II Issues in the Current Conjuncture
Author:
International Monetary Fund
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English
Print Publication Date:
15 Oct 1997
Keywords:
WEO; exchange rate; state enterprise; trade balance; country; China; net debtor countries; EU economy; advanced economy; deutsche mark; EMU member; Exchange rates; Exchange rate arrangements; Currencies; Inflation; Exchange rate flexibility; Middle East; Europe; Western Hemisphere; Africa; Central and Eastern Europe; structural unemployment; private sector; fiscal policy; economic growth; Fiscal stance; Current account deficits; Unemployment; Asia and Pacific; Global
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Abstract

Prospects for the global economy as a whole are little changed from the May 1997 World Economic Outlook (Table 1). World output growth is projected to edge up to 4¼ percent this year and in 1998, slightly slower than projected in May but still the fastest expansion in a decade. Inflation is again projected to remain subdued in the advanced economies, at average rates of 2–2 ¼ percent, and to decline further in the developing countries and the countries in transition. World trade volume is projected to expand by 7¾ percent in 1997 and 6¾i percent in 1998, rates that are somewhat faster than those in 1996 but below the exceptionally rapid growth rates of 1994–95.

Prospects for the global economy as a whole are little changed from the May 1997 World Economic Outlook (Table 1). World output growth is projected to edge up to 4¼ percent this year and in 1998, slightly slower than projected in May but still the fastest expansion in a decade. Inflation is again projected to remain subdued in the advanced economies, at average rates of 2–2 ¼ percent, and to decline further in the developing countries and the countries in transition. World trade volume is projected to expand by 7¾ percent in 1997 and 6¾i percent in 1998, rates that are somewhat faster than those in 1996 but below the exceptionally rapid growth rates of 1994–95.

Table 1.

Overview of the World Economic Outlook Projections

(Annual percent change unless otherwise noted)

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Note: Real effective exchange rates are assumed to remain constant at the levels prevailing during July 18–August 14, 1997, except for the bilateral rates among ERM currencies, which are assumed to remain constant in nominal terms.

Simple average of spot prices of U.K. Brent, Dubai, and West Texas Intermediate crude oil. The average price of oil in U.S. dollars a barrel was $20.42 in 1996: the assumed price is $19.39 in 1997 and $19.03 in 1998.

Average, based on world commodity export weights,

London interbank offered rate.

The slight downward revision in projected global growth masks a number of significant changes in the IMF staff’s projections for individual countries and country groups that are largely offsetting. The projections for growth in the group of advanced economies as a whole are in fact virtually unchanged, while there are more significant downward revisions for both the developing countries and the countries in transition.

In the advanced economies, the largest change has been the downward revision to growth in Japan by about 1 percentage point in both 1997 and 1998. In the United States and to a lesser extent in Canada, growth projections have been upgraded. Projected growth in the EU as a whole is virtually unchanged, although within the EU the growth outlook has deteriorated slightly in Germany and France while improving in some of the smaller economies (Table 2). For the newly industrialized countries of Asia, projected growth also remains broadly unchanged despite downward revisions to projections in some cases.

Table 2.

Advanced Economics: Real GDP, Consumer Prices, and Unemployment Rates

(Annual percent change and percent of labour force)

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Consumer prices arc based on the retail price index excluding mortgage interest.

Consumer prices excluding interest rate components; for Australia also excluding other volatile items.

Recent developments have widened further the cyclical divergences among the major industrial countries, and these divergences are projected to narrow to only a limited extent over the next year or two (Figure 4). The United States and the United Kingdom, the major industrial countries closest to full capacity utilization, have continued to see buoyant growth in 1997. In the United States, growth in the first half of the year was about 4½ percent at an annual rate, far exceeding the economy’s potential growth rate of about 2¼ percent. Unemployment fell below 5 percent during the second quarter, but even though most estimates of the nonaccelerating inflation rate of unemployment (NA1RU) are around or above 5½ percent, there have been few signs of higher inflation (see below). The U.S. expansion has moderated somewhat since the first quarter, and growth is expected to be close to potential in the remainder of 1997 and 1998, reflecting a slowdown in both consumer spending and business investment, partly in response to some assumed further lightening of monetary conditions in the second half of the year (The Federal Reserve has held the federal funds rate at 5½ percent since late March.) With the structural budget balance roughly unchanged during 1996–98, fiscal policy will have little effect on overall demand (Table 3). The United Kingdom also experienced continued above-potential growth (3¾ percent annualized) in the first half of 1997, but the expansion there also is projected to slow to more sustainable rates, owing to the strength of sterling, increases in short-term interest rates, and continuing significant fiscal consolidation. The recovery in Canada continues to gather strength with domestic demand expanding at a fairly robust pace. Unemployment fell to 9 percent during the second quarter, the lowest level since 1990.

Figure 4.
Figure 4.

Major Industrial Countries: Output Gaps1

(Actual less potential as a percent of potential)

Recently, greater differences have emerged in the relative cyclical positions of the major industrial countries.

1 Shaded areas indicate IMF staff projections. The gap estimates are subject to a significant margin of uncertainly. For a discussion of approaches to calculating potential output, see Paula De Masi, “IMF Estimates of Potential Output,” Staff Studies for the World Economic Outlook (IMF, forthcoming).2 Data through 199 apply to west Germany only.
Table 3.

Major Industrial Countries: General Government Fiscal Balances and Debt1

(in percent of GDP)

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Note: The budget projections are generally based on information available through August 1997. The specific assumptions for each country are set out in Box 1.

The output gap is actual less potential output, as a percent of potential output. Structural balances are expressed as a percent of potential output. The structural budget balance is the budgetary position that would be observed if the level of actual output coincided with potential output. Changes in the structural budget balance consequently include effects of temporary fiscal measures, the impact of fluctuations in interest rates and debt-service costs, and other noncyclical fluctuations in the budget balance. The computations of structural budget balances are based on IMF staff estimates of potential GDP and revenue and expenditure elasticities (see the October 1993 World Economic Outlook, Annex i). Net debt is defined as gross debt less financial assets, which include assets held by the social security insurance system. Estimates of the output gap and of the structural budget balance are subject to significant margins of uncertainty.

Data before 1990 refer to west Germany. For net debt, the first column refers to 1986–90. Beginning in 1995, the debt and debt-service obligations of the Treuhandanstalt (and of various other agencies) were taken over by the general government. This debt is equivalent to 8 percent of GDP and the associated debt service to ½ of 1 percent of GDP.

Figure for 1980–90 is average of 1983–90.

In contrast, in Japan, following a strengthening of the recovery in late 1996 and early 1997, activity declined sharply in the second quarter partly owing to the unwinding of the first quarter surge in consumption, which had occurred in anticipation of the April increase in the consumption tax. The Japanese recovery is discussed in detail below.

Growth in the major economies of continental Europe in 1997 as a whole is projected to be below potential, as in 1996. There have, however, been a number of signs of more satisfactory growth emerging, and output in both Germany and France is projected to rise by 2¾ percent in 1998—growth that would narrow output gaps, though only modestly, for the first time since 1994. With unemployment having recently risen to postwar peaks in both countries, a dent in cyclical unemployment is badly needed; but structural reforms will also be needed to reduce joblessness toward more tolerable levels (see below). Among the factors stimulating recovery in continental Europe, perhaps the most important has been the easing of monetary conditions since early 1995, which has stemmed partly from further reductions in official interest rates, and partly from the depreciation in foreign exchange markets of the deutsche mark and the currencies closely linked to it in the ERM (Figures 5 and 6). The expansionary influence of greater monetary accommodation and improved international competitiveness has been most evident in the performance of net exports. This has helped to offset the effects of continued budgetary consolidation aimed at the Maastricht targets and weakness in both consumer spending and business investment, which may partly reflect the adverse effects on confidence of uncertainties about employment prospects, fiscal adjustment, and economic policies generally. Consumer confidence has picked up somewhat since early 1996 in France and Germany, but remains weak, in marked contrast to the United States (Figure 7).

Figure 5.
Figure 5.

Major Industrial Countries: Monetary Conditions Indices1

An easing of monetary conditions—broadly defined to include both interest rates and exchange rate changes—in Germany and France is expected to support a resumption of growth.

1 For each country, the index is defined as a weighted average of the percentage point change in the real short-term interest rate and the percentage change in the real effective exchange rate from a base period (January 1990). Relative weights of 3 to 1 are used for Canada. France, Italy, and the United Kingdom, 4 to I for Germany, and 10 to 1 for Japan and the United States The weights are intended to represent the relative impacts of interest rates and exchange rates on aggregate demand: they should be regarded as indicative rather than precise estimates. For instance, a 3-to-l ratio indicates that a 1 percentage point change in the real short-term interest rate has about the same effect on aggregate demand over time as a 3 percent change in the real effective exchange rate. Movements in the index are thus equivalent to percentage point changes in the real interest rates. The lag with which a change in the index may be expected to affect aggregate demand depends on the extent to which the change stems from a change in the interest rate or the exchange rate, and varies depending on the cyclical position; the lag also differs across countries. No meaning is to be attached to the absolute value of the index; rather, the index is intended to show the degree of lightening or easing in monetary conditions from the (arbitrarily chosen) base period. Small changes in the relative weights may affect the value of the index but not the qualitative picture.
Figure 6.
Figure 6.

Three Major Industrial Countries: Policy-Related Interest Rates and Ten-Year Government Bond Yields1

(In percent a year)

Policy-related interest rates in Japan and Germany have fallen significantly over the past three years.

1 The U.S. federal funds “target” rate. Japanese overnight tall rule. German repurchase rate, and all ten-year government bond yields are monthly averages. All other series are end of month.
Figure 7.
Figure 7.

European Union and the United States: Indicators of Consumer Confidence1

Consumer confidence remains weak in the countries of the European Union.

Sources; For the United States, the Conference Board; and the European Commission.1 Indicators are not comparable across countries,2 Percent of respondents expecting an improvement in their situation minus percent expecting a deterioration.

In the smaller economies of western Europe, growth performance has been generally better than in the largest continental European countries, with short-term prospects having improved in a number of cases, including the Netherlands, Portugal, most of the Scandinavian countries, and Spain, reflecting easier monetary conditions and a strengthening of confidence. Ireland is projected to remain the fastest-growing advanced economy in Europe, although its expansion is projected to moderate next year to slightly below 6 percent. However, Austria, Belgium, and especially Switzerland continue to lag in the cycle. Unemployment in the EU as a whole is projected to decline to just below 11 percent next year from 11½ percent in 1996, with jobless levels remaining close to postwar peaks in Germany and France.

The broadly unchanged growth projections for the newly industrialized economics of Asia reflect the offsetting effects of the predominantly temporary nature of last year’s export slowdown in that region—discussed in the May 1997 World Economic Outlook—and the downward revisions to growth associated with the recent turbulence in Asian currency markets.

For the developing countries as a whole, downward revisions to the projections in the May 1997 World Economic Outlook have left prospective growth in 1997 and 1998 above 6 percent, close to the rates at which growth has been running in most years since 1992, and clearly above the growth performance of the 1980s and early 1990s (Table 4). The downward revisions to growth projections for 1997 are largest in the case of Africa, but are quite widely spread except in the Middle East and Europe region. For 1998, the reductions in projected growth mainly concern Asia and Latin America.

Table 4.

Selected Developing Countries: Real GDP and Consumer Prices.

(Annual percent change)

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African countries that had arrangements, as of the end of 1996, under the IMF’s Structural Adjustment Facility (SAF) or Enhanced Structural Adjustment Facility (ESAF).

“Consumer prices” are based on a price index of domestic demand, which is a weighted average of the consumer price index, the wholesale price index, and a price index for construction activity. The average year-on-year increase in 1995 in this price index was 59.6 percent, which largely was the result of carryover effects from the high inflation rate prevailing prior to the introduction of the real on July 1, 1994. Consequently, the inflation rate from December 1994 to December 1995, which was 14.8 percent, better reflects the underlying rate during 1995. The December 1995 to December 1996 inflation rate was 9.3 percent; on the same basis, the inflation rate is projected to be 6.6 in 1997.

In Africa, growth is now projected to weaken to below 4 percent in 1997 before recovering to 5 percent in 1998. A major factor underlying the temporary setback this year is severe drought in much of North Africa, which is now expected to cause activity in Morocco to decline by 1 percent; output in Algeria and Tunisia is also adversely affected. Growth projections for Nigeria have also been revised down, reflecting a slower-than-expected recovery in industrial output, while in South Africa, efforts to stabilize the economy and various structural weaknesses continue to constrain the pace of growth. In sub-Saharan Africa excluding Nigeria and South Africa, growth is expected to remain in the 5–5½ percent range. The growth outlook for Kenya now seems somewhat less favorable, given political uncertainties, a significant slowing of the reform effort, and adverse effects on private sector confidence. In a number of other African countries, however, including Côte d'Ivoire, other countries in the CFA franc zone, Ethiopia, and Uganda, performance and prospects have remained quite favorable.

In the developing countries of the Western Hemisphere, the recovery of growth is still projected to continue in 1997 and 1998, but at a more gradual pace than envisioned in the May 1997 World Economic Outlook. The main downward revisions have been to the projections for Brazil and Colombia. For both countries, less sanguine assumptions have been made about fiscal adjustment. The revised projections for Brazil assume that higher real interest rates will be needed to rein in strong domestic demand. In Colombia, a slowdown in construction and manufacturing activity and political uncertainty have weakened growth. By contrast, projected growth in Argentina in 1997 has been revised up by 2½ percentage points to 7½ percent, reflecting continuing progress with reforms, the environment of stable prices, and associated gains in private sector confidence. The growth outlook for Mexico and Venezuela is broadly unchanged.

Asia is projected to remain the fastest growing region in the developing world, and even with the downward revisions to growth projections for 1997 and 1998 owing mainly to the recent currency turmoil in a number of east Asian countries, its expansion this year, by 7½ percent, will still significantly exceed average growth in the 1980s and early 1990s. For Thailand, projected growth has been downgraded by 3½—4 percentage points in the wake of the exchange market crisis, reflecting both the effects of the crisis itself, and the adjustment measures put in place. Spillover effects from the crisis were felt in Indonesia, Malaysia, and the Philippines and growth projections for all of these countries have been downgraded by ½ to 1½ percentage points. If the turbulence were to continue, all four countries might well experience a more significant slowdown. The financial crisis and its impact are discussed below. Among other developing countries in Asia, growth projections have also been revised downward for Pakistan where a significant slowdown in economic activity has followed in the wake of last year’s balance of payments crisis and subsequent adjustment measures; a sustained pickup in growth is contingent on the implementation of sound macroeconomic policies and structural reforms as addressed below. In contrast, growth in China is expected to continue at about 9 percent, with inflation declining further, to below 5 percent next year on an annual average basis.

In the Middle East and Europe region, growth is now expected to be maintained at around 4½ percent in 1997 and 1998, with inflation remaining steady. The upward revisions to projected growth in the region are accounted for largely by developments in the Islamic Republic of Iran and Turkey. For the Islamic Republic of Iran, the projections assume an accelerated pace of economic reforms, laying the ground for a substantial improvement in growth performance, especially in the non-oil sector. In Turkey, growth has been stronger than expected previously, but with inflation remaining at about 80 percent, the economic situation is precarious, and the financial system fragile.

In the countries in transition as a group, output in 1997 is now projected to increase by 1¾ percent, still the first significant positive growth rate in eight years, but revised down by over 1 percentage point from the May 1997 World Economic Outlook (Table 5). In spite of a small downward revision for 1998, the growth rate next year is projected to rise above 4 percent. The downward revisions to projected growth are accounted for mainly by Russia, Ukraine, and a number of other countries in central and eastern Europe, including Albania, the Czech Republic, Moldova, and the Slovak Republic. In the Czech Republic and Poland, and to a lesser extent in the Slovak Republic, output growth this year could be adversely affected by extensive floods that occurred during May–July.

Table 5.

Countries in Transition: Real GDP and Consumer Prices.

(Annual percent change)

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The countries more advanced in transition have generally continued to make progress in reducing inflation, while growth has picked up in a number of countries, including Hungary, after slowdowns in 1996.5 Exchange market pressures related to large current account deficits have affected both the Czech and Slovak Republics (see below). In Poland, inflation on a 12-month basis has fallen below 15 percent. Output growth above 7 percent (annualized) in the first half of 1997, generated by strong domestic demand, led to a widening current account deficit. Import growth, however, has been skewed toward capital goods associated with investment rather than consumption, and capital inflows have consisted largely of foreign direct investment. In Hungary, growth has picked up after a pause in 1996, while inflation has continued to edge downward.

Among countries less advanced in transition, measures aimed at macroeconomic stabilization have led to a significant output decline in Bulgaria and to a milder recession this year in Romania, but also to promising developments in both cases. In Bulgaria, inflation fell rapidly from 400 percent in the first quarter of 1997 to about 4 percent in July, and yields on government securities declined substantially. The authorities’ stabilization program is centered on a currency board arrangement, which went into effect on July 1 with a peg of 1,000 leva to the deutsche mark, supported by an acceleration of structural reforms and a budget that does not require net domestic bank financing. In Romania, monthly inflation fell below 1 percent in July after reaching a high of 31 percent, and the authorities’ policy program includes fiscal austerity, price liberalization, banking reform, and industrial restructuring. Civil order remains to be fully restored in Albania in the wake of the crisis earlier in the year, and reforms, including measures to wind up pyramid financial schemes, remain to be enacted. Output in Albania is projected to drop by 10 percent in 1997 after four years of rapid growth.

In other countries less advanced in transition, Russia and most other countries of the former Soviet Union have made substantial progress in bringing down inflation. In the middle of 1997, 12-month inflation rates were in the single digits in Armenia, and Azerbaijan, below 15 percent in Georgia, Moldova, and Russia, and in the 20–25 percent range in Kazakhstan and Ukraine. Further reductions in inflation in these countries are expected, although fiscal imbalances or delays in structural reform pose risks to price performance. In Belarus, Turkmenistan, and Uzbekistan, however, financial policies have remained relatively loose, and these countries have failed to reduce inflation as rapidly as the other countries in the region.

Finally, turning to balance of payments developments, the current account imbalances of some of the major industrial countries are projected to widen somewhat, but to remain generally smaller than the imbalances seen in some cases in the 1980s. The projected narrowing of cyclical divergences should help contain both the U.S. deficit and the surpluses of Japan and the EU (Table 6). In Japan, after declining to 1½ percent of GDP in 1996, the current account surplus is projected to increase as the depreciation of the yen since 1995 boosts exports. The current account deficit of the United States is expected to widen slightly in 1998 as strong economic activity and the recent appreciation of the dollar continue to spur import demand. After reaching virtual balance in 1996, the United Kingdom’s current account is expected to move into moderate deficit in 1997–98, reflecting the recent appreciation of sterling and strong growth in domestic demand. The continuing growth of exports, against a background of weak domestic demand, is expected to virtually eliminate the current account deficit in Germany, and to increase France’s current account surplus to about 2¼ percent of GDP by 1998. The current account surplus in Italy is expected to remain broadly unchanged.

Table 6.

Selected Economics: Current Account Positions.

(in percent of GDP)

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For European Union (EU) countries, transfers from the EU budget that finance capital outlays are considered to be capital transfers in accordance with standard national accounts and balance of payments methodologies; such transfers are not included in the current account of the balance of payments.

Based on data for the current balance, including a surplus on unrecorded trade transactions, as estimated by IMF staff.

Among other advanced economies, already relatively large current account deficits are expected to widen somewhat further in Australia and in New Zealand. Korea’s current account deficit, which reached 5 percent of GDP in 1996 is expected to narrow in 1997 with the slowing of import growth. In Singapore, despite the export slowdown, the current account surplus has remained at 15 percent of GDP, and is expected to remain at this level in the year ahead.

In a number of the developing countries of Asia, current account developments in 1996 reflected the partly offsetting effects of the slowdown in export growth in 1995–96 and policies to contain domestic demand and overheating. In Malaysia in 1996, the slowdown of domestic demand dominated, and the current account deficit declined significantly; it is projected to widen slightly in 1997, but to narrow to 4½ percent of GDP in 1998 in response to the depreciation of the exchange rate and moderating domestic demand growth. In Thailand, after reaching 8 percent of GDP in 1995½96, the current account deficit is expected to narrow this year to 5 percent as the pace of economic growth moderates further and macroeconomic adjustment measures put in place in the aftermath of the exchange rate crisis take effect. In Indonesia, the recent depreciation of the rupiah is expected to boost exports and contribute to a modest narrowing of the current account deficit in 1998. In the Philippines, the current account deficit is projected to remain roughly unchanged this year, but to narrow to 3½ percent of GNP next year. In China, the current account is expected to remain in approximate balance.

With significant capital inflows and growth picking up in Latin America, current account deficits have increased, Mexico’s current account deficit is expected to reach 2¼ percent of GDP by 1998, as domestic demand continues to strengthen. Current account deficits are also expected to increase in Argentina, to just above 3 percent of GDP in 1997 and in Brazil, to 5 percent of GDP in 1998.

In a number of African countries, current account deficits widened in 1996 owing to declines in commodity prices, and a slight further deterioration is expected for the region in 1997. Current account deficits are projected to widen somewhat in Ethiopia, but to narrow or remain unchanged in a number of the CFA franc zone countries, Kenya, South Africa, Tanzania, Uganda, and Zimbabwe. The recent decline in oil prices is expected to shrink current account surpluses in Algeria and Nigeria.

Current account deficits in many countries in transition increased in 1996, and relatively wide deficits are expected to persist. In the Czech and Slovak Republics, deficits increased to over 8 percent of GDP in 1996, reflecting strong import demand and appreciated currencies. Buoyant domestic demand in Poland is expected to contribute to a significant widening of its current account deficit in 1997.

Capital flows to developing countries, which reached a record high in 1996, have, according to all indications, remained strong during 1997 in most developing countries (Table 7). Some countries, however, whose currencies have recently come under attack—as discussed below-—may experience a decline in net inflows for the year as a whole.

Table 7.

Capital Flows to Developing Countries, Countries in Transition, and Newly Industrialized Economics1

(In billions of U.S. dollars)

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Net capital flows comprise net direct investment, net portfolio investment, and other long- and short-term net investment flows, including official and private borrowing.

Annual averages.

Because of data limitations other net investment may include some official flows.

A minus sign indicates an increase.

Hong Kong, China; Israel; Korea; Singapore; and Taiwan Province of China.