Net foreign assets (NFA) determine whether a country is a creditor or debtor nation by measuring the difference between its external assets and liabilities. These assets refer to the value of overseas properties, investments, and financial instruments owned by a nation, minus the value of its domestic assets that are owned by foreigners, adjusted for changes in valuation and exchange rates.
A nation’s NFA position also captures the cumulative changes in its current account, which accounts for the balance of trade, net income over time, and net current transfers over time.
Key Takeaways
- NFA determines a country’s status as a global creditor or debtor by assessing the difference in external assets and liabilities.
- A nation’s NFA position reflects cumulative changes in its current account, including the balance of trade, net income, and net current transfers over time.
- NFA metrics are influenced by changes in valuation and exchange rates.
The Significance of NFA in National Financial Health
The NFA position indicates whether a nation is a net creditor or debtor to the world. A positive NFA balance signifies a net lender status, whereas a negative NFA balance indicates that the nation is a net borrower.
According to the World Bank’s definition, NFA is the sum of foreign assets held by monetary authorities and deposit money banks, minus their foreign liabilities.
Understanding the correlation between a nation’s NFA position and changes in its current account is straightforward because an entity’s debt position at any time reflects the cumulative result of its borrowing and lending activities. For example, if an entity has borrowings totaling $500 and loans of $1,500, it is a net creditor by $1,000.
Similarly, if a nation encounters a current account deficit of $10 billion, it must borrow this amount from foreign sources to cover the shortfall. Borrowing $10 billion increases its foreign liability and reduces its NFA by the equivalent amount.
Impacts of Valuation and Exchange Rates on Net Foreign Assets (NFA)
To obtain a comprehensive understanding of an NFA position, one must consider changes in valuation and exchange rates. For instance, foreign governments hold significant amounts of U.S. government bonds. Should interest rates increase, causing the price of these bonds to fall, the value of the foreign governments’ holdings and, consequently, their NFA would decrease.
Exchange rate fluctuations also substantially influence the NFA position. Currency appreciation against other nations’ currencies decreases the value of both foreign currency-denominated assets and liabilities, while depreciation increases their value. Thus, if a nation is a net debtor, currency depreciation will escalate its foreign currency debt burden.
Furthermore, the NFA position can impact exchange rates. Persistent current account deficits are unsustainable over time and can lead to devaluation pressures. Nations with significantly negative NFA positions and growing current account deficits might experience their currency value plummet, potentially triggering speculative attacks aiming to devalue the currency further.
Related Terms: current account, balance of trade, net income, liabilities, currency depreciation.
