External Balance in Low‐Income Countries

Abstract

This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate. This paper offers a coherent empirical analysis of the determinants of the real exchange rate, the current account, and the net foreign assets position in low income countries. The paper focuses on indicators specific to low income countries, such as the quality of policies and institutions, the special access to official external financing, and the role of shocks. In addition to more standard factors, we find that domestic financial liberalization is associated with higher current account balances and net foreign asset positions, while capital account liberalization is associated with lower current account balances and net foreign asset positions and with more appreciated real exchange rates. Negative exogenous shocks tend to raise (reduce) the current account in countries with closed (opened) capital accounts. Finally, foreign aid is progressively absorbed over time through net imports, and is associated with a more depreciated real exchange rate in the long-run.

Long-Run Determinants and Misalignments of the Real Effective Exchange Rate in the EU

“…Concerning the low income countries, Christiansen et al (2010) provide an analysis of REER determinants in the long-run adding demographic variables such as population growth and old-age dependency ratio and international aids, which are strongly significant for these countries. Galstyan and Lane (2009) instead highlighted the role of government spending decomposed as consumption and investments 4 .…”

Workers' Remittances and the Equilibrium Real Exchange Rate: Theory and Evidence

“…For that purpose, we have sought to include the most comprehensive set of theoretically-suggested fundamentals for which data are available. Fortunately, a recent study by Christiansen et al (2009) on the determinants of external balance in low-income countries compiled data on a large set of potential real exchange rate fundamentals for a comprehensive sample of countries. The availability of their dataset allows us to include a relatively large group of countries as well as a large number of potential fundamentals.…”

“…The theoretical rationale for the inclusion of each of these variables, and their expected signs in the cointegrating equations, are provided in Christiansen et al (2009). The last three variables in this list are somewhat unconventional, but because they are potentially important in explaining variations in the real exchange rate for low-income countries in particular, and because such countries are heavily overrepresented among remittance recipients, we retain them here.…”

“…The last three variables in this list are somewhat unconventional, but because they are potentially important in explaining variations in the real exchange rate for low-income countries in particular, and because such countries are heavily overrepresented among remittance recipients, we retain them here. The sources for the non-remittance data are described in Christiansen et al (2009), and the remittance data are taken from the World Bank's Word Development Indicators (WDI).…”

“…In each table, eight different results are reported: columns (1) - (4) use the values of the explanatory variables in levels, with columns (5) - (8) measuring the explanatory variables as deviations from their trade-weighted partner-country counterparts, following Christiansen et al (2009). 15 The reason for doing so is as follows: conceptually, we would like to measure the real exchange rate as the relative price of traded in terms of nontraded goods (as in our analytical model), sometimes referred to as the "internal" real exchange rate (see Hinkle and Montiel 1999).…”