Current Account Imbalances in the Southern Euro Area:  C tA tI b l i th S th E A Causes, Consequences and Cures  Florence Jaumotte  Piyaporn Sodsriwiboon European Department International Monetary Fund International Monetary Fund The views expressed are those of the authors and do not necessarily represent those of the IMF.

Current accounts (CA) in the Southern Euro Area (SEA)  have deteriorated sharply since the mid‐1990s

6

6

Current Account Balance, % of GDP 4

4

2

2

0

0

-2

-2

-4

-4

-6

-6

8 -8

8 -8

Northern euro area, excl. Luxembourg Southern euro area, excl. Slovenia Euro area excl. Luxemburg and Slovenia, weighted average Italy

-10

-10

-12

-12 1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

Source: IFS statistics, IMF Staff Calculations

2

Plan ‰

What explains the growing current account deficits in Southern Euro  countries?

‰

Are the current account deficits excessive?

‰

Policy options in a currency union?

‰

Conclusions

3

What explains the growing current account deficits in  Southern Euro countries? Southern Euro countries? 1 Stylized facts 1. Stylized facts

4

CA declines were accompanied by a large fall in saving  and a modest rise in investment

10

30 SEA

8

25 22.3 20

24.4

22.3

6

Changes in Saving-Investment 2005-2008 vs 1994-1997 (Percent of GDP)

4 15 14.4

Current account balance 10

0

0

Domestic saving

5

2

-2

Domestic investment (Percent of GDP)

-4

0.2

-6 -5

-8

-10

-9.9

-10 10

Domestic Saving Domestic Investment

-12

-15 1994

1996

1998

2000

2002

2004

2006

2008

Cyprus Greece

Italy

Malta PortugalSlovenia Spain

SEA

Source: IFS statistics, IMF Staff Calculations

5

Saving rates in SEA have been diverging from levels in  NEA

35

35 Domestic Saving (Percent of GDP)

30

30

25

25

20

20

15

15

10

10 NEA Greece Malta Slovenia SEA

5

Domestic Investment (Percent of GDP)

Cyprus Italy Portugal Spain

NEA Greece Malta Slovenia SEA

5

Cyprus Italy Portugal Spain

0

0 1994

1996

1998

2000

2002

2004

2006

2008

1994

1996

1998

2000

2002

2004

2006

2008

Source: IFS statistics, IMF Staff Calculations

6

The decline in saving rates reflected private saving,  with public saving actually improving or stable

10

30

Changes in Domestic Saving, 2005-2008 vs 1994-1997 (Percent of GDP)

SEA 25 23.7

5

20 15 Current account balance 10

13.5

0

Private Saving

5

Public saving (P (Percent t off GDP)

-5 5

0 0.2

0.9

-1.4 -5

-10 Private Saving

-10 10

Public Saving

-9.9 -15

-15 1994

1996

1998

2000

2002

2004

2006

2008

Cyprus Greece

Italy

Malta PortugalSlovenia Spain

SEA

Source: IFS statistics, IMF Staff Calculations

7

The modest increase in investment was also due to the  private sector, but concentrated in a few countries

25

8 SEA

20 15

18.8

6

Changes in Investment, 2004-2007 vs 1994-1997 (Percent of GDP)

17.2 Current account balance

4

Public Investment

10

2

Private Investment (Percent of GDP)

5

3.3

3.3 0 0.2

0

-2

-5

-4

-10

-9.9 99

-15

Public Investment Pi Private IInvestment

-6 1994

1996

1998

2000

2002

2004

2006

2008

Cyprus Greece

Italy

Malta Portugal Slovenia Spain

SEA

Source: IFS statistics, IMF Staff Calculations

8

Investment rates increased mostly in the construction  sector, which may not be as productive

SEA

1.3 Changes in Investment in Construction from avg avg. 1995-1998 to avg. 2005-2008 (Percent of GDP)

Spain p Slovenia Portugal

5.5 2.8

1.5 20 -2.0 2.5

Cyprus -4

-2

0

2

6

1.1

-3.2

Italy

0.4

G Greece

04 0.4 -0.1

Cyprus 4

2.4

-0.5

Malta

Italy

-6

Spain p

Portugal -0.6

G Greece

Changes in Investment in Machinery from avg. 1995-1998 to avg. 2005-2008 (Percent of GDP)

Slovenia

-1.9

Malta

-0.1

SEA

-6

-4

-2

0

2

4

6

Source: IFS statistics, IMF Staff Calculations

9

The CA deficits were heavily financed with debt instead  of FDI inflows

12 8

30

30 SEA current account balance, average g from 2000 to 2008 (Percent of GDP)

20

Net Portfolio Investment, Avg 2000-2008 Avg. 2000 2008

20

4

10

10

0

0

0

-10

-10

-4 -8

Current Account Balance FDI Portfolio/Other Investment Reserve Assets

-12

Money market Bonds Equities

-20

Others Deposits Loans Trade credits

-20 -30

-30 Cyprus Greece Italy Malta Portugal SloveniaSpain SEA

Net Other Investment, Avg. 2000 2000-2008 2008

Cyprus Greece

Italy

Malta

PortugalSlovenia Spain

Cyprus Greece

Italy

Malta

PortugalSlovenia Spain

Source: IFS statistics, IMF Staff Calculations

10

Negative net income flows are already exerting strong  pressure on the CA ‰

Due to the large negative international investment position, especially in  Greece, Portugal and Spain

Contributions to Current Account Deficits in 1994 and 2008 SEA 1994 2008 Difference 1994 Current Account Balance 0.2 -9.9 -10.1 1.3 Balance on Goods and Services -3.7 -6.3 -2.6 3.6 Net Income 0.6 -3.8 -4.4 -1.6 N tT Net Transfer f 33 3.3 01 0.1 -3.1 31 -0.7 07 Primary Current Account Balance 1/ -3.9 -11.5 -7.6 n.a.

Italy 2008 -3.2 -0.5 -1.9 -0.8 08 -4.6

Difference -4.5 -4.0 -0.3 -0.1 01 n.a.

Source: IFS statistics 1/ primary current account balance is current account balance net of interest payments.

11

What explains the growing current account deficits in  Southern Euro countries? 1. Stylized facts 2. Role of EMU

12

CA declines coincided with the creation of the EMU and  and its subsequent introduction of the euro

6

6 Stage two of EMU

Current account balance (Percent of GDP)

4

Euro Adoption

SEA-3 EMU

4

2

2

0

0

-2

-2

-4

-4

-6

-6

-8 8

8 -8

NEA SEA-4

-10

-10

SEA-3 Italy

-12

-12 1976

1978

1980

1982

1984

1986

1988

Source: IFS statistics, IMF Staff Calculations

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

13

EMU may have affected CA in various ways EMU may have affected CA in various ways ‰

Financial liberalization:  ‰ ‰

‰ ‰

‰ ‰

External: opening the “gates” to let capital and credit flow in Domestic: easier availability of credit boosting domestic consumption Domestic: easier availability of credit boosting domestic consumption

Improvement in macroeconomic policies due to convergence criteria Reduction in nominal and real interest rates reflecting reduced exchange  rate risk and improved macroeconomic policies Effects can go in opposite directions Effects can go in opposite directions Effects may depend on starting income level

14

SEA made substantial progress in financial liberalization SEA made substantial progress in financial liberalization

3.0

1.0

Capital Account Openness

Financial liberalization index

0.8

2.5

SEA-4 NEA It l Italy

20 2.0

SEA-4 SEA-3 Italy

1.5 0.6

1.0 05 0.5

0.4 0.0 -0.5

0.2 Stage two of EMU

Euro Adoption

SEA-3 SEA 3 EMU

-1.0

Stage two of EMU

Euro Adoption

SEA-3 EMU

-1.5

0.0 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006

1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006

Source: IMF Staff Calculations

15

Fiscal deficits and inflation were sharply reduced Fiscal deficits and inflation were sharply reduced 

6 4

Stage two of EMU

Euro Adoption

16

SEA-3 EMU

14

2

Stage two of EMU

Euro Adoption

SEA-3 EMU Inflation (Percent)

12

0

10

NEA SEA-4 SEA-3 Italy

-2 8 -4 4 6

-6 Fiscal Balance (Percent of GDP)

-8

NEA SEA-4 SEA 4 SEA-3 Italy

-10 10

2 0

-12 1992

1994

1996

1998

2000

2002

2004

2006

4

2008

1992

1994

1996

1998

2000

2002

2004

2006

2008

Source: IFS statistics, IMF Staff Calculations

16

Interest rates fell rapidly and converged to the low  levels in NEA

25

10 Nominal interest rate, 10-year government bonds

8

20

Real interest rate, 10-year government bonds

6 4

15 2 0

10

-2 5

0

SEA-4 excl GRC NEA excl LUX & FIN Italy Stage two of EMU

-4 Euro Adoption

SEA-3 SEA 3 EMU

-6

SEA-4 excl GRC NEA excl LUX & FIN Italy Stage two of EMU

Euro Adoption

SEA-3 SEA 3 EMU

-8 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006

1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006

Source: IFS statistics, IMF Staff Calculations

17

What explains the growing current account deficits in  What explains the growing current account deficits in Southern Euro countries? 1. Stylized facts 2 Role of EMU 2. Role of EMU 3. A quantitative analysis

18

Regression analysis Regression analysis ‰

Standard current account regression: CA is a function of the fiscal balance  Standard current account regression: CA is a function of the fiscal balance (+), growth opportunities (‐), current dependency ratios (‐), future  dependency ratios (+), initial net foreign assets (+), time dummies   ‰

‰

See for instance Lee et al. (2008)

Augmented with financial liberalization and dummy variables for  Augmented with financial liberalization and dummy variables for participation into EMU and adoption of the euro Use of dummy variables to capture “exogenous” effect of EMU and euro  adoption  adoption ‰ Dummy variables for EMU and euro adoption are differentiated for NEA and  SEA (different income levels, different accompanying policies) => Northern EMU, Southern EMU, Northern euro, Southern euro ‰

19

Regression analysis (continued) Regression analysis (continued) ‰

Repeat regression separately for saving and investment rates Repeat regression separately for saving and investment rates

‰

Focus on medium‐run determinants of CA (data are averaged over four‐ year periods); unbalanced panel of 49 advanced and emerging economies  over the period 1973‐2008

20

Main results ‰ ‰ ‰

Financial liberalization weakens CA by depressing saving rate EMU had positive impact on CA of NEA, negative insignificant impact on SEA Euro adoption lowered CA in SEA and NEA by raising investment D t Determinants i t off the th Current C t Accounts A t and d Saving S i and d IInvestment t t Rates R t (continued) ( ti d) 1/ (Percent of GDP)

Financial factors: Financial liberalization index EMU and euro factors: Northern EMU dummy variable Southern EMU dummy variable Northern euro dummy variable Southern euro dummy variable Observations Adjusted R-squared

Current Account

Saving Rate

Investment Rate

(a)

(b)

(c )

-0.04 [3.58]***

-0.088 [4.62]***

-0.049 [2.52]**

0.031 [2 10]** [2.10]** -0.015 [1.19]

-0.024 [1 67]* [1.67]* -0.002 [0.17]

-0.055 [3 15]*** [3.15]*** 0.012 [1.14]

-0.04 [2.12]** -0 042 -0.042

0.007 [0.36] -0 003 -0.003

0.047 [2.22]** 0 039 0.039

[2.71]*** 411 0.56

[0.12] 409 0.49

[2.49]** 409 0.24

Source: IMF staff calculations. 1/ Robust t statistics are in parentheses; *, **, and *** denotes significance at the 10 percent, 5 percent, and 1 percent, respectively. All regressions include a constant and time-fixed effects and are estimated by ordinary least squares.

21

Most of the decline in SEA CA is due to EMU/euro effects Most of the decline in SEA CA is due to EMU/euro effects ‰

Financial liberalization, demography, and initial net foreign assets also  Financial liberalization, demography, and initial net foreign assets also played a role, but a more limited one  Change in Current Account, 1989-92 to 2005-08 (Percent of GDP) -8 -6 -4 -2 0 2 4

6

current account net foreign assets fiscal balance growth opport. demography oil balance financial center EMU/euro financial lib. time dummies residual

average euro south average euro north

Source: IMF Staff Calculations.

22

Euro adoption allowed to maintained investment  higher than domestic saving would have financed ‰

‰

One benefit from economic integration is improved access to the  international pool of saving Financial liberalization and demography were major factors behind the drop  in saving rates but also reduced investment through lower availability of in saving rates but also reduced investment through lower availability of  domestic saving Change in Saving Rate, 1989-92 to 2005-08 (P (Percent t off GDP) -8 -6 -4 -2 0 2

4

6

Change in Investment Rate, 1989-92 to 2005-08 (Percent of GDP) -8 -6 -4 -2 0 2

saving rate

investment rate

net foreign assets

net foreign assets

fiscal balance

fiscal balance

growth opport.

growth opport.

demography

demography

oil balance

oil balance

financial center

fi financial i l center t

EMU/euro

EMU/euro

financial lib. time dummies residual

average euro south average euro north Source: IMF Staff Calculations.

financial lib. time dummies residual

4

6

average euro south average euro north

23

Are the current account deficits excessive? 1. Evidence from real effective exchange rates (REER)  and growth performance and growth performance

24

REER of SEA appreciated by 10 15 percent since 1999 REER of SEA appreciated by 10‐15 percent since 1999

130

130 125

REER (1999=100), HICP Deflator

125

NEA SEA-4 SEA-3 Italy

120

120

REER (1999=100), Price Deflator GDP at Market Prices

NEA SEA-4 SEA-3 Italy

115

115

110

110

105

105

100

100

95

95

90

90

85

85

80

80 1994

1996

1998

2000

2002

2004

2006

2008

1994

1996

1998

2000

2002

2004

2006

2008

Source: European Commission, IMF Staff Calculations

25

Unit labor cost based REER show an even more serious  appreciation of about 25 percent

130 125

130 REER (1999=100), Nominal Unit Labor Costs in Manufacturing

REER (1999=100), Price Deflator Exports of Goods and Services

125

120

120

115

115

110

110

105

105

100

100

95

95

90

NEA SEA-4 SEA 3 SEA-3 Italy

85 80

NEA SEA-4 SEA 3 SEA-3 Italy

90 85 80

1994

1996

1998

2000

2002

2004

2006

2008

1994

1996

1998

2000

2002

2004

2006

2008

Source: European Commission, IMF Staff Calculations

26

Growth performance after EMU entry is mixed Growth performance after EMU entry is mixed ‰ ‰

Growth per capita declined in Italy, Spain, Portugal and Malta Italy, Portugal and Malta are diverging from NEA income levels or not  converging 6

100 Average real GDP growth per capita

5

before EMU

after EMU

90

4

80

3

70

2

60

1

50

0

40 Cyprus

Greece

Italy

Malta

Portugal Slovenia

Spain

PPP GDP per capita in percent of Northern euro-area countries (population-weighted average)

Cyprus Greece Italy Malta Portugal Slovenia Spain 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007

Source: IFS statistics, World Bank WDI, IMF Staff Calculations

27

Are the current account deficits excessive? 1. Evidence from real effective exchange rates (REER)  and growth performance 2. Formal measures of competitiveness gaps

28

The Macro Balance Approach (MB) The Macro Balance Approach (MB) ‰

Drawback of CA and REER measures: change in CA and REER may reflect  Drawback of CA and REER measures: change in CA and REER may reflect adjustment to a new equilibrium instead of competitiveness problem

‰

In MB approach, CA norm is the predicted value of CA regression including  fundamental determinants of saving and investment (see IMF Consultative  Group on Exchange Rate Issues) Group on Exchange Rate Issues)

‰

Use our regression to calculate norms for each country for 2008 and  compare these to the actual CA deficit corrected for the cycle

‰

One issue is whether the EMU and euro effects should be part of the norm  One issue is whether the EMU and euro effects should be part of the norm – to what extent are they structural, representing a structural shift on the  financing side, versus an over‐reaction to the process of economic  integration and e cessi e borro ing? integration and excessive borrowing?  29

The External Sustainability Approach (ES) The External Sustainability Approach (ES) ‰

The ES approach calculates the CA which stabilizes net foreign assets (NFA)  The ES approach calculates the CA which stabilizes net foreign assets (NFA) at some reference level, usually the latest observed value

g +π CA = NFA 1+ g + π where g is assumed medium‐term real GDP growth rate and π the  assumed medium‐term inflation.

30

CA of SEA countries are excessive CA of SEA countries are excessive ‰

‰

‰

The excessive component of deficits are much larger if EMU/Euro effects  are not or only partially considered to be structural are not or only partially considered to be structural The ES norms are more in line with the MB norms without EMU/Euro  effects And ES norms are not particularly demanding for many countries which  have already very low NFA Current Account Norms (Percent of GDP) Current Accounts in 2008

Underlying Current Account 1/

Estimated MB Norm with EMU/Euro Dummies

Estimated MB Norm without EMU/Euro Dummies

ES Norm

SEA

-9.0

-8.4

-5.3

-1.1

-1.5

SEA-4

-9.9

-9.8

-8.0

-4.0

-2.8

Italy

-3.4

-3.7

-4.8

-0.5

-0.2

Source: IMF Staff Calculations 1/ The current account balance that would emerge at zero output gap both domestically and in partner countries, i.e., the current account adjusted for the presence of output gaps in 2008.

31

The needed adjustments in CA are sizeable The needed adjustments in CA are sizeable ‰

‰ ‰

1‐1.5 percentage point annual improvement in CA needed to reach norm  in 5 years Larger adjustments in Cyprus, Greece, Malta, Portugal and Spain Smaller adj stments in Ital and Slo enia Smaller adjustments in Italy and Slovenia

Annual Improvement in Current Accounts to Reach Norms in 5 years (Percent of GDP) Underlying Current Account 1/

Estimated MB Norm Estimated MB Norm with EMU/Euro without EMU/Euro Dummies Dummies

ES Norm

SEA

-8.4

0.6

1.5

1.4

SEA-4

-9.8

0.4

1.1

1.4

Italyy

-3.7

-0.2

0.6

0.7

Source: IMF Staff Calculations 1/ The current account balance that would emerge at zero output gap both domestically and in partner countries, i.e., the current account adjusted for the presence of output gaps in 2008.

32

The estimated competitiveness gaps are large The estimated competitiveness gaps are large ‰

‰

Competitiveness gap is measured as percent change in REER needed to  b bring actual CA to its norm, using elasticities of CA to REER l l f Competitiveness gap is 40 percent on average for SEA‐4 and somewhat  lower for Italy at 20 percent y p Estimates of Real Exchange Rate Gap 1/ (Percent) Estimated MB Norm with EMU/Euro Estimated MB Norm without EMU/Euro Dummies 2/ Dummies 2/

ES Norm 2/

SEA

16.1

32.2

33.2

SEA-4

17.1

36.9

43.5

Italyy

-7.0

21.0

23.1

Source: IMF Staff Calculations 1/ The elasticity of current account to real effective exchange rate assumes changes in the real effective exchange rate affect the current account mainly through trade balance, i.e., ε∆(CA/GDP)/∆RER can be calculated from (export elasticity)x(export to GDP ratio)-(import elasticity -1)x(import to GDP ratio). The export and import elasticity are from CGER estimates with the values of -0.71 and 0.92 respectively. 2/ Corresponded to the underlying current account which is the current account balance that would emerge at zero output gap both domestically and in partner countries, i.e., the current account adjusted for the presence of output gaps in 2008.

33

Are the current account deficits excessive? Are the current account deficits excessive? 1. Evidence from real effective exchange rates (REER)  1 Evidence from real effective exchange rates (REER) and growth performance 2 Formal measures of competitiveness gaps 2. Formal measures of competitiveness gaps 3. Impact of the global financial crisis

34

Despite the current unwinding, CA deficits are  expected to remain vulnerable ‰

Expected average improvement of 2.8 percent of GDP

8

8 Current Account Balance (Percent of GDP)

4

8

8 Current Account Balance (Percent of GDP)

4

4

0

0

0

0

-4

-4

-4

-4

-8

-8

-8

-8

12 -12

12 -12

12 -12

-16 Southern euro area Northern euro area

-20 -24 2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

-16

-16

-20

-20

-24

-24

4

12 -12 Greece Portugal Spain Cyprus Malta Slovenia Italyy

-16 -20 -24

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

Source: IFS statistics, IMF Staff Calculations

35

200

-50

-100 Iceland Greece Croatia Portugal Hungary Ne ew Zealand Bulgaria Spain Estonia Latvia Australia Lithuania Slova ak Republic Romania Czecch Republic Brazil Mexico Finland Korea Slovenia Unite ed Kingdom Ukraine Ireland Austria Un nited States Euro Area Russia Canada Denmark Sweden India Israel Italy Netherlands N Cyprus France Germany Malta Belgium Chin na,P.R.:Mai Japan Norway Singapore Luxemburg Switzerland S Chin na,P.R.:Hon

…putting further pressure on already very negative net  international investment positions for Greece Spain international investment positions for Greece, Spain,  and Portugal

250

Net International Investment Position at end-2007 (Percent of GDP) 250

-150 200

150 150

100 100

50 50

0 0

-50

-100

-150

Source: IFS Statistics Statistics, IMF Staff Calculations

36

Policy options in a currency union?

37

Why should a country worry about a large CA deficit in  a currency union? ‰

They may be suboptimal if they result from distortions (Blanchard 2007) They may be suboptimal if they result from distortions (Blanchard, 2007) ‰

‰

When CA deficit is associated to a competitiveness problem, it is likely to  require a protracted period of low growth to recover afterwards – q p p g especially in currency union ‰ ‰

‰

Examples: low net savings resulting from transitory booms in asset prices  (Spain); excessively rosy expectations about future growth (Portugal)

Potential threat to the stability of the union Accentuation of political problems Accentuation of political problems

They imply multiple and mutually‐reinforcing macroeconomic  vulnerabilities in case of sudden stop of external financing ‰

‰

Vulnerability to sudden stop of external financing (liquidity issues,  deleveraging and sharp contraction of domestic demand) g g p ) Vulnerabilities on the asset side of banks’ balance sheet

38

What are the policy options? What are the policy options? ‰

Fiscal policy ‰

‰

‰

“Internal devaluation”: reducing labor costs at home relative to trading  partners ‰ ‰ ‰

‰

Reducing social security contributions financed by increased VAT rates Reducing indexation of wages to inflation Reassessing other wage impacting policies: minimum wage growth Reassessing other wage impacting policies: minimum wage growth,  unemployment benefits

Structural policies to improve productivity growth, including in  nontradable sector d bl ‰

‰

Removing policies that might be distorting and reducing savings (e.g.  R i li i th t i ht b di t ti d d i i ( mortgage interest relief) Fiscal consolidation, especially if public saving is too low or monetary policy  too lax l

Capital investment, education, innovation, product market regulation and the  business environment

Regulatory financial policies

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The impact of appropriate policy adjustments can be  large

The Improvement in Current Accounts from Policy Changes (Percent of GDP)

Italy Greece Portugal g Spain

ratio of min to mean wage 1/ avg NEA min NEA -1.1 0.0 1.0 2.1 1.4 2.5 0.0 1.1

labor productivity growth 2/ avg NEA max NEA 1.9 2.6 -1.1 -0.4 0.8 1.6 1.7 2.4

Source: IMF Staff Calculation 1/ Each country lowers its ratio of minimum to mean wage to the lowest/average level in the NEA (Austria, Germany, Finland) 2/ Each country brings its labor productivity growth to the highest/average levels observed in NEA (Finland and Netherlands)

40

Conclusions ‰

‰

‰

‰

‰

The large CA declines in SEA were associated with large declines in private  The large CA declines in SEA were associated with large declines in private saving rates, and only moderate increases in investment rates. Yet, the CA declines would not have occurred, despite the decline in saving  rates, if it was not for the creation of EMU and especially the introduction  of the Euro. Euro adoption allowed to maintain investment at a higher  level than domestic saving by improving access to the international pool of  saving. The CA deficits are larger than what we can explain with equilibrium  models using underlying fundamentals and therefore would appear models using underlying fundamentals and therefore would appear  excessive. The large CA deficits present risks to the economy and therefore matter,  even in a currency union. If countries don’t take action, they could be faced with a protracted period  of low growth, with possible consequences of the stability of the currency  o o go , poss b e co seque ces o e s ab y o e cu e cy union. 41

Italy ‰

Not an external sustainability problem: CA deficit is still moderate (despite  declining trend), net international investment position is close to balance, declining trend), net international investment position is close to balance,  household saving rate is high.

‰

More a dynamism issue: growth is low and has declined; income per  capita has been diverging from NEA levels. Chronic weak productivity  growth is feeding into weakening competitiveness. Wage growth is not  particularly high. Some evidence of moving up the value added ladder but  not strong enough.

‰

Italy has lost competitiveness but less than boom countries. CA deficit is  relatively large given that growth was slow and domestic demand was not  booming. Current estimated competitiveness gap is about 20 percent.

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The End The End

43

xxx ‰

xxx Determinants of the Current Accounts and Saving and Investment Rates 1/ (Percent of GDP)

Standard variables: Initial net foreign assets General government balance (percent of GDP) Growth opportunities: Growth of GDP per capita Relative income per capita Demographics: Population growth Current old-age dependency ratio Future old-age dependency ratio Oil balance Financial center dummy variable Observations Adjusted R-squared

Current Account

Saving Rate

Investment Rate

(a)

(b)

(c )

0.042 [5.88]***

0.037 [3.94]***

-0.005 [0.58]

0.204 [4 00]*** [4.00]***

0.377 [4 41]*** [4.41]***

0.175 [2 08]** [2.08]**

-0.057 [0.68]

0.921 [5.85]***

0.979 [6.43]***

0.031 [2.44]**

0.087 [4.46]***

0.056 [3.31]***

-0.716 [2.01]**

-1.367 [2.36]**

-0.647 [1.15]

-0.158 [2.67]*** 0.057 [1.25] 0.238

-0.591 [6.65]*** 0.205 [2.78]*** 0.259

-0.433 [4.97]*** 0.148 [2.12]** 0.021

[6.61]*** 0.022 [2.75]*** 411 0.56

[3.85]*** 0.047 [4.24]*** 409 0.49

[0.40] 0.025 [2.05]** 409 0.24

Source: IMF staff calculations. 1/ Robust t statistics are in parentheses; *, **, and *** denotes significance at the 10 percent, 5 percent, and 1 percent, respectively. All regressions include a constant and time-fixed effects and are estimated by ordinary least squares.

44