additional 25-basis point increases in August, September and
As discussed below, the currencies of different economies showed
varying degrees of flexibility relative to the dollar, as some monetary
authorities sought to dampen or prevent movements of their exchange rates
against the dollar while others did not intervene at all.
States did not intervene in foreign
exchange markets during the first half of 2004.
Nominal exchange rates in the region on average depreciated
against the U.S. dollar in the first half of the year.
Interest rate spreads between the Latin American Emerging Market
Bond Index (EMBI+) and U.S. Treasury securities increased from 518 basis
points at the end of 2003 to 600 basis points by end June.
The region's growth outlook remains positive for 2004, with the
major economies posting solid growth rates in the first half of the
has had a flexible exchange rate since the end of 2001 when it abandoned
its convertibility law, which pegged the peso one-to-one with the U.S.
currency remained relatively steady in the first half of 2004,
depreciating 1.0 percent from 2.93 pesos per dollar to 2.96 pesos per
trade surplus was $5.9 billion in the first half of 2004, compared with
$8.3 billion for the same period the previous year, with exports rising 13
percent and imports rising 71 percent. The
seasonally adjusted current account surplus narrowed to 2.1 percent in the
first half of 2004 compared to 7.5 percent in the first half of
gross foreign exchange reserves grew by $3.3 billion during the first half
of the year to $17.4 billion at the end of June 2004 as
intervened during periods of peso strengthening in order to rebuild
reserves. The economic recovery continued after the
severe contraction in the first half of 2002, with real GDP growing 6.7
percent at a seasonally adjusted annualized rate in the first half of 2004
over the second half of 2003. Consumer prices
accelerated somewhat, with the year-on-year increase reaching 4.8 percent
in June 2004 compared with 3.8 percent in December 2003.
Conditions in the banking system continued to improve.
Interest rates on saving deposits of 30-44 day maturities fell from
3.6 percent at end-December 2003 to 2.4 percent as of end-June
has a floating exchange rate regime and relies on inflation targeting to
guide monetary policy. Following a 22 percent nominal
appreciation in 2003, the real depreciated 6.3 percent in the first
half of the year to BRL3.08/US$.
sovereign risk spread stood at 646 basis points over U.S. Treasuries at
end-June 2004 versus 463 basis points at the end of 2003.
Year-on-year inflation stood at 6.0 percent in June, slightly
above the center of the central bank's 5.5 percent target for 2004 but
within the target band.
had seasonally adjusted current account surpluses of 1.2 percent and 2.2
percent of GDP in the first and second quarters of 2004, respectively.
States had a bilateral trade
of $2.4 billion in the first half of 2004 compared to a $3.3 billion
deficit during the same period in 2003. Foreign direct investment
inflows grew in the first half of the year to $4.0 billion compared with
$3.5 billion during the same period in 2003. Net international
reserves increased to $25 billion at the end of June 2004 compared to
$20.5 billion at the end of December 2003, in part due to central bank
purchases of foreign exchange. The economic recovery continued in
the first half of the year with annualized GDP growth rates of 7.5 percent
and 5.5 percent in the first and second quarters, respectively.
has a floating exchange rate regime. It has not
intervened in the foreign exchange market since 1998, except to make a
small contribution to the brief G-7 intervention in support of the euro in
September 2000. During the first half of 2004 the
Canadian dollar depreciated 3.6 percent, from 0.77 US$/C$ to 0.75
The J.P. Morgan trade-weighted index for
the real exchange rate for
depreciated 5.6 percent while the J.P. Morgan trade-weighted index for the
nominal exchange rate for
depreciated 3.2 percent.
current account surpluses during the first and second quarters of 2004
were 2.6 percent and 3.5 percent of GDP, respectively. The merchandise
trade surplus with the
$32.5 billion during the first half of 2004.
international reserves declined by 2.3 percent in the first half of 2004
to $35.4 billion. M3 grew 8.1 percent year-on-year in
June 2004 compared to 6.8 percent year-on-year in December 2003.
Year-on-year headline inflation in June 2004 was 2.5 percent. The economy
expanded in the first half of 2004, with annualized real GDP growth of 2.7
percent and 3.9 percent in the first and second quarters,
has a floating exchange rate regime. Its central bank
targets an inflation rate of 3 percent with a +/-1percent
band. The Bank of Mexico also follows a transparent
rule for selling foreign reserves accumulated by state
enterprises. During the first half of 2004 the Mexican
peso depreciated 2.6 percent, from 11.2 pesos/dollar to 11.5
pesos/dollar. J.P. Morgan's Narrow Nominal
Effective Exchange Rate Index of the peso depreciated 1.0 percent while
the J.P Morgan real effective index of the peso appreciated by 1.8
current account deficits during the first and second quarters of 2004 were
1.2 percent and 0.9 percent of GDP, respectively. The merchandise trade
surplus with the
$22.3 billion during the first half of 2004.
Foreign direct investment during the period was
$11.0 billion, versus $6.8 billion in the comparable period in
2003. International reserves grew $1.7 billion during
the first half of the year, reaching $59.1 billion by the end of
June. M3 grew 13.9 percent year-on-year in June 2004
compared with 13.6 percent year-on-year in December 2003.
Year-on-year headline inflation was 4.4 percent in
June. The economy grew robustly in the first six months
of 2004, with real seasonally adjusted GDP increasing at annual rates of
5.5 percent and 4.5 percent during the first and second quarters,
The European Monetary Union
The euro depreciated 3.3 percent against the dollar in the first half
of 2004. The real effective exchange rate depreciated
2.0 percent over the period. The ECB did not intervene
in foreign exchange markets during the first half of 2004.
The countries in the Euro-zone taken together had a current account
surplus during the first half of 2004 equal to $41.1 billion (sa) or 0.9
percent of GDP, up from $7.2 billion and $20.5 billion in the first and
second halves of 2003, respectively. Goods exports
increased 8.0 percent while goods imports increased 4.6 percent in the
first half of 2004 over the same period in 2003. The
trade surplus of the Euro-zone vis-à-vis the
$35.2 billion, which is about the same level as in the second half of
Euro-zone growth was an estimated 2.3 percent (annualized) in the first
half of 2004.
have held back Euro-zone growth, but
annualized growth of 3.3 percent in the second quarter, led by strong
domestic demand. For the region, final consumption
expenditure rose 0.8 percent in the first half of 2004 while investment
declined 0.1 percent. The harmonized consumer price
index rose at an annual rate of 2.8 percent in the first half of 2004
while the index excluding energy, food, alcohol and tobacco rose 2.0
The currencies of the major central European economies weakened
slightly against the dollar during the first half of 2004.
This largely resulted from the dollar's appreciation against the
euro. Each of the currencies strengthened against the
euro, their main reference currency, supported by expectations of higher
domestic interest rates.
shorter term yields of 11.0 percent helped the forint appreciate 3.5
percent against the euro (and decrease 0.4 percent against the dollar),
despite continued concern about large fiscal and current account
deficits. The National Bank of
index of the real value of the forint rose 7.8 percent during the first
half due to higher inflation.
Expectations of upcoming interest rate increases also led to
appreciation of the Polish zloty and the Czech koruna.
The koruna appreciated 2.0 percent against the euro (a decrease of
1.6 percent against the dollar), while the zloty rose 3.8 percent against
the euro during the first half of 2004 (a decrease of 0.2 percent against
the dollar). The koruna was little changed in real
terms, but the National Bank of
index of the real zloty appreciated 7.6 percent.
the koruna appreciated 3.0 percent against the euro (and decreased 0.2
percent against the dollar) supported by strong export growth and
expectations of large FDI inflows. High inflation
contributed to a real koruna appreciation of 6.6 percent.
Separately, the Bulgarian lev weakened against the dollar as its
value was fixed to the euro as part of
successful currency board arrangement.
The large net inflows resulting from high oil prices and high foreign
borrowing by Russian corporations in 2003 continued during the first half
current account surplus in the first half of 2004 was $22.6 billion, or
8.1 percent of GDP, compared to $17.4 billion, or 7.6 percent of GDP, in
the second half of 2003. The ruble appreciated 0.6 percent against the
U.S. dollar in the first half 2004 compared to 3.8 percent in the second
half of 2003. According to the J.P. Morgan Broad Real
Effective Exchange Rate Index, the ruble appreciated 6.0 percent in the
first half of 2004 compared to 3.3 percent in the second half of
2003. The Russian monetary authorities continued to
intervene to moderate the appreciation of the ruble against the dollar,
and foreign exchange reserves increased $11.3 billion to a record high of
$88.2 billion. M2 grew 40.4 percent in the year through
June 2004 compared to 51.6 percent in the year through December
2003. Consumer prices rose 10.1 percent in the year
through June 2004 compared to 12.0 percent in the year through December
Many African countries maintain pegged exchange rates.
The currencies of the CFA zone depreciated against the dollar
during the period, in line with the euro to which these currencies are
pegged. Sub-Saharan African currencies with more
flexible regimes saw their currencies generally appreciate against the
U.S. dollar on a nominal basis in the first half of 2004.
The South African rand, which is close to freely floating,
continued to strengthen, appreciating by 9.2 percent on a nominal
effective basis and 5.2 percent on a real effective basis.
The rand has now appreciated by over 60 percent in real terms from
lows reached in December 2001. This strength reflects
unwinding of the undershooting in 2001, rising commodity prices, strong
economic fundamentals, and improved investor sentiment toward emerging
markets in general. In
the introduction of new foreign exchange regulations including a managed
foreign exchange auction, together with a government clampdown on parallel
market activities, led to an appreciation of the
dollar in the early part of the year. Later in the
period, in an effort to encourage exporters and overseas workers to remit
foreign exchange earnings through formal channels, the government allowed
the auction rate to depreciate. Nevertheless, the
depreciation of the
dollar has not kept pace with inflation, which stood at 363 percent in the
year to end-July.
Real GDP growth in sub-Saharan Africa is
expected to rise to around 4 ½ percent in 2004 from 3 1/2 percent in
2003. This pickup in growth reflects improving
macroeconomic stability in many countries, easing external debt burdens,
large increases in oil production, higher global commodity prices, and
improved security situations in several countries.
Sub-Saharan Africa's overall current account
deficit is projected to be 1.4 percent of GDP in 2004, compared to a
deficit of 2.4 percent in 2003, due largely to higher oil and other
commodity prices. Africa's trade
surplus with the United
States increased to $22.6 billion during
the first three quarters of 2004, compared to $16.5 billion during the
same period of 2003, due in large part to higher oil prices.
North Africa, the
Middle East and
Growth continues to be very strong across the Middle
East and North Africa, supported by
record high oil prices. GDP in the oil-exporting countries of the Gulf
Cooperation Council countries
Arabia, and the UAE), in particular,
increased significantly. Current accounts across the Gulf remain largely
in balance or surplus, and have increased significantly, along with
holdings of official reserves, mainly due to higher oil prices.
Oil-exporting GCC countries tie their currencies directly to the U.S.
Many other countries in the region, such as
the countries of North Africa, also maintain pegged
exchange rate regimes.
returned to a de facto peg after the Egyptian pound depreciated 23
percent in nominal terms in the six months following its official float in
January 2003. In the first six months of 2004, the pound depreciated 0.7
percent in the official market, while at the same time very strong export
receipts (primarily due to high oil export revenues, Suez Canal receipts,
and a rebound in tourism) and a tightening of monetary policy helped the
pound to appreciate nearly 10 percent on the black market, virtually
eliminating the spread between the two rates. Net international reserves
increased by $60 million to $14.8 billion during that period.
however, maintains a floating exchange rate regime. The Turkish
lira depreciated 5.5 percent in nominal terms against the U.S. dollar in
the six months to June, but the lira's real trade-weighted value fell a
more modest 2.2 percent. Real GNP in the first half of
2004 grew by 13.5 percent compared to the first half of 2003,
a significant increase from the 5.9 percent growth rate recorded in
2003. Despite the strong growth, the inflation rate
continued to decline, falling to 8.9 percent year-on-year in June 2004
from 18.4 percent in 2003. The current account deficit for the first half
of 2004 widened to 4 percent of GNP from its 2.8 percent level in 2003 on
the back of the strong domestic economy and consumer demand.
In the first six months of 2004, imports and exports increased 47
percent and 32 percent, respectively, compared with the same period in
2003. Imports of capital and consumption goods grew by
84 percent and 109 percent, respectively, in the same period, but
intermediate goods continue to account for 67 percent of
imports. The growing current account deficit is still
mostly financed through short-term capital inflows. As a result, gross
foreign exchange reserves changed little to June 2004, continuing to hover
around $33 billion compared to $33.6 billion at end-December 2003.
which also maintains a floating exchange rate, the shekel depreciated
during the first half of 2004, falling 2.7 percent against the dollar in
nominal terms and 3.0 percent in real trade-weighted terms. This followed
a 5.8 percent trade-weighted depreciation in the last half of the 2003.
Foreign exchange reserves remained nearly unchanged at around $25.7
billion at end-June, as compared with the 4.9 percent growth in reserves
in the second half of 2003. A weaker currency and rising demand in
major export markets helped boost exports, and as a result GDP growth
increased to 2.5 percent for the first half of 2004 compared to 1.2
percent for 2003 as a whole.
In South Asia,
targets a Real Effective Exchange Rate (REER) benchmark based on
cross-border inflation differentials and currency movements. Although the
Reserve Bank of
not intervene to curtail short-term volatility relative to the U.S.
dollar, the exchange rate has not been allowed to stray too far from its
REER benchmark. The rupee depreciated by less than 1
percent in the first half of 2004. The
bilateral merchandise trade deficit with
to $4.8 billion for the first half of 2004, compared to $4.1 billion for
the first half of 2003. Foreign exchange reserves stood
at $114.15 billion at the end of June, up from $96.5 billion at the end of
2003. Real GDP grew by 7.4 percent year-on-year in the
second quarter of 2004.
After picking up speed in the last half of 2003, East Asian GDP growth
accelerated in the first quarter of 2004, fueled by buoyant export
markets, the recovery of the global IT sector, and strong growth in
domestic demand, most notably in
Economic growth has been widespread across the economies of
East Asia, increasing at the fastest rate since the
1997 financial crisis.
After a very strong first quarter, East Asian growth rates dropped off
in the second quarter, particularly in
Higher oil prices, and the expectation that they might persist for
some time, were clearly part of the reason.
But efforts to slow the growth of
the Chinese economy also had an impact, since rapidly growing Chinese
import demand had provided a major boost to growth throughout the
Rising interest rates in the United States; a sharp, although
relatively brief, widening of emerging market spreads; and higher oil
prices all appear to have reduced portfolio investment inflows to East
Asia in the second quarter of 2004. As a result,
monetary authorities that faced large foreign exchange inflows and upward
pressures on their currencies in the second half of 2003 and first quarter
of 2004 saw diminished inflows in the second quarter.
Trade flows among East Asian economies have increased sharply in recent
years, reflecting increased integration of economies in the
region. But increased intra-regional trade also
reflects the increasing diffusion of component production among economies
in the region, often for products that are exported outside
East Asia. As a result, monetary
authorities appear to be increasingly concerned about the effect of
currency appreciation on their competitiveness relative to other economies
in East Asia. While noting these
concerns, the Administration has encouraged increased exchange rate
flexibility for East Asian economies generally, both in bilateral
discussions and in regional fora such as APEC.
APEC Finance Ministers took a significant step in this direction in
their statement of September 3, welcoming steps taken by member economies
to facilitate the move to greater exchange rate flexibility.
economic recovery, which began in the second quarter of 2002, continued in
the first half of 2004. Strong growth carried over into the first
quarter but slowed markedly in the second quarter.
also made some progress in its long struggle to overcome deflation.
In the first half of the year, consumer prices, excluding fresh food,
declined at the rate of 0.1 percent year-over-year, compared to a
deflation rate of about 0.6 percent a year ago. However, if the
effect of higher oil prices and other special factors are excluded,
underlying consumer price deflation appears to remain close to half a
percent per year, and other measures of price change show greater and
As in past recoveries, exports have contributed to this recovery,
with particularly strong growth of exports to
in this case. In the first half of 2004, exports grew
by 6.5 percent and imports by 4.8 percent.
global current account surplus grew to $88.9 billion (3.8 percent of GDP)
in the first half of 2004, up from $75.8 billion (3.4 percent of GDP) in
the second half of 2003.
bilateral merchandise trade surplus with the
States totaled $36.2 billion
in the first half, up from $33.8 billion in the second half of 2003.
However, private spending, notably private investment and
consumer spending, has played an important role in this recovery, and
contributed most of first half 2004 growth.
In contrast to past recoveries, expansionary fiscal policy has not
contributed to output growth this time, as the government continues with
its medium-term fiscal consolidation program. The persistent
Japanese global current account surplus reflects the high rate of Japanese
domestic saving relative to domestic investment. Despite the recent
recovery of investment, expectations of slower trend growth have meant
lower investment, and the share of private investment in GDP has fallen
from 26 percent in the 1960s, to 22 percent in the 1980s, to 19 percent in
the last three years. Rates of return on domestic
investment have been generally low, although the Prime Minister's program
of structural reform and deregulation and the recent acceleration of
corporate restructuring and mergers and acquisition activity hold out the
prospect of higher returns.
surplus of private saving over private investment has been only partially
absorbed by government deficits, leading to a persistent current account
surplus and capital outflows to the rest of the world.
The Japanese recovery and the prospects of higher stock market
prices led to large net portfolio capital inflows in
starting in May 2003. These inflows strengthened over
the course of 2003 and into the first quarter of 2004. Expectations
of yen appreciation also contributed to first quarter 2004 inflows.
International Monetary Market (IMM) data on short and long futures
positions show that market expectations of an appreciation of the yen were
particularly strong at the beginning of 2004.
This net portfolio capital inflow slowed and then reversed in the
second quarter in response to changing expectations of
growth relative to Japanese growth and higher
interest rates. About one-third of the net capital
inflows during the first quarter were subsequently reversed in the second
quarter. Following the end of the Japanese fiscal year March 30,
pension fund reinvestment overseas surged in April and
May. Japanese investors also began diversifying
into overseas equities and shifted funds into
During the December 31, 2003 to
2004 reporting period, the yen depreciated 2.1
percent against the dollar, and 2.7 percent on a real trade-weighted
basis, as measured by the J.P. Morgan Broad Real Effective Exchange Rate
index. The yen appreciated by 2.8
percent to ¥104.2 during the first quarter, a period in which its value
fluctuated fairly widely.
The yen subsequently weakened by 4.8 percent during the second
quarter. Over a more extended period, since late February 2002
through the end of June 2004, the dollar has depreciated by 18.7 percent
against the yen, similar to its 22.6 percent depreciation against the
major currency component of the index over the same period.
Since June 30, the yen has traded more narrowly against the dollar,
ending October at ¥106.04, or 3.2 percent stronger than at end-June.
Japanese authorities intervened in the foreign exchange market
during the first quarter of 2004, with yen sales totaling approximately
$138 billion. Japanese authorities publicly report their foreign
exchange market intervention at the end of each month, and have not
reported any intervention since March 16,
authorities have stated that their "intervention is carried out when
excess volatility or over-shooting is observed in the markets," and that
they do not target particular values of the exchange rate.
The Treasury is actively engaged in discussions with Japanese
authorities on these issues, both bilaterally and through the meetings of
the G-7 finance ministers and central bank governors. At G-7
Raton and more recently
the Treasury worked with the G-7 to promote a strong consensus in support
of flexible exchange rates.
joined the United
States and other G-7 nations
in these declarations.
economic growth rate accelerated in 2003 and into the first half of 2004,
with particularly rapid growth in investment. The
officially reported growth figure for 2003 was 9.3 percent,
but estimates based on expenditure suggest that growth in 2003 was over 11
percent. This led to bottlenecks in several sectors and
rising prices. Macroeconomic policy during 2004 has
primarily been directed at slowing credit and investment growth in order
to dampen inflationary pressures and assure sustained growth.
fixed exchange rate regime has made carrying out macroeconomic policy more
difficult during this period.
accumulation of foreign exchange reserves continues to create monetary
pressures that have fueled domestic credit and investment growth and
inflation. Chinese policymakers took administrative measures over the last
year to curb lending, but, until October 2004, hesitated to raise domestic
These macroeconomic policy measures have had some success in cooling
off the economy. Recent data suggest that the growth of
several economic indicators has moderated from the rapid pace of
2003. Industrial production, broad money growth, and
total loan growth slowed during the third quarter of this year compared to
the same period in 2003. Reported real GDP growth
slowed to a year-over-year rate of 9.1 percent in the third quarter of
this year, down from 9.7 percent in the first half.
But the risk of an inflationary boom followed by the hard landing
that has characterized past Chinese cycles remains.
Fixed asset investment is still growing at a double digit
pace. Moreover, headline consumer price inflation
rose to 5.2 percent year-on-year in September 2004, compared to 1.2
percent year-on-year one year ago.
Reflecting strong import demand driven by investment growth,
overall trade balance recorded a (seasonally unadjusted) deficit in the
first half of 2004 of $7 billion (1.0 percent of GDP), compared to a
$4 billion surplus in the same period in 2003.
exports rose 36 percent in the first half of 2004 compared to the
first half of 2003 on strong external demand.
imports grew by 43 percent during the same period.
import growth has been driven by its rapid economic growth and
integration into the world trading system following accession to the World
Trade Organization (WTO). Growth rates for both Chinese
imports and exports have also been driven by increasing use of
as a locale for assembly and final processing for East Asian manufacturing
components into products destined for other markets, often the
As a result of the latter factor,
trade surplus with the United
States has been much larger than its
overall trade balance.
bilateral surplus on trade in goods with the
States in the first half of 2004 reached
$68.5 billion compared to $53.9 billion in the comparable period of
kept its fixed exchange rate of 8.28 renminbi to the U.S. dollar
throughout the reporting period, a rate it has maintained since 1995,
through periods of both upward and downward pressures on the balance of
payments. Its real trade-weighted exchange rate, a more
important determinate of competitiveness, has fluctuated
considerably. With faster domestic inflation, the
renminbi appreciated 3.0 percent in real trade-weighted terms, as measured
by the J.P. Morgan Broad Real Effective Exchange Rate Index, in the first
half of 2004.
official foreign exchange reserves grew by a net $67 billion to $471
billion during the first half of 2004.
This growth in Chinese reserves is the counterpart of
current account balance and net financial and capital inflows to the
nonofficial sector. Foreign direct investment inflows
in the first nine months of 2004 were $48.7 billion, up 21 percent from
the comparable period in 2003. As in 2003, net non-FDI
financial inflows to the non-official sector continue to be large and
positive in 2004, due mainly to a sharp increase in portfolio capital
inflows reflecting investors' expectations of continued strong growth and
possible change in the exchange rate regime.
The Administration has urged Chinese leaders to move as soon as
possible to greater flexibility, and has initiated an unprecedented level
of engagement with the Chinese government and other major trading partners
of the United
States to help bring this
about. In September 2004, the Treasury held
the 16th U.S.-China Joint Economic Committee (JEC) meeting in
Washington to discuss
progress on a broad range of economic and financial issues, including
exchange rates and how greater flexibility would better enable
conduct monetary policy. In the JEC Joint Statement,
strengthened its commitment to move to a market-based, flexible exchange
rate. In early October, G-7 Finance Ministers and
Central Bank Governors met for the first time as a group with their
exchange rate policy was an important component of the
States continues to work actively with
identifying and overcoming impediments to greater exchange rate
flexibility. Treasury held three sessions with
Chinese officials in 2004 focused on the mechanics of a flexible currency
regime, as part of its Technical Cooperation Program.
In February, meetings dealt with assessing and supervising currency
risk in banking systems and developing financial instruments to manage
that risk. The session in June discussed banking supervision,
credit analysis, international accounting standards, and resolution of
non-performing loans. In September, Chinese central
bank officials met with Treasury and other
government agencies to discuss foreign reserve management and supervision
and regulation of a currency derivatives market.
has publicly stated its commitment to move to a flexible exchange rate
regime. In September 2004, Chinese Premier Wen said
"will further advance the reform and forge a mechanism which is more
adapted to the changes in market supply and demand, with still better
flexibility." In the communiqué of the 16th
U.S.-China Joint Economic Committee (JEC) meeting,
"reaffirmed its commitment to further advance reform and to push ahead
firmly and steadily to a market-based flexible exchange rate."
Governor Zhou of
central bank has referred to the movement to a flexible exchange rate as a
top priority issue for
is laying the groundwork for a shift to a market-based, flexible exchange
rate. The People's Bank of China, the central bank,
recently liberalized certain interest rates, which is consistent with a
move towards a flexible exchange rate.
has taken steps to reduce barriers to capital flows, which will help to
deepen markets involving foreign exchange transactions.
announced it would allow its national social security fund to invest in
overseas capital markets.
is working to strengthen its banks and bank supervision, and to prepare
these institutions for exchange rate flexibility. In
taken steps to develop financial products and systems to support foreign
exchange trading and hedging of exchange rate risk.
The U.S. Government will pursue persistently and firmly its approach to
promote economic, financial and market reforms in
move as soon as possible to a flexible exchange rate regime.
Like the other economies in East Asia,
greatly from growing Chinese and
import demand and the recovery of the global IT sector.
But domestic private demand in
been much weaker than in other economies in the region, as
struggled with the after-effects of a credit card boom and bust that has
depressed household spending. Although
economy was strong in the second half of 2003, growth decelerated to a 4.9
percent annual rate in the first half of 2004, largely due to a decline in
private consumption of 0.7 percent. While
inflation increased to 3.6 percent year-on-year by June 2004, this was
mainly due to higher oil prices. Citing a slowdown in
the pace of economic recovery, particularly in domestic demand, the Korean
central bank reduced its benchmark call rate a quarter-point in August and
again in November, bucking the global trend towards interest rate
stabilization or increase.
External demand continued to support Korean growth in the reporting
period. Exports in the first half of 2004 were up 38.4
percent year-on-year, continuing the strong pace set in the second half of
2003. Export growth to
particularly strong, rising 57 percent. The
growth of imports did not nearly match that of exports, although imports
did rise 27 percent over the year. The difference in
import and export growth rates was reflected in Korean external
current account surplus was 4.4 percent of GDP for the first half of 2004,
compared to 0.2 percent in the first half of 2003. The
bilateral trade deficit with
the first half of 2004 totaled $9.0 billion, up from $2.1 billion for the
same period in 2003, as
by 21 percent, and exports to
Korea by 5
percent. Total capital and financial flows, exclusive
of reserve accumulation, registered a net deficit (outflow) of $0.6
billion (nsa) for the first half of 2004, down from a surplus of $13.2
billion for 2003, as investors become more concerned about
maintains a managed floating exchange rate regime.
Consistent with maintaining a relatively accommodative monetary
stance in light of weak domestic demand, the Korean authorities continued
to intervene in the first half of 2004, although the pace of reserve
accumulation slackened. Official foreign reserves increased by $11.7
billion over the first half of 2004 to $166.2 billion, roughly equivalent
to the total external debt of Korea, and equal to 2.8 times short-term
external debt. In April, the government partially
removed restrictions that were imposed in January 2004 limiting positions
that domestic financial institutions could take in the foreign exchange
non-deliverable forwards market. These measures had
been imposed in an attempt to curb upward speculation on a won
appreciation. Despite the Korean authorities'
intervention, by end-June 2004 the won had risen 3.1 percent against the
dollar since end-2003.
real effective exchange rate appreciated 5.5 percent over the course of
the first half of 2004.
Accommodative monetary policy, along with higher oil and commodity
prices, succeeded in halting three years of deflation as the headline
consumer price index rose 3.1 percent saar in the six months through June
2004. Taiwan's GDP growth slowed to 3.6 percent in the first half of 2004
relative to the second half of 2003, after having rebounded at an
annualized, seasonally adjusted rate of 10.7 percent in the second half of
2003 due to a sharp recovery of domestic demand (in particular business
investment) and strong export growth (particularly to China).
The slowdown was the result of both a slowing of investment from
the very high growth of the second half of 2003 and a modest slowdown in
exports grew by 25.5 percent in the first half of 2004, compared to the
first half of 2003, with growth of exports to
particularly strong. Imports expanded by 34.6 percent,
resulting in a decline of the overall trade surplus from $12.0 billion to
bilateral trade surplus with the United
States decreased from $7.4 billion in the
first half of 2003 to $5.8 billion in the first half of 2004.
The current account surplus in the first half of 2004 was 7.5 percent
of GDP (or $11.4 billion), marking a decline from a surplus of nearly
10 percent of GDP in 2003.
high domestic saving relative to domestic investment make it a substantial
net exporter of capital, contributing to continued current account
experienced strong portfolio capital inflows in the last half of 2003 and
the first quarter of 2004. These followed the decision
government in July 2003 to scrap a rule restricting foreign fund
investments in Taiwanese shares to $3 billion per fund.
However, portfolio capital inflows turned negative in the second
quarter due to tensions with
several weeks of uncertainty following the presidential election.
maintains a managed floating exchange rate regime.
Total foreign exchange reserves increased by $23 billion in the
first half of 2004, compared to a $30 billion increase in the latter half
of 2003. By end-June, total foreign exchange reserves
had reached $230 billion, or 80 percent of GDP and four times short term
external debt. Most (roughly
four-fifths) of the first half growth in reserves occurred in the first
quarter. Reserve growth due to intervention diminished
along with capital inflows in the second quarter of 2004.
Reserve growth has continued at this slower pace since mid-year,
with reserves rising by 1.3 percent in the third quarter to $233 billion.
The NT dollar appreciated gradually against the U.S. dollar during the
first quarter of 2004, reaching a
NT32.93/USD in mid-April, up
3.8 percent from its end-2003 value. It depreciated
during the latter part of the reporting period, ending June only slightly
above its December 31 level. While
central bank maintains that "the NT dollar exchange rate is determined by
market forces," the bank also notes that "when the foreign
exchange market is disrupted by seasonal or irregular factors the Bank
will step in."
economic recovery continued to accelerate in the first half of 2004,
growing at an 6.8 percent saar pace from the second half of 2003 after
growth of 5.3 percent in 2003 and 4.1 percent in 2002.
Personal spending picked up, and private investment
strengthened. Fiscal consolidation continued, as total public sector
spending grew moderately and public investment contracted.
The current account surplus was 13.1 percent of GDP in the first half
of 2004, compared with 14.4 percent in the first half of
bilateral trade surplus with the United
States totaled $7.5 billion in the first
half of 2004, up 13.7 percent from its level a year earlier.
has maintained a fixed peg to the dollar since September 1998, when it
also expanded capital controls. Although unchanged against the
dollar in nominal terms, the ringgit depreciated 0.7 percent over the
first half of 2004 on a real trade-weighted basis, as measured by the JP
Morgan index. At the end of June, total foreign
exchange reserve holdings stood at $53.9 billion, about five times
short-term external debt and up from $44.9 billion at end-December
Controls on capital flows have been relaxed since 1998, but offshore
trading of the ringgit remains prohibited, and foreign portfolio
investment by residents continues to be restricted.
implemented a number of capital account liberalization measures in the
first half of 2004. On March 26, the central bank raised the
ceilings on foreign currency holdings by residents, relaxed reporting
requirements for exporters, allowed domestic institutional investors and
mutual funds to invest up to 10 percent of their assets abroad, made it
easier for non-residents to borrow in ringgit, and allowed forward foreign
Including a relatively small statistical
Although the current account measures are conceptually the same, balance
of payments statistics are compiled on a slightly different basis from
national income statistics. Saving includes the statistical discrepancy
between the income and product accounts.
That is, 4.2 percentage points of the 5.3 percent annualized
yen varied over a range of 8-10 percent between
its highs and lows against the dollar during the first
Chinese government used $45 billion of its foreign exchange reserves to
recapitalize two Chinese banks at the end of 2003. This
figure is not included in the $471 billion foreign exchange reserves