External Balance Sheets and the COVID-19 Crisis

Area of Science:

• International Finance
• Macroeconomics
• Financial Crises

Background:

• The COVID-19 pandemic triggered an economic crisis, characterized by rapid appreciation of safe haven currencies.
• Previous financial crises often led to significant losses on aggregate external balance sheets for emerging markets.

Purpose of the Study:

• To quantify currency-induced balance sheet valuation effects for aggregate external positions and asset classes in 2020.
• To analyze the impact of currency fluctuations on the net international investment positions (NIIP) of 46 countries.

Main Methods:

• Utilized new data on the currency composition of cross-border assets and liabilities for 46 countries.
• Employed stock-flow reconciliation of NIIP to measure overall valuation effects.
• Calculated the proportion of valuation effects attributable to currency value changes.

Main Results:

• Many emerging markets avoided aggregate external balance sheet losses despite domestic currency depreciation.
• Currency-induced valuation gains on equity positions offset losses on debt positions.
• Reduced currency mismatch in external debt positions contributed to resilience.
• Currency-induced valuation effects were substantial for about half of the sample countries, exceeding 50% of total valuation effects in Q1 and full-year 2020.

Conclusions:

• The COVID-19 crisis exhibited different dynamics for emerging market balance sheets compared to past crises.
• Currency valuation effects played a significant role in shaping external balance sheets during the pandemic.
• Diversification of assets and liabilities across currencies can mitigate crisis-related financial risks.