Chapter

Chapter 1 Developments in the World Economy

Author(s):
International Monetary Fund
Published Date:
January 1988
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Introduction

Much of 1987 and the first part of 1988 were characterized by continued expansion in world output and trade. At the same time, there was growing evidence that exchange rate changes and economic policy adjustments in the major industrial countries were beginning to affect external imbalances. Among the developing countries, rapid export growth permitted a strengthening of external positions and a decline in debt-to-export ratios. Nevertheless, despite these positive aspects of the world economic situation there is no room for complacency. Much remains to be done to restore the heavily indebted countries’ creditworthiness, as well as growth throughout the developing world. Moreover, the imbalances among the major industrial countries remain large and the momentum of adjustment needs to be reinforced through the continued implementation of the commitments made under the economic policy coordination process (see Box 1). The Fund, for its part, should continue to support and promote this process.

Real output in the industrial countries expanded by over 3 percent in 1987, somewhat faster than in 1986. The strong momentum of growth in the second half of the year continued in the early part of 1988, and largely offset the dampening impact of the wealth losses resulting from the decline in equity prices in October 1987. At the same time, inflation has remained low, which is a remarkable achievement after five years of expansion. In spite of a slight acceleration in consumer price increases, the underlying rates of inflation in the industrial countries—as measured by GNP deflators—averaged some 3 percent last year. Moreover, although the large external imbalances among the major industrial countries have remained a source of concern, they have begun to diminish in real terms. In the United States, for example, net exports of goods and services increased by 0.2 percent of GNP in volume terms in 1987, while the current account surpluses of Japan and the Federal Republic of Germany in real terms declined by 0.7 percent and 1.1 percent of GNP, respectively. Finally, relatively buoyant activity in the industrial countries was associated with a strong growth of world trade, which expanded by about 5½ percent in volume in 1987.

In the developing world, recent economic developments have been more mixed; balance of payments strains eased somewhat in 1987 and real output continued to expand, but there were substantial differences in performance among different groups of countries. Many countries have benefited from vigorous export growth, which was accompanied by a partial recovery of export prices. As a result, debt-to-export ratios declined significantly in 1987. Current account positions also strengthened markedly, being approximately in balance for the developing countries as a whole, compared with a deficit of $41 billion in 1986. Nonetheless, despite the improvement in the external environment, the average growth rate in the developing countries fell from 4.2 percent in 1986 to 3.4 percent in 1987. This was partly because of stagnation in the fuel exporting countries, which reflected the impact of continued adjustment to the decline in export earnings in 1986. In addition, growth in some of the larger non-fuel exporting countries also decelerated. While activity was particularly strong among the Asian exporters of manufactures, in the group of sub-Saharan African countries the rise in output remained below the rate of population growth, a trend that continued the steady erosion of living standards these countries have experienced in almost every year since 1980. A sharp intensification of inflationary pressures, reflecting in part the effects of currency depreciations in combination with relatively lax financial policies, was a particularly worrisome aspect of the situation in many developing countries.

Box 1Recent Accords on the International Economy and Statements of the Group of Seven

The Louvre Accord. The finance ministers and central bank governors of six major industrial countries (Canada, France, the Federal Republic of Germany, Japan, the United Kingdom, and the United States) in a meeting on February 22, 1987 at the Palais du Louvre in Paris agreed to intensify efforts at economic policy coordination to promote more balanced economic growth and to reduce existing imbalances. In their communiqué (known as the Louvre Accord), they noted the progress that had been made in achieving sustainable, noninflationary expansion. They stated that “surplus countries committed themselves to following policies designed to strengthen domestic demand and to reducing external surpluses.” At the same time, “deficit countries committed themselves … to encourage steady, low-inflation growth while reducing their domestic imbalances and external deficits.” They further agreed to cooperate “to foster stability of exchange rates around current levels.”

Venice Economic Declaration. At the thirteenth economic summit meeting, held in Venice, Italy, on June 8—10, 1987, the heads of state or government of the seven major industrial countries (Canada, France, the Federal Republic of Germany, Italy, Japan, the United Kingdom, and the United States) agreed to strengthen the existing arrangements for multilateral surveillance and economic coordination. In their communiqué, they agreed to strengthen, with the assistance of the Fund, the surveillance of their economies by using economic indicators. This strengthening would include (1) a “commitment by each country to develop medium-term objectives and projections for its economy,” as well as for the group of countries “to develop objectives and projections that are mutually consistent,” and (2) “the use of performance indicators to review and assess current economic trends and to determine whether there are significant deviations from an intended course that require consideration of remedial actions.”

Group of Seven Statements. Against the background of the commitments made under these two agreements, the ministers and central bank governors of the Group of Seven during the financial year 1987/88 issued a number of statements on the world economy and on the need for intensified policy coordination.

On September 26, 1987, prior to the Fund’s Annual Meetings in Washington, the ministers and governors of the Group of Seven issued a statement in which they welcomed the exchange rate stability that had been achieved since the Louvre Accord, which had benefited their countries’ policies and performance. Some important favorable results were beginning to be seen, they noted, particularly the reduction in the U.S. federal budget deficit, the rapid implementation of the program of additional expenditures and income tax cuts in Japan, the greater-than-planned reductions in income taxes from January 1988 in the Federal Republic of Germany, and the reductions that had been achieved in real external imbalances, although these still remained high. The ministers and governors also noted that the large trade surpluses of some newly industrializing economies continued to be “an important factor contributing to external imbalances.” They committed themselves to take further appropriate action to achieve the agreed goals of the Louvre agreement, and to “intensify their efforts to liberalize markets, implement tax reforms and pursue other structural changes … to foster a high rate of sustained noninflationary growth, and to reduce external imbalances” while fighting protectionism. They concluded by reaffirming their intentions to carry forward their economic policy coordination efforts under the strengthened surveillance arrangements that had been outlined at the Venice Summit.

The statement issued by the Group of Seven on December 22, 1987 reaffirmed their conviction that “the basic objectives and economic policy directions agreed in the Louvre Accord remain valid and provide for a positive development of the world economy.” The ministers and governors emphasized their view that “the major external imbalances in the world economy must be corrected” and that the policies that were being implemented were showing the intended effects. They observed that the “greater stability of exchange rates achieved for much of the past year following the earlier substantial exchange rate changes contributed to this adjustment.” However, there was a need “to strengthen underlying economic fundamentals and to continue policy cooperation.” They noted that “developments in stock markets since mid-October may have some adverse effect on prospects for the industrialized countries,” but they believed that “with sound economic policies and effective coordination, the rate of growth should be substantial.” They accordingly agreed to intensify their economic policy coordination, to continue to direct monetary policies toward providing the conditions for achieving “strong economic growth in the context of price stability as well as to foster financial market stability,” and to reject “protectionist measures as a means of dealing with present imbalances.” They expressed their belief that the reduction of external trading imbalances required cooperative action by other countries, particularly those with surpluses, and agreed that “either excessive fluctuation of exchange rates, a further decline of the dollar, or a rise in the dollar to an extent that becomes destabilizing to the adjustment process could be counterproductive by damaging growth prospects in the world economy.”

Following their meeting in Washington prior to the meeting of the Interim Committee, the Group of Seven issued a statement on April 13, 1988 in which they reported that, “as part of their continuing efforts to strengthen coordination, they agreed to develop, for inclusion in the set of existing indicators, a commodity price indicator as an additional analytical instrument. In this context, they agreed to consider ways of further improving the functioning of the international monetary system and the coordination process.” In their statement, the ministers and governors noted that “their renewed cooperation has provided a basis for improvements in their economies that will strengthen economic performance. They reaffirmed the validity of the policy directions and commitments” set forth in the statement of December 22, 1987 and reiterated “their common interest in stable exchange rates among their currencies.” They also “reaffirmed their full support for the current case-by-case debt strategy as the only viable and realistic approach for overcoming international debt problems” and “welcomed the progress being made by some debtor countries in achieving increased growth and reduced payments deficits through the implementation of sound macroeconomic and structural policies.”

Toronto Economic Declaration. In the communiqué issued on June 21, 1988, the heads of state or government of the seven major industrial countries affirmed the need for governments to “consider fully the international dimensions of their deliberations” and singled out three areas for concerted attention: “the overriding need to resist protectionism and strengthen the open, multilateral trading system; to maintain and strengthen an effective strategy to address the challenge of development and alleviate the burden of debt; and to deal with the serious nature of the world agricultural problem.” They welcomed the progress made in refining the analytical use of indicators and the addition of a commodity price indicator to existing indicators and agreed to pursue structural reforms by removing barriers, increasing competition, and removing disincentives to work, save, and invest. Acknowledging that concessional resource flows were necessary to help the poorest developing countries resume sustained growth, the heads of state or government welcomed proposals for easing debt-service burdens. The proposals included concessional interest rates, usually on shorter maturities, longer repayment periods at commercial rates, and partial write-off of debt-service obligations during the consolidation period. For the highly indebted, middle-income countries, the summit participants noted that a market-oriented, growth-led strategy based on a case-by-case approach remained the only viable approach for overcoming their external debt problems.

The debt situation continues to require a cooperative approach. Although, as indicated above, debt-to-export ratios declined in 1987, for most countries the debt burden remains significantly higher than before the outbreak of the debt crisis in 1982 and output growth has remained unsatisfactory. Further progress in resolving the debt problem and a return to higher growth rates in the developing world will require better domestic policies in the indebted countries, a continued favorable external environment, and adequate external financing.

In implementing the debt strategy a distinction should be made between small, low-income countries and the heavily indebted, middle-income countries. The Fund’s structural adjustment facility (SAF) and the newly created enhanced structural adjustment facility (ESAF) are specifically designed to support adjustment and to help the low-income countries improve their growth prospects. Other official creditors—notably the World Bank—also have an important role to play in assisting these countries, particularly in cases where action is being taken to enhance the efficiency of resource allocation.

Solutions to the debt difficulties of the heavily indebted, middle-income countries, which have borrowed predominantly from private sources, must take into account market realities. Since the level of existing debt is often a constraint on these countries’ access to new financing, recent developments under the so-called menu approach are important steps toward improved creditworthiness. However, private financial flows will only recover to the extent that countries demonstrate an ability to service their debt on commercial terms and implement policies that address the underlying issues of economic flexibility and efficiency. In turn, commercial banks and other private lenders must continue to expand the menu of financing options to ensure that sound adjustment programs are supported with adequate financing. To promote growth-oriented adjustment policies, the Fund has continued to adapt its facilities and instruments. In particular, the compensatory and contingency financing facility has been established to help maintain the momentum of adjustment in the face of adverse external shocks. Decisions have also been taken to make the extended Fund facility more effective in promoting comprehensive medium-term macroeconomic adjustment and structural reforms and in catalyzing financing from other sources.

The remainder of this chapter reviews recent developments in the world economy in more detail. This discussion serves as background for Chapter 2, which presents the policies and activities of the Fund.

Domestic Policies and Activity

Policy Setting

Industrial Countries

The major industrial countries have made important strides since the inception of the economic policy coordination process toward promoting sustained growth with low inflation, reducing external imbalances, and fostering greater stability of exchange rates. A significant achievement has been the regular discussions in the Group of Seven of policies and performance on the basis of economic indicators. This has led to a number of changes in the stance and mix of policies across countries that have enhanced the conditions for noninflationary growth over the medium term. A particularly important achievement has been the strengthening of the growth of domestic demand in the major surplus countries, and a moderation of this growth in the United States. This shift in the pattern of demand has reinforced the effects of the substantial realignment of exchange rates since 1985 on real trade flows.

Nevertheless, the need for strong policy coordination continues. Although external imbalances have begun to diminish in real terms, they remain large. In addition, financial market developments suggest that investors may have remained skeptical about the speed and extent of adjustment. Besides the considerable volatility of stock prices toward the end of 1987 and in early 1988, there was, immediately following the stock market decline in October 1987, some instability in foreign exchange markets. Otherwise, exchange rates for the major currencies were generally stable. Changes in monetary conditions have promoted the needed adjustments in relative rates of growth of domestic spending while contributing to the maintenance of low inflation in the major industrial countries.

The reduction of the federal fiscal deficit in the United States by the equivalent of 2 percent of GNP in fiscal year 1987 is one of the most important policy achievements of the period under review. On a national accounts and calendar year basis, the reduction amounted to 1.4 percent of GNP—see Table 1. Moreover, the deficit-reduction package of December 1987 has helped to contain the deficit in fiscal year 1988 and will also contribute to restraint in fiscal year 1989. Furthermore, there is a firm commitment to deficit reduction in future years, although there is some uncertainty about the pace of budgetary consolidation.

Table 1Major Industrial Countries: Fiscal Balances and Impulses, 1983–871(In percent of GNP/GDP)
Central Government2General Government3
1983198419851986198719831984198519861987
Fiscal balance
(+ surplus, - deficit)
Canada–6.2–6.7–6.6–4.8–4.3–6.9–6.4–7.0–5.5–4.6
United States–5.6–5.1–5.3–4.8–3.4–3.8–2.8–3.3–3.5–2.4
Japan–5.6–4.7–3.9–3.6–3.3–3.7–2.1–0.8–1.1–0.4
France–3.2–3.3–3.3–2.8–2.3–3.2–2.7–2.9–2.9–2.3
Germany, Fed. Rep. of4–1.9–1.6–1.3–1.2–1.4–2.5–1.9–1.1–1.2–1.7
Italy–13.9–13.1–13.8–12.2–11.6–10.6–11.5–12.5–11.4–10.5
United Kingdom–2.8–3.1–2.4–2.2–1.2–3.4–3.9–2.9–2.7–1.4
Seven major countries above–5.3–5.0–4.9–4.4–3.5–4.1–3.4–3.4–3.3–2.5
Seven major countries except the United States–5.1–4.9–4.5–4.0–3.6–4.4–3.9–3.4–3.2–2.5
Fiscal impulse
(+ expansionary, – contractionary)
Canada0.71.60.5–1.5–0.41.11.51.5–1.0–0.6
United States1.70.70.3–0.5–1.40.60.60.70.2–1.0
Japan–0.5–0.6–0.5–0.7–0.2–0.2–1.2–0.9–0.2–0.7
France0.1–0.1–0.2–0.5–0.6–0.2–0.8–0.1–0.6
Germany, Fed. Rep. of–0.20.3–0.4–0.40.5–0.80.20.1
Italy0.1–0.70.8–1.4–0.4–1.50.81.1–0.8–0.7
United Kingdom0.30.4–0.30.2–0.21.30.5–0.50.3–0.3
Seven major countries above0.70.30.1–0.5–0.80.20.20.2–0.7
Seven major countries except the United States–0.1–0.2–0.6–0.3–0.1–0.1–0.3–0.2–0.5
Memorandum
Germany, Fed. Rep. of

Fiscal balance, territorial

authorities
–3.3–2.6–2.1–2.2–2.7

The fiscal impulse is a measure of the thrust of budgetary changes. In general, the impulse points to an expansionary thrust to the extent that, relative to the previous year, revenues increase less rapidly than actual GNP/GDP and/or expenditures increase more rapidly than potential GNP/GDP. For a detailed description of this indicator, see Peter S. Heller, Richard D. Haas, and Ahsan S. Mansur, A Review of the Fiscal Impulse Measure, Occasional Paper No. 44 (Washington: International Monetary Fund, May 1986). Composites for the country groups are weighted averages of the individual national ratios for each year, with weights proportionate to the U.S. dollar value of the respective GNPs/GDPs in the preceding three years.

Data for Canada and the United Kingdom are on a national income accounts basis. Data for Japan cover the consolidated operations of the general account, certain special accounts, social security transactions, and disbursements of the fiscal investment and loan program (FILP) except those to financial institutions. Japanese data other than FILP transactions are based on national income accounts. Data for France and the Federal Republic of Germany are on an administrative basis and do not include social security transactions. Data for Italy refer to the state sector and cover the transactions of the state budget as well as those of several autonomous entities operating at the state level. They also include the deficit, but not the gross transactions, of social security institutions, and part of that of local authorities.

Data are on a national income accounts basis.

In discussions of fiscal policy the German authorities normally refer to the financial position of the territorial authorities, which include federal, state, and local authorities but exclude social security (the latter being included in the definition of general government); see memorandum item.

The fiscal impulse is a measure of the thrust of budgetary changes. In general, the impulse points to an expansionary thrust to the extent that, relative to the previous year, revenues increase less rapidly than actual GNP/GDP and/or expenditures increase more rapidly than potential GNP/GDP. For a detailed description of this indicator, see Peter S. Heller, Richard D. Haas, and Ahsan S. Mansur, A Review of the Fiscal Impulse Measure, Occasional Paper No. 44 (Washington: International Monetary Fund, May 1986). Composites for the country groups are weighted averages of the individual national ratios for each year, with weights proportionate to the U.S. dollar value of the respective GNPs/GDPs in the preceding three years.

Data for Canada and the United Kingdom are on a national income accounts basis. Data for Japan cover the consolidated operations of the general account, certain special accounts, social security transactions, and disbursements of the fiscal investment and loan program (FILP) except those to financial institutions. Japanese data other than FILP transactions are based on national income accounts. Data for France and the Federal Republic of Germany are on an administrative basis and do not include social security transactions. Data for Italy refer to the state sector and cover the transactions of the state budget as well as those of several autonomous entities operating at the state level. They also include the deficit, but not the gross transactions, of social security institutions, and part of that of local authorities.

Data are on a national income accounts basis.

In discussions of fiscal policy the German authorities normally refer to the financial position of the territorial authorities, which include federal, state, and local authorities but exclude social security (the latter being included in the definition of general government); see memorandum item.

Japan also adopted a major package in 1987 aimed at stimulating domestic demand in line with the commitments under the Louvre Accord. In the Federal Republic of Germany, the fiscal deficit rose somewhat in 1987, mainly because of revenue losses associated with tax reductions, deceleration in the growth of nominal income, and changes in remitted accounting profits of the Bundesbank. Efforts to contain budget deficits continued in Canada, France, and Italy, whereas the process of budget consolidation and rapid growth of tax revenue due to the buoyancy of activity in the United Kingdom resulted in a surplus on the overall budget balance and, hence, a negative Public Sector Borrowing Requirement, including proceeds from the privatization of publicly owned enterprises. Some of the smaller industrial countries, including Australia, Belgium, New Zealand, Spain, and Sweden also improved their budget positions significantly during 1987. However, in several other countries budget positions worsened because of weak activity (Denmark), lower revenues from oil and gas exports (the Netherlands and Norway), or expansionary policy shifts (Austria and Finland).

The increased emphasis on fiscal policy measures has been complemented by supportive monetary policies within the framework of the policy coordination process. In the United States, interest rates were allowed to rise somewhat in mid-1987, reflecting fears of an acceleration in inflation and exchange rate considerations (Chart 1). Short-term interest rates tended to increase also in Japan and the Federal Republic of Germany, but interest rate differentials, nevertheless, widened significantly in favor of dollar-denominated assets. Although the behavior of money supply has remained difficult to interpret in many countries, developments in monetary aggregates also seem to confirm that monetary conditions in the United States tightened relative to those in other countries (Table 2). In the days following the stock market crisis in October 1987, the monetary authorities acted quickly and in concert to ensure adequate liquidity, but subsequently reabsorbed most of this liquidity as the crisis abated. In their December 22 statement, the Group of Seven agreed that monetary policies should continue to be directed toward providing adequate monetary conditions to achieve strong economic growth in the context of price stability, as well as to foster financial market stability. During the first quarter of 1988 both long-term and short-term interest rates in the United States remained somewhat below the level that prevailed prior to the stock market decline. However, as interest rates also fell in European countries, a significant short-term interest rate differential was maintained between dollar assets and assets denominated in the major European currencies; against yen-denominated assets, the interest rate differential narrowed significantly after October 1987 (Chart 11). In much of 1987 financial markets were characterized by a steepening of yield curves as investors became more reluctant to commit themselves to longer-term investments.

Chart 1Major Industrial Countries: Interest Rates, 1980–First Quarter 1988

(In percent)

1 Quarterly averages of daily rates on money market instruments of about 90 days’ maturity.

2 Quarterly averages of daily or weekly yields on government bonds, with maturities ranging from 7 years for Japan to 20 years for the United Kingdom.

3 Canada, France, Italy, and the United Kingdom.

4 The real interest rate is the average of those calculated as the nominal rate deflated, first, by a three-quarter (current plus following two quarters) moving average of the private final domestic demand deflator and, second, by the similarly defined GNP deflator.

Table 2Major Industrial Countries: Monetary Aggregates and Nominal GNP, 1985–871(Annual changes, in percent)
Fourth Quarter2
19851986198719861987
Narrow money (M1)3
Canada4.14.812.95.410.3
United States9.013.611.615.66.3
Japan5.06.910.510.44.8
France9.07.84.66.04.3
Germany, Fed. Rep. of4.38.59.07.67.6
Italy13.710.19.310.77.4
United Kingdom18.624.423.421.822.8
Seven major countries above8.611.711.313.07.2
Broad money4
Canada9.48.710.09.07.3
United States8.98.46.59.44.0
Japan8.48.710.49.210.8
France7.76.43.14.14.3
Germany, Fed. Rep. of4.95.97.16.86.0
Italy13.99.09.59.48.3
United Kingdom13.919.120.719.422.8
Seven major countries above9.08.88.29.37.0
Nominal GNP
Canada7.75.88.54.310.7
United States6.45.66.84.88.3
Japan6.44.44.13.35.3
France7.67.25.06.34.9
Germany, Fed. Rep. of4.35.63.85.63.9
Italy12.110.68.910.78.4
United Kingdom9.77.09.27.09.9
Seven major countries above6.95.96.25.17.3

Composites for the country groups are averages of percentage changes for individual countries weighted by the average U.S. dollar value of their respective GNPs over the preceding three years.

Percent change over four quarters earlier.

M1 is generally currency in circulation plus private demand deposits. In addition, Canada excludes private sector float; the United States includes traveler’s checks of nonbanks and other checkable deposits and excludes private sector float and demand deposits of banks; the Federal Republic of Germany includes demand deposits at fixed interest rates; and Japan includes government demand deposits and excludes float.

M1 plus quasi-money—generally M2 except for the United Kingdom, Japan, and the Federal Republic of Germany, for which the data are based on sterling M3, M2 + certificates of deposit (CDs), and M3, respectively. Quasi-money is essentially private term deposits and other notice deposits. The United States also includes money market mutual fund balances, money market deposit accounts, overnight repurchase agreements, and overnight Eurodollars issued to U.S. residents by foreign branches of U.S. banks. France also includes government savings bonds. Sterling M3 is M1 plus private sterling time deposits. For Japan, M2 + CDs is currency in circulation plus total private and public sector deposits and installments of Sogo banks plus certificates of deposit. For the Federal Republic of Germany, M3 is M1 plus private time deposits with maturities of less than four years plus savings deposits at statutory notice.

Composites for the country groups are averages of percentage changes for individual countries weighted by the average U.S. dollar value of their respective GNPs over the preceding three years.

Percent change over four quarters earlier.

M1 is generally currency in circulation plus private demand deposits. In addition, Canada excludes private sector float; the United States includes traveler’s checks of nonbanks and other checkable deposits and excludes private sector float and demand deposits of banks; the Federal Republic of Germany includes demand deposits at fixed interest rates; and Japan includes government demand deposits and excludes float.

M1 plus quasi-money—generally M2 except for the United Kingdom, Japan, and the Federal Republic of Germany, for which the data are based on sterling M3, M2 + certificates of deposit (CDs), and M3, respectively. Quasi-money is essentially private term deposits and other notice deposits. The United States also includes money market mutual fund balances, money market deposit accounts, overnight repurchase agreements, and overnight Eurodollars issued to U.S. residents by foreign branches of U.S. banks. France also includes government savings bonds. Sterling M3 is M1 plus private sterling time deposits. For Japan, M2 + CDs is currency in circulation plus total private and public sector deposits and installments of Sogo banks plus certificates of deposit. For the Federal Republic of Germany, M3 is M1 plus private time deposits with maturities of less than four years plus savings deposits at statutory notice.

Structural reforms have also played a key role in economic policies. Major advances have been achieved in many countries in reforming tax systems by lowering marginal tax rates and broadening tax bases. Many countries have also deregulated financial and goods markets. Moreover, privatization of publicly owned corporations has been undertaken with a view to enhancing competition and efficiency, while contributing to budgetary consolidation efforts. Although steps have also been taken to reduce rigidities in labor markets, relatively high real wage increases in some European countries in 1987 suggest that further progress is needed if unemployment is to be reduced. Several countries have taken steps to reform agricultural support policies, not only to reduce fiscal burdens and improve resource allocation, but also to correct the distortions of international markets caused by such policies. All of these policies have contributed to domestic goals such as the more efficient utilization of resources, better price performance, reduced unemployment, and improved responsiveness to unexpected developments. More recently, attention has turned to ways in which structural policies may more directly aid the adjustment of external imbalances. For example, the Uruguay Round of multilateral trade negotiations seeks to liberalize trade in both traditional and new areas, such as farm products and services. Japan, in particular, has undertaken several reform measures and is considering others to promote economic restructuring and to stimulate domestic demand.1

Developing Countries

Faced with weak export prices, large debt-service obligations, and the virtual drying up of foreign financing from private sources, most developing countries in recent years have concentrated on consolidating external positions. In response to these efforts, and reflecting some improvement in the external environment, developing countries as a group in 1987 recorded their first current account surplus since 1980.

In many of the fuel exporting countries, the internal and external imbalances that had emerged in the wake of the sharp decline in oil prices during 1986 continued to pose a major adjustment challenge. Since revenues from oil production and exports account for a large share of these countries’ total budgetary revenue, fiscal positions had deteriorated sharply in 1986, despite immediate cuts in public expenditure. To correct these imbalances, expenditure controls continued to be reinforced and efforts were made to increase non-oil revenue. As a consequence, and aided by a partial recovery in oil prices, fiscal deficits in most of the fuel exporting countries narrowed markedly in 1987.

Most primary product exporting countries in sub-Saharan Africa also intensified their adjustment efforts in 1987. The terms of trade of these countries have deteriorated almost continuously for nearly two decades. This trend continued in 1987 despite a recovery in the prices of some commodities. Together with relatively weak growth in the volume of exports, the purchasing power of these countries’ exports eroded further and was 9 percent lower in 1987 than in 1980. In response to these developments, and in view of the limited availability of external financing and a relatively low level of foreign reserves, both fiscal and monetary policies were tightened. Moreover, in order to increase economic efficiency and enhance their potential for growth, many countries in sub-Saharan Africa began or continued to implement structural reforms designed to strengthen the role of market forces in resource allocation.

External developments were more favorable for the developing countries of the Western Hemisphere, improving the conditions for a resumption of higher growth in the period ahead. Because a relatively large share of external debt carries floating interest rates, the countries in this region have benefited more than others from the easing of interest rates in the industrial countries since 1982.

In addition, both export prices and export volumes recovered in 1987, permitting some reduction in debt-to-export ratios and an easing of external constraints on economic growth. However, as illustrated by the high inflation rates that characterize many countries in this region, difficulties in the implementation of policies have remained a major obstacle to the restoration of higher growth and improved creditworthiness. In recent years, in order to come to grips with inflation, a number of these countries (such as Argentina and Brazil) have adopted comprehensive stabilization programs that combine traditional fiscal and monetary policy measures with more “heterodox” approaches, including wage and price controls, deindexation, and exchange rate pegging. While the experience with these programs has so far been mixed, it is evident that their success depends crucially on the stance of fiscal and monetary policy. Where fiscal and monetary conditions have remained too expansionary to be compatible with lower inflation, inflation expectations have persisted, and wage and price controls have achieved, at best, only a temporary reduction in the rate of inflation. When price controls have been lifted, inflation has accelerated sharply, accommodated by an acceleration of monetary growth.

The Asian exporters of manufactures have benefited from a relatively favorable external environment in recent years. Some of the newly industrializing economies have even experienced large trade surpluses, significant reserve accumulation, and an opportunity to reduce external indebtedness. In these economies, economic policies have shifted in an expansionary direction in an effort to contain the surpluses. In contrast, in most Asian countries other than the exporters of manufactures, a cautious policy stance continued to be pursued in 1987, playing a key role in their satisfactory overall economic performance. Many of these countries reduced their fiscal deficits at the same time as they made progress in containing monetary expansion and implementing structural reforms. In India, despite the large-scale emergency outlays needed for drought relief, the fiscal balance improved, while monetary policy helped to contain the inflationary impact of supply shortages. Structural reform measures continued to be implemented in China, stimulating continued rapid growth of output. However, the buoyancy of the economy has been accompanied by an intensification of inflationary pressures.

Domestic Activity

Industrial Countries

Following a slowdown in 1986, output growth in the industrial countries as a group strengthened significantly in 1987. This marked the fifth year of the recovery that began in 1983 (Table 3). The strength of activity was particularly striking on a fourth-quarter-to-fourth-quarter basis. On that basis, real GNP rose by 4 percent, compared with 2.3 percent during 1986; year-on-year, growth strengthened from 2.7 percent in 1986 to 3.3 percent in 1987. The growth performance was somewhat better than had been expected at the beginning of the year as the positive effects of the large terms of trade and exchange rate changes in 1985–86 gradually outweighed their mainly negative short-run impact. This lag pattern can be attributed to asymmetric responses of losers and gainers from the large changes in competitiveness and relative prices, with the former adjusting considerably faster than the latter.

Table 3Industrial Countries: Changes in Output and Prices, 1970–871(Annual changes, in percent)
AverageFourth Quarter3
1970–7921980198119821983198419851986198719861987
Real GNP
Canada4.71.53.7–3.23.26.34.63.24.01.26.1
United States2.8–0.21.9–2.53.66.83.42.83.42.05.0
Japan5.24.33.73.13.25.04.82.54.22.05.5
France44.01.61.22.50.71.41.62.12.21.92.8
Germany, Fed. Rep. of3.11.5–1.01.93.32.02.51.72.42.3
Italy53.33.91.10.21.13.22.92.93.13.02.8
United Kingdom52.3–2.5–1.11.53.22.63.73.24.64.54.6
Other industrial countries3.22.60.40.52.33.63.02.22.82.22.9
All industrial countries3.31.41.5–0.32.85.03.32.73.32.24.4
Of which,
Seven major countries above3.31.21.7–0.42.95.23.42.73.42.24.6
European countries3.21.60.20.71.92.72.62.52.72.72.9
GNP deflator
Canada7.710.610.88.75.03.12.92.54.33.04.4
United States7.09.19.66.43.83.73.02.73.32.83.1
Japan8.03.83.22.00.71.21.61.8–0.21.3–0.2
France48.913.211.411.89.77.45.95.12.84.02.5
Germany, Fed. Rep. of5.64.84.04.43.22.02.23.02.13.01.6
Italy513.420.718.516.215.011.38.97.55.67.55.5
United Kingdom512.719.811.57.65.34.35.93.64.42.35.0
Other industrial countries9.58.49.19.77.06.35.55.64.35.43.9
All industrial countries8.19.38.87.25.04.23.73.42.93.22.7
Of which,
Seven major countries above7.99.58.76.84.73.93.43.12.72.92.6
European countries9.311.49.79.27.45.95.34.73.54.33.2

Composites for the country groups are averages of percentage changes for individual countries weighted by the average U.S. dollar value of their respective GNPs over the preceding three years.

Compound annual rates of change.

From fourth quarter of preceding year.

GDP at market prices.

Average of expenditure, income, and output estimates of GDP at market prices.

Composites for the country groups are averages of percentage changes for individual countries weighted by the average U.S. dollar value of their respective GNPs over the preceding three years.

Compound annual rates of change.

From fourth quarter of preceding year.

GDP at market prices.

Average of expenditure, income, and output estimates of GDP at market prices.

An additional positive element that may have influenced demand was the strength of stock markets during the current business cycle and especially during most of 1987, which added substantially to household wealth. Since the beginning of the recovery, the rise in wealth stemming from declining interest rates and substantial capital gains on both financial and real assets appears to have stimulated the relatively rapid growth of consumption. As a result, ratios of household saving to income have fallen substantially, a trend that has continued in many countries in 1987. While the impetus from valuation gains may have been arrested or even reversed in some countries following the stock market decline in October, other components of demand, particularly business investment and exports, have continued to sustain growth. Furthermore, the acceleration of growth can also be attributed to policy action, particularly the fiscal package adopted in Japan in May 1987.

The strength of activity in the industrial countries as a whole masks a major shift in the pattern of demand growth among countries. Together with the substantial changes in real exchange rates that have taken place since 1985, this shift contributed importantly to the reversal of the previous trend toward widening external imbalances among the three largest economies. In the United States, the growth of domestic demand fell to 3 percent in 1987, the lowest rate of increase since 1982. The marked tightening of fiscal policy led to a moderation of the growth of both private and public consumption. In addition, the stock market decline late in 1987 contributed to a retrenchment of consumer spending in the fourth quarter. However, as exports recovered sharply and import growth slowed, the growth of real GNP was sustained at a rate of about 3 percent, similar to that of 1985 and 1986, and sufficiently strong to permit a further reduction in unemployment. The improvement in real net exports of the United States was the first since 1980.

In most other industrial countries, domestic demand continued to expand at a faster rate than output. This reflected the counterpart to the improvement in real net exports of the United States and, more important, the sharp turnaround of the external position of the developing countries. In several countries—notably Japan, the United Kingdom, Italy, and Canada—the buoyancy of domestic demand more than outweighed the withdrawal of stimulus from the foreign sector, so that output growth either accelerated significantly or was maintained at a relatively high rate. However, in France and the Federal Republic of Germany, even though domestic demand growth remained considerably stronger than in the 1983–85 period, the deterioration in the real foreign balance was so pronounced that output growth remained comparatively weak, or decelerated. Among the smaller industrial countries, output grew by 5.2 percent in Spain and the Australian economy recovered markedly from the slowdown in 1986. However, in several other countries activity weakened because of losses in competitiveness or tight financial policies related to balance of payments constraints or inflation concerns.

For the industrial countries as a whole, the relatively high growth rate of output was associated with increases in employment in 1987 well in excess of the increase in the size of the labor force. As in previous years, the impact of the rise in output on labor market conditions was unevenly distributed among countries (Chart 2). In North America, demand for labor remained strong, partly reflecting the continuation of moderate wage increases. Hence, both Canada and the United States experienced a further marked reduction in unemployment; in the United States, the unemployment rate fell to 5.4 percent in the second quarter of 1988, about 5 percentage points below the level recorded at the trough of the 1982 recession. In response to the strong acceleration in growth, Japan also experienced a reversal of the rise in labor market slack that occurred in 1986. In Europe, the most encouraging development was a marked reduction in unemployment in the United Kingdom; by mid-1988 the unemployment rate stood at 8½ percent, 3 percentage points below the level of two years earlier. In most other European countries unemployment rates have continued to creep upward or have remained at relatively high levels.

Chart 2Major Industrial Countries: Unemployment, 1968–First Quarter 1988 (In percent of labor force)1

1 National unemployment rates weighted by labor force in the respective countries.

2 France, the Federal Republic of Germany, Italy, and the United Kingdom.

Developing Countries

While growth in the developing countries as a group in 1987 was similar to the rate of growth in the industrial countries, output performance deteriorated somewhat relative to 1986 and was weaker than had been expected at the beginning of the year. It is also important to note that, because of high population growth and low income levels, a growth rate of 3½ percent, which may be considered fairly high in industrial countries, is relatively low in the developing world (Table 4). Overall, living standards improved only marginally, and in most regions remained well below the levels that prevailed at the beginning of the decade (Chart 3). The gains experienced by the Middle Eastern countries in the wake of the 1979–80 oil price increase have now been completely reversed. The situation in Africa, where average living standards have fallen by over 20 percent since 1981, is particularly critical.

Table 4Developing Countries: Growth of Real GDP, 1970–871(In percent)
AverageFrom Preceding Year
Weights21970–79319801981198219831984198519861987
Developing countries1005.73.41.81.71.94.03.54.23.4
Memorandum
Per capita growth3.10.7–0.5–0.9–0.41.91.52.01.3
Median growth rates5.13.73.01.71.52.93.13.42.7
By region
Africa124.43.62.01.2–1.30.83.72.12.3
Sub-Saharan Africa43.02.62.91.7–0.61.23.03.62.3
Asia325.45.55.85.27.67.86.36.46.8
Europe115.60.11.11.94.32.44.12.5
Middle East187.3–2.5–2.10.20.9–0.2–1.12.2–0.5
Western Hemisphere275.76.00.2–1.1–2.43.53.53.92.5
By predominant export
Fuel exporters317.10.90.90.1–1.00.61.21.00.6
Non-fuel exporters695.14.32.22.43.35.74.75.74.6
Primary product

exporters
335.05.30.3–0.33.72.95.13.2
Exporters of manufactures305.53.43.94.57.07.96.46.76.3
Service and remittance
countries64.64.62.03.32.13.14.43.82.4
Memorandum
Fifteen heavily indebted

countries
325.95.40.1–0.5–2.72.33.93.82.4
Countries with recent debt-
servicing problems445.34.20.1–0.3–1.62.83.23.52.2

Except where otherwise indicated, arithmetic averages of country growth rates weighted by the average dollar value of GDPs over the preceding three years.

Weights are calculated on the basis of the average dollar values of GDPs for 1982–84.

Compound annual rates of change. Excluding China.

Excluding Nigeria and South Africa.

Except where otherwise indicated, arithmetic averages of country growth rates weighted by the average dollar value of GDPs over the preceding three years.

Weights are calculated on the basis of the average dollar values of GDPs for 1982–84.

Compound annual rates of change. Excluding China.

Excluding Nigeria and South Africa.

Chart 3Developing Countries: Real Absorption 1 per Capita, by Region, 1980–87

(Indices, 1980 = 100)

1 Real absorption is used as a measure of living standards and is defined as real total domestic demand.

A variety of transitory factors contributed to the slowdown of growth in the developing world in 1987, even though some more deeply entrenched impediments to faster growth were also apparent in several regions. Economic activity stagnated in the fuel exporting countries, as efforts to adjust to the sharp decline in oil prices in the previous year continued. Although oil prices recovered partially in dollar terms in 1987, import prices rose significantly, so that in 1987 the terms of trade of these countries were still almost 40 percent lower than three years earlier. In the Middle East, the contractionary impulses stemming from tight fiscal and monetary policies in the fuel exporting countries spilled over to other countries in the region; as a result, real GDP of the region taken together declined by ½ of 1 percent in 1987.

Aggregate output in Asia grew by 6.8 percent—similar to the rate achieved in 1986—despite a drought-related slowdown in India, where GDP growth fell from 4½ percent in 1986 to 2 percent in 1987. The strong growth of Asian economies reflected to a large extent the performance of the exporters of manufactures—China, Hong Kong, Korea, Singapore, and Taiwan Province of China. Fueled by a rapid growth of domestic demand and continued buoyancy of exports stemming from a combination of strong competitiveness and a rise in productivity, growth rates of real GDP in these economies ranged from 8 percent in Singapore to 12 percent in Korea.

In the Western Hemisphere, aggregate real GDP growth slowed by 1½ percentage points in 1987, mainly because of a marked deceleration of growth in Brazil owing to a decline in investment spending and an erosion of real wages as a result of a sharp upturn in inflation. Economic activity also slowed down in Argentina but in most other countries in the region output growth was reasonably well maintained or accelerated. Among the fuel exporting countries in the region, economic activity revived in Mexico after a sharp contraction in 1986, largely because of the strong growth of non-oil exports.

Growth also slowed markedly among those European countries that are classified as developing. Although exports grew strongly in a few countries such as Portugal, the Eastern European countries were less able to benefit from the improved external conditions. Moreover, in several of these countries adjustment efforts were intensified in order to contain external deficits and curb inflation.

Activity also remained weak in most of Africa. Real GDP in the region grew by slightly over 2 percent in 1987, the same rate as in 1986. Among the sub-Saharan countries, the rate of output growth slowed to 2.3 percent in 1987, from 3.6 percent in 1986, as a result of a further deterioration in terms of trade and weak export growth. Output contracted further in the majority of the fuel exporting countries in the region, with the notable exception of Tunisia where increases in non-oil exports appear to have contributed to a strong recovery of growth.

A decline in the share of national income devoted to capital formation, often in combination with low rates of productivity growth, has been a common characteristic of many developing countries with an unsatisfactory output performance. Although in some cases the investment ratio may have been unsustainably high in earlier years, the depth of this decline is a cause for serious concern. As a result of external financing constraints and serious difficulties in mobilizing domestic funds, partly because of capital flight, the share of investment in aggregate expenditure declined sharply in the early 1980s in all regions, with the exception of the Middle East (Chart 4). This decline was especially pronounced in Africa and in the Western Hemisphere; in these regions there has been relatively little recovery in recent years and investment ratios have remained some 25–35 percent below their levels at the beginning of the decade.

Chart 4Developing Countries: Gross Capital Formation, by Region, 1980–87

(In percent of nominal GDP)

Inflation

Industrial Countries

After having decelerated to only about 1 percent (on a 12-month basis) at the end of 1986, the rate of increase of consumer prices in the major industrial countries picked up again during 1987, and reached some 3 percent in early 1988 (Chart 5). Given that the marked reduction in inflation in recent years has been one of the major accomplishments of the economic strategy pursued since the beginning of the 1980s, there has been concern that the firming of prices in the course of 1987 might signal the return of higher inflation. However, both the exceptionally low inflation rate in 1986 and the reversal in 1987 can be largely attributed to the impact of the sharp drop in oil and other commodity prices in 1985–86 and to the subsequent partial recovery of these prices in 1987.

Chart 5Major Industrial Countries: Commodity Price Changes and Aggregate Inflation Trends, 1970–April 1988

(In percent per annum)1

1 Three-month centered moving averages of 12-month inflation rates. Consumer prices are measured in local currencies and are averaged using GNP weights. The commodity price index is a global export-weighted basket of 40 commodities that includes oil and gold using the same average exchange rate as the one used for the composite inflation index.

Indicators of domestically generated inflation, such as GNP deflators, suggest that the underlying rate of inflation in the industrial countries continued to moderate in 1987, falling below 3 percent for the first time since 1963 (Table 3). Moreover, hourly earnings in manufacturing rose by only 3 percent in 1987, 1 percentage point less than in 1986, while unit labor costs in manufacturing fell by ¼ of 1 percent (compared with an increase of 1.5 percent in 1986) under the influence of strong productivity growth.

Despite the relatively favorable overall picture, the convergence of inflation rates among the major industrial countries that had been experienced since 1980 appeared to have come to a halt in 1987, and was even reversed in some cases. The risk of renewed inflation in the United States seems to have increased since 1986, given, inter alia, the higher rate of capacity utilization and rising import prices. However, while consumer price inflation picked up during 1987, reaching 4.5 percent at the end of the year (Chart 6), developments in other inflation indicators such as the GNP deflator, hourly earnings, and monetary growth have remained quite favorable.

Chart 6Major Industrial Countries: Consumer Price Inflation, 1980–April 1988

(In percent)1

1 Average of consumer price index for the three months ended in month indicated over corresponding three months a year earlier.

Inflation has also remained a matter of concern in several other countries, partly reflecting relatively rapid output growth. In the case of Canada, for example, the rate of inflation accelerated in 1987. In Italy and the United Kingdom, price and wage increases, although much lower than in the early 1980s, have remained somewhat higher than in their trade partner countries. In Japan and the Federal Republic of Germany prices remained essentially stable in 1987, partly under the influence of significant reductions in import prices in the wake of the marked appreciation of these countries’ currencies since 1985, while in France inflation continued to fall to a level close to the average of industrial countries as a group. Several of the smaller industrial countries, including Austria, Belgium, the Netherlands, and Switzerland, also have reduced inflation to very low levels, again partly as a result of import price declines.

Developing Countries

The developing countries have generally been much less successful than the industrial countries in containing inflationary pressures. In these countries, the weighted average inflation rate reached almost 40 percent in 1987, compared with about 30 percent in 1986 (Table 5). To a large extent, this increase reflected a reacceleration of inflation in several high-inflation countries that had recorded significant, albeit transitory, stabilization gains in 1986. However, inflation accelerated also in a large number of countries where prices had risen more moderately in the past.

Table 5Developing Countries: Changes in Consumer Prices, 1970–87(In percent)
AverageFrom Preceding Year
1970–79119801981198219831984198519861987
Developing countries218.127.325.925.433.038.638.929.840.0
By region
Africa12.716.221.213.118.920.413.215.315.8
Sub-Saharan Africa315.624.830.318.829.122.319.123.625.7
Asia9.513.110.56.46.67.37.17.88.8
Europe12.331.823.633.122.825.425.424.830.3
Middle East11.616.815.212.712.214.812.211.414.7
Western Hemisphere34.858.360.766.8108.6131.8143.588.3131.2
Medians
Developing countries10.014.613.110.69.910.48.77.88.1
By region
Africa10.012.513.112.910.911.510.59.18.1
Sub-Saharan Africa310.313.312.713.111.211.410.59.48.1
Asia7.813.912.57.68.77.04.85.55.5
Europe8.515.820.021.020.215.015.111.79.4
Middle East10.610.58.89.15.26.44.710.09.0
Western Hemisphere11.619.214.79.013.112.015.011.514.6

Compound annual rates of change. Excluding China.

Geometric averages of country consumer price indices weighted by the average dollar value of GDPs over the preceding three years.

Excluding Nigeria and South Africa.

Compound annual rates of change. Excluding China.

Geometric averages of country consumer price indices weighted by the average dollar value of GDPs over the preceding three years.

Excluding Nigeria and South Africa.

The acceleration of inflation was particularly pronounced in the Western Hemisphere. In some of the larger high-inflation countries in that region, setbacks occurred in the implementation of stabilization programs, mainly because of slippages in fiscal and monetary policies. There was also a rise in inflation in the fuel exporting countries in the region, in part because of difficulties in containing the spillover effects to domestic prices and costs of import and export price increases in the wake of currency depreciations. The same mechanism caused inflation rates to rise in other regions, as monetary policy tended to accommodate price impulses from exchange rate adjustments. Nevertheless, in a number of African countries, firm financial policies together with more abundant food supplies owing to improved weather helped to contain inflationary pressures somewhat. At less than 9 percent, the average level of inflation in Asia remained markedly lower than in other regions. But in several individual Asian countries inflation rose because of strong demand and high rates of capacity utilization.

International Trade and Payments

Global Perspectives

World Trade

The volume of world trade expanded by about 5¾ percent in 1987, a somewhat faster rate than in 1986 (Table 6). Key commodity prices recovered or stabilized in real terms, so that the terms of trade of the major country groups changed only slightly following the large shifts of 1986. Overall, world trade developments were quite favorable for most countries, allowing continuing improvements in external positions, reductions in debt-to-export ratios, and, in some cases, marked increases in imports (Chart 7). A particularly welcome development was the progress that was made in reducing the underlying trade imbalances among the major industrial countries.

Chart 7Developing Countries: Import Volumes, 1978–87

(Indices, 1978 = 100)

The relatively rapid growth of trade, however, masks some important shifts in the pattern of trade, reflecting both the impact of recent policy changes and large exchange rate adjustments. On the demand side, import growth in the industrial countries decelerated from 8.8 percent in 1986 to 6.7 percent in 1987, largely as a result of a marked slowdown in the growth of the volume of imports into the United States, which was only partly offset by strong import growth in Japan and the Federal Republic of Germany. While imports continued to contract in the fuel exporting developing countries, in other developing countries imports expanded by 8.9 percent, the strongest rate of expansion since 1978. Key factors in this recovery were strong import demand by the Asian exporters of manufactures and an acceleration of import growth in many primary product exporting countries of the Western Hemisphere. The latter countries benefited from gains in both export volumes and prices, and were consequently able to sustain higher import growth while continuing to consolidate external positions.

Table 6Summary of World Trade Volumes and Prices, 1970–87(In percent)
Average
1970–79119801981198219831984198519861987
World trade2
Volume6.51.41.2–1.83.08.93.04.85.7
Unit value
(in U.S. dollar terms)12.419.8–1.6–4.6–4.8–2.6–2.04.510.1
(in SDR terms)9.519.08.61.9–1.71.6–1.1–9.5–0.1
Volume of trade
Exports
Industrial countries6.64.23.8–2.13.09.94.72.75.0
Developing countries4.9–3.9–5.6–7.13.27.51.110.98.6
Fuel exporters2.6–13.2–14.9–16.6–3.70.8–5.713.8–0.5
Non-fuel exporters7.18.86.22.98.612.25.49.912.1
Imports
Industrial countries6.5–1.5–1.7–0.64.712.54.78.86.7
Developing countries8.48.08.5–2.5–2.33.3–0.3–3.94.4
Fuel exporters13.713.519.1–1.4–10.4–6.1–10.9–21.9–11.1
Non-fuel exporters6.85.94.0–3.01.97.64.03.08.9
Unit value of trade
(in SDR terms)3
Exports
Industrial countries8.511.95.52.7–0.81.2–0.3–1.80.7
Developing countries14.336.215.01.5–4.63.2–4.3–27.31.1
Fuel exporters23.562.022.93.7–8.62.6–3.6–49.911.0
Non-fuel exporters7.912.06.4–0.7–1.23.7–4.7–14.5–2.2
Imports
Industrial countries9.420.77.30.8–2.20.9–1.0–10.10.1
Developing countries9.016.410.81.5–1.11.3–2.2–9.7–1.9
Fuel exporters8.412.110.43.11.9–1.1–2.4–1.2
Non-fuel exporters9.218.211.00.8–1.71.1–2.7–12.3–2.1
Terms of trade
Industrial countries–0.8–7.3–1.71.91.50.20.69.10.6
Developing countries4.817.03.8–3.51.9–2.1–19.43.1
Fuel exporters13.944.411.40.6–8.60.7–2.5–48.712.3
Non-fuel exporters–1.2–5.3–4.2–1.50.62.6–2.1–2.6–0.2
Memorandum
World trade prices (in U.S. dollar terms) for major commodity groups3
Manufactures10.610.4–3.9–2.1–2.8–3.01.117.912.3
Oil29.163.59.9–4.3–11.9–2.1–5.0–50.228.4
Non-oil primary commodities11.35.5–13.5–9.96.94.2–12.9–1.23.4

Compound annual rates of change. Excluding China.

Averages of growth rates of world exports and imports based on data for the two groups of countries shown separately below and on partly estimated data for the U.S.S.R. and nonmember countries of Eastern Europe.

As represented, respectively, by the export unit value index for the manufactures of the industrial countries; the oil export unit value of the oil exporting countries (according to the former analytical categories—see Appendix IX); and the index of market quotations for non-oil primary commodities exported by the developing countries.

Compound annual rates of change. Excluding China.

Averages of growth rates of world exports and imports based on data for the two groups of countries shown separately below and on partly estimated data for the U.S.S.R. and nonmember countries of Eastern Europe.

As represented, respectively, by the export unit value index for the manufactures of the industrial countries; the oil export unit value of the oil exporting countries (according to the former analytical categories—see Appendix IX); and the index of market quotations for non-oil primary commodities exported by the developing countries.

The pattern of supply also changed significantly. Strong export growth in the United States, where the volume of exports rose by almost 12 percent in 1987, accounted for half of the increase in the industrial countries’ exports. Export volumes essentially remained unchanged for the second consecutive year in Japan, but continued to grow in the Federal Republic of Germany, albeit at a much slower pace than in 1984–85. Among the developing countries, exports from the fuel exporting countries stagnated following a recovery in 1986 (Table 6). This stagnation reflected changes in the production policies of the major oil exporting countries. In contrast, the non-fuel developing countries registered a further strong expansion of export volumes, particularly among the countries that export manufactures. Within this group, the newly industrializing economies in Asia continued to register the largest gains in market shares. But export growth strengthened also in many other developing countries, including many of the heavily indebted countries. Export growth remained subdued in most African countries, in part due to supply constraints.

As in 1986, changes in oil prices played a key role in the shifts in relative prices in international trade. Following a halving in 1986, the average U.S. dollar export price of oil recovered by 28 percent in 1987 (Chart 8). In real terms, however, prices of internationally traded oil only recovered by about 14 percent in 1987 and were still almost 10 percent below their level in 1975. The wide fluctuations of international oil prices during the past two years mainly reflected marked shifts in production policies in the oil exporting countries, in particular in the member countries of the Organization of Petroleum Exporting Countries (OPEC).

Chart 8Oil Prices, 1972–April 1988

1 Unit value of the oil exporting countries (according to the former analytical categories) in terms of U.S. dollars.

2 Unweighted average of Brent, West Texas Intermediate, and Dubai spot prices in terms of U.S. dollars.

3 Oil price deflated by import unit value of the oil exporting countries.

4 Import unit value of the oil exporting countries in terms of U.S. dollars.

In late 1986, new production quotas for OPEC members were introduced, together with a new official export price. As a result, oil prices recovered significantly between mid-1986 and mid-1987. In the second half of 1987, however, production in a number of OPEC countries began to rise considerably above existing quotas, and prices started weakening again. Even though existing production quotas and prices were confirmed at an OPEC meeting in late 1987, the oil market continued to show signs of weakness and prices declined to some $15 a barrel during the first quarter of 1988, compared with an average price level of $16.91 a barrel in 1987.

Prices of non-oil commodities exported by the developing countries recovered strongly during the second half of 1987 and the first part of 1988. This recovery followed a cumulative decline of 14 percent during 1984–86 (Chart 9) which had mainly reflected temporary supply influences. Hence, as a result of the general weakness of commodity markets during most of the 1980s, real non-oil commodity prices at the end of 1987 were still some 30 percent lower than they had been in 1980. The prices of agricultural raw materials and metals rose particularly strongly during 1987 and early 1988 because of low inventories and higher demand for industrial inputs as economic activity strengthened in the industrial countries. These prices recovered to the levels that had prevailed at the beginning of the decade. Price increases were considerably more modest for food commodities, for which inventories were high, and for beverages, whose prices continued to fall through most of 1987 before recovering toward the end of the year. The decline in beverage prices reversed much of the gain registered in late 1985 and early 1986 which had been caused by weather-related supply shortages.

Chart 9Developing Countries: Non-Oil Primary Commodity Prices, January 1980–April 1988

(Moving three-month averages of indices, 1980 = 100)

1 Nominal commodity prices deflated by the index of unit values of manufactures exported by the industrial countries.

International Capital Markets

The volume of international bank lending expanded during the first three quarters of 1987 to $723 billion, which was about two fifths larger than lending in the corresponding period in 1986. Banking flows among industrial countries accounted for slightly more than half the overall increase in activity; such lending during 1987 was $527 billion, of which $463 billion represented interbank lending. Transactions with Japanese institutions accounted for about two thirds of the increase in overall banking activity among industrial countries. Part of this increase was due to the rapid expansion of activity with the Japan Offshore Market (established in December 1986).

Bank claims on developing countries, excluding offshore centers, rose by $17 billion during 1987, compared with a net reduction of $ 1 billion a year earlier. This increase in claims included disbursements of $5.6 billion in concerted lending, of which $4.4 billion (gross) was disbursed to Mexico and $1.3 billion to Argentina, and an accumulation of $4.2 billion in interest arrears by some developing countries. Net deposit-taking from developing countries, by contrast, totaled $34 billion, compared with a withdrawal of $1 billion in 1986. This sharp increase, which was evident in all regions, but was particularly large in Taiwan Province of China, Mexico, and oil exporting countries in the Middle East, reflected an accumulation of official reserves of about $24 billion by developing countries. The net flow from these countries to international banks of $17 billion compares with a negligible net flow from banks to developing countries a year earlier.

In contrast to the expansion of international bank lending, new international bond issues declined in 1987 for the first time in this decade, falling by 22 percent to $177 billion, compared with an increase of 35 percent in 1986 to $227 billion. A reduction in new issues of floating rate notes (FRNs), following the collapse of the perpetual floating rate note market in December 1986, accounted for about 80 percent of the decline of $50 billion in new issues. New issues of equity-related bonds, which had been the most buoyant component of international bond markets during the first three quarters, ceased after the unprecedented fall in stock market prices in October 1987 (see Box 2).

Borrowing by industrial countries accounted for 86 percent of all new international bond issues, while new bond issues by developing countries fell to $4.5 billion in 1987, their lowest level since 1983. The currency composition of bond issues in 1987 shifted sharply away from the dollar, whose share in total issues fell from 55 percent in 1986 to 35 percent in 1987, toward the Japanese yen and the Swiss franc, whose shares increased to 15 percent each in 1987 from 10 percent in 1986. In addition, the share of external bond issues denominated in European Currency Units (ECUs) increased from 3 percent in 1986 to 4 percent in 1987.

International Liquidity

During 1987, non-gold reserves expanded by SDR 88 billion, reflecting an accumulation of foreign exchange reserves (SDR 119 billion) that more than outweighed losses in the SDR value of existing holdings (SDR 28 billion) resulting from the depreciation of the dollar relative to the SDR (Table 7). Foreign exchange reserves in the industrial countries rose by SDR 74 billion in 1987, following increases of SDR 23 billion in 1986 and SDR 3 billion in 1985, mainly reflecting the heavy interventions in foreign exchange markets by the central banks of some of the major industrial countries. Foreign exchange reserves of the developing countries increased by SDR 17 billion in 1987, compared with reductions of SDR 7 billion in 1986 and SDR 4 billion in 1985.2

Table 7International Reserves, Excluding Gold, 1984–87(Annual changes, in billions of SDRs)
1984198519861987
All countries
International reserves, excluding gold45–21388
Of which, foreign exchange141–11691
Accumulation37823119
Valuation effects4–9–8–28
Industrial countries
International reserves, excluding gold2032171
Of which, foreign exchange11632374
Accumulation1652488
Valuation effects–1–1–15
Developing countries
International reserves, excluding gold26–5–817
Of which, foreign exchange125–4–717
Accumulation21430
Valuation effects4–8–7–13
Memorandum
U.S. dollars per SDR, end of period0.9801.0981.2231.419

Estimates shown here pertain to total foreign exchange reserves. The breakdown into accumulation and valuation (i.e., quantity and price) components is based on the data for identified holdings of seven major currencies shown in Appendix Table I.2, adjusted, however, to cover total foreign exchange holdings. The adjustment assumes that the valuation effects on unidentified holdings are proportional to those on identified holdings.

Estimates shown here pertain to total foreign exchange reserves. The breakdown into accumulation and valuation (i.e., quantity and price) components is based on the data for identified holdings of seven major currencies shown in Appendix Table I.2, adjusted, however, to cover total foreign exchange holdings. The adjustment assumes that the valuation effects on unidentified holdings are proportional to those on identified holdings.

The ratios of non-gold reserves to imports have increased continuously since 1982 for both the industrial and the developing countries, apart from a pause in 1985. During 1985–87, this ratio rose for all major country groups despite significant negative effects from the decline in the exchange rate of the dollar, which has a major weight in the SDR.3 The industrial countries increased their ratio of non-gold reserves to imports from 17 percent at the end of 1982 to 25 percent at the end of 1987, which represents its highest value since 1972. During 1985–87, the most rapid increases in this ratio have been associated with periods of reportedly heavy exchange market intervention by some of the major industrial countries. The ratio of non-gold reserves to imports for the developing countries increased from 26 percent in 1982 to 42 percent in 1987, when it reached its highest value since 1970. This rise, however, reflected contrasting patterns of reserve accumulations and changes in the SDR value of imports: the ratio increased during 1982–84 because of vigorous rebuilding of reserves, while in 1985–86 the reserve holdings of developing countries declined. Their ratio of non-gold reserves to imports nonetheless increased because the decline in the SDR value of their imports was even greater.

Box 2Disturbances in Global Equity Markets

The sharp decline in prices on major stock markets in October 1987 raised questions about the stability and liquidity of the international financial system. On October 19 and 20, stock prices declined by 21 percent in the United Kingdom, 18 percent in the United States, 17 percent in Japan, 11 percent in the Federal Republic of Germany, and 10 percent in France (Chart 10). Prices in other equity markets also declined, and some markets (such as Hong Kong) were closed. This sharp drop in stock prices worldwide was accompanied by a decline in world interest rates, especially on long-term government securities. Changes in the exchange rates of key currencies were relatively limited in the period immediately before and after the disturbances. On a global scale, these developments were suggestive of a shift in preference from stocks to high-quality bonds.

Chart 10World and Regional Stock Market Prices in Real Terms, 1970–First Quarter 19881

Source: Morgan Stanley Capital International, and Fund staff estimates.

1 Morgan Stanley index of stock prices in local currency terms, deflated by composite GNP deflator, where composite deflators are averages for individual countries weighted by the average dollar value of their respective GNPs over the preceding three years.

2 Comprising North America, Europe, and the Pacific region.

3 Comprising the United States, Canada, and Mexico.

4 Comprising Austria, Belgium, Denmark, France, the Federal Republic of Germany, Italy, the Netherlands, Norway, Spain, Sweden, Switzerland, and the United Kingdom.

5 Comprising Japan, Australia, Hong Kong, Malaysia, and Singapore.

The sharp movements in stock prices and the resulting “flight to quality” also affected activity in markets for other financial instruments, including those for Eurobonds and financial futures and options. Moreover, the rise in the volume of trading that accompanied the sharp decline in stock prices in some markets and the recovery of bond prices also created problems for some clearing mechanisms.

A number of macroeconomic and technical factors are thought to have contributed to the magnitude of the fall in stock prices, as well as to its globalization. Until the crisis in October, there had been a widening divergence in world equity markets between the yield on equities and that on government securities. This growing difference created pressures for portfolio adjustments to bring rates of return into a more sustainable alignment. As discussed earlier, interest rates in the major industrial countries had begun to rise in early 1987, in part owing to concerns about inflation, fiscal imbalances, and exchange rate developments.

In addition to these macroeconomic factors, several technical aspects of stock markets and related markets may have exacerbated declines in share prices. In particular, concerns have been expressed that certain trading practices may have created a sense of panic that became self-reinforcing in the highly integrated system of international electronic trading. Major institutions now manage their trading operations on a global basis, and a response in one market to domestic economic or political developments can be transmitted across markets and time zones, while technological advances permit markets to respond faster to new information. In some markets, computerized program trading systems, used in a popular hedging strategy that called for the sale of stock index futures as equity price indexes began to fall, may have contributed to the downward spiral in October 1987. In addition, in the absence of a spot index that is updated adequately and in a timely fashion, automated arbitrage activity between the index futures markets and the spot market may have worsened the price decline.

During the periods prior to and after these market disturbances, there was a risk that some institutions would be unable to obtain funding for their trading and investment portfolios. But measures designed to protect investors helped prevent a general withdrawal of funds from securities houses and broker-dealers. In addition, the clear commitment by major central banks to provide adequate liquidity to the financial markets was a key factor that prevented the emergence of widespread funding difficulties.

In some markets, perception that the macroeconomic policies in place were inadequate to bring about the necessary medium-term adjustment of external imbalances among the major industrial countries may also have contributed to the drop in stock prices. Thus, although the near-term macroeconomic effects of the decline appear to have been limited, some observers have argued that the longer-term implications might depend on the responses of policymakers. As already noted, the monetary authorities in some countries reinforced confidence through the provision of immediate liquidity and by making clear that they stood ready to provide as much additional liquidity as was needed. Furthermore, the process of international policy coordination was strengthened, as evidenced by the statement of December 22, 1987 of the seven major industrial countries (see Box 1).

While the currency composition of foreign exchange reserves has been diversified considerably since the mid-1970s, the accumulation of reserves held in dollars by some industrial countries in 1986 and 1987 has raised the share of that currency in foreign exchange reserves. The estimated share of dollar assets in total identified foreign exchange reserves declined from 76 percent at the end of 1978 to 64 percent at the end of 1985 but then recovered to 67 percent at the end of 1987.4

In contrast, the share of assets denominated in deutsche mark rose from 11 percent at the end of 1978 to 15 percent at the end of 1987, and the share of assets denominated in Japanese yen increased from 3 percent at the end of 1978 to 7 percent at the end of 1987. Industrial countries have diversified their foreign exchange reserves more than the developing countries. The share of dollars in the reserve portfolio of industrial countries decreased from 86 percent to 71 percent between the end of 1978 and the end of 1987.5

However, it only decreased slightly for the developing countries, falling from 63 percent to 59 percent over the same period.

Exchange Rates

During the first part of 1988 the downward pressure on the dollar declined significantly and was reversed by the middle of the year. Compared with developments over the three preceding years, the recent pattern reflected changes in underlying economic fundamentals, as the major industrial countries intensified their efforts to coordinate policies. In line with the commitments under the Louvre Accord of February 1987, the major industrial countries increased the emphasis they gave to changes in underlying fiscal and structural policies as a means of reducing external imbalances and agreed to foster greater stability of exchange rates in view of the significant realignment that had taken place since the Plaza Accord in September 1985. Subsequent efforts to stabilize exchange rates led to a relative tightening of monetary conditions in the United States—whether measured by interest rate differentials or relative rates of growth of money supply—and a significant increase in the volume of official intervention in foreign exchange markets.

The Louvre Accord was followed by a period of relative stability in exchange markets, and between May and August 1987 the pressure on the dollar even reversed. As the year progressed, however, the continued large monthly trade deficits in the United States, together with uncertainties about the implementation of further cuts in the federal fiscal deficit, contributed to a gradual weakening of the dollar (Chart 11). Pressure continued to mount following the decline in equity prices on October 19, and led to a depreciation of the dollar by close to 7 percent during November and December. On December 22 the Group of Seven major industrial countries issued a statement reaffirming their policy intentions and undertakings and re-emphasizing their common interest in more stable exchange rates. The dollar fell to new lows during the following week but recovered in early January 1988, partly in response to large-scale official intervention. During the first quarter of 1988, the dollar was again relatively stable as U.S. trade data, released monthly, became more favorable.

Chart 11Interest Rate Differentials and Exchange Rates, January 1986–April 19881

(In percent, and deutsche mark or yen per U.S. dollar)

1 Short-term interest rates.

2 U.S. rate minus German rate.

3 U.S. rate minus Japanese rate.

Between the Louvre Accord in February 1987 and April 1988, the dollar depreciated by about 13 percent in real effective terms, as indicated by developments in unit labor costs (see Chart 12). This represented a cumulative depreciation of about 42 percent relative to the peak value of the dollar in early 1985, and brought the real exchange rate of the dollar to a level close to its previous postwar trough in 1978. The Japanese yen continued to reflect the largest counterpart to the dollar’s depreciation; in April 1988, the yen traded at ¥ 125 per dollar, compared with ¥ 153 per dollar at the time of the Louvre Accord. In real effective terms, the yen appreciated by 13 percent during this period, bringing its cumulative appreciation since early 1985 to 39 percent.

Chart 12Major Industrial Countries: Monthly Average U.S. Dollar and Real Effective Exchange Rates, January 1978–April 1988

(Indices, 1980 = 100)

1 Real effective exchange rates are calculated on the basis of normalized unit labor costs.

The pound sterling also came under periodic upward pressure during the year under review, appreciating not only against the dollar but also against other European currencies. The appreciation of the pound intensified during March and April 1988 when its exchange rate rose to almost DM 3.15 a pound, some 6 percent higher than a year earlier. In real effective terms, the pound sterling appreciated by 18 percent from February 1987 to April 1988, which reversed the depreciation that had taken place during 1985–86. The exchange rate of the Canadian dollar also appreciated moderately during 1987 and early 1988, both against the U.S. dollar and in real effective terms, in contrast to its experience during 198–586, when it had depreciated significantly in real terms in line with the U.S. dollar.

The currencies participating in the exchange rate mechanism of the European Monetary System (EMS) also continued to appreciate vis-à-vis the dollar during 1987. However, given the importance of intra-European trade, the real effective exchange rates of EMS currencies were broadly stable. The spot exchange rate of the deutsche mark, for example, rose by 9 percent against the dollar between February 1987 and April 1988, but by only ½ of 1 percent in real effective terms (bringing its real cumulative appreciation since early 1985 to 20 percent). Despite occasional strains within the EMS, particularly during periods of dollar weakness, the real exchange rate of the Italian lira varied only slightly during 1987 and early 1988, while that of the French franc depreciated slightly during the same period. The last EMS realignment took place in January 1987 (involving a 3 percent revaluation of the deutsche mark and the Netherlands guilder and a 2 percent revaluation of the Belgian/Luxembourg franc, in terms of bilateral central rates).

The relative stability of the EMS currencies can be partly attributed to exchange market intervention, the stability of the U.S. dollar, and to a series of coordinated interest rate adjustments under a new agreement to strengthen the operational mechanisms of the system. In the final months of 1987 several adjustments under this agreement took place, involving changes in both the level of interest rates and the differentials among them. These adjustments led to lower interest rates throughout Europe in an effort to support the dollar while minimizing tensions within the EMS. In early December, as part of this policy, the discount rate in the Federal Republic of Germany was lowered to 2½ percent, the lowest rate in the country’s recent history.

The currencies of most of the smaller industrial countries were also more stable in 1987 than in previous years. Within Europe, formal as well as informal links between these currencies and the currencies of the major countries, particularly the deutsche mark, led to further appreciations vis-à-vis the dollar. However, as exchange rates among European currencies changed only slightly, movements in real effective exchange rates were generally small (Table 8).

Table 8Smaller Industrial Countries: Real Effective Exchange Rates1(Percent change from 12 months earlier)
DecemberDecemberDecember
198519861987
Australia–23.7–5.5–2.9
Austria3.85.50.2
Belgium/Luxembourg–0.40.3–1.7
Denmark4.58.36.9
Finland0.2–2.43.3
Ireland0.8–0.4–4.1
Netherlands1.45.1–0.5
New Zealand12.72.616.8
Norway2.7–4.67.1
Spain–3.54.44.1
Sweden2.3–0.8–0.7
Switzerland0.98.54.3

Real effective exchange rates are based on relative unit labor costs in manufacturing except for Australia and New Zealand where the data are based on consumer price indices.

Real effective exchange rates are based on relative unit labor costs in manufacturing except for Australia and New Zealand where the data are based on consumer price indices.

Among the developing countries, the pace of exchange rate depreciation slowed somewhat in 1987, following two years of rapid adjustments (Chart 13). The more moderate depreciation in 1987 to some extent reflected the slower rate of adjustment of the dollar to which many currencies are pegged. More generally, however, in many countries, following a period during which the exchange rate had played a key role in adjustment and stabilization programs, the need for further real exchange rate depreciation diminished. In some countries, notably in the Western Hemisphere, a sharp acceleration in inflation was not fully matched by changes in nominal exchange rates, leading to appreciations in real exchange rates and an erosion of previous gains in competitiveness. There was also a move toward less flexible exchange rate arrangements in 1987.6 Finally, some of the newly industrializing economies in Asia with strong external positions began to allow their currencies to appreciate in real terms, in an effort to contain and eventually reduce their external surpluses.

Chart 13Developing Countries: Real Effective Exchange Rates, by Region, 1979–First Quarter 1988

(Indices, 1979 = 100)

Note: Composites for regional groups are weighted averages, where countries’ weights are dollar values of their respective GDPs in 1980. Because of the lack of appropriate domestic price data, the countries included for the Middle East and African regions cover only about 50 percent and 85 percent, respectively, of their regional GDPs. For the Western Hemisphere, Europe, and Asia, the coverage is complete.

Balance of Payments Developments

The aggregate current account deficit of the industrial countries rose from $16 billion in 1986 to $43 billion in 1987 (Table 9), equivalent to 0.3 percent of aggregate GNP. In contrast, the overall current account position of the developing countries changed from a deficit of $41 billion in 1986 to approximate balance in 1987. The implied reduction in the world current account discrepancy amounted to some $13 billion, and partly reflected the impact of the widely fluctuating oil prices in 1986–87.7 These overall adjustments conceal markedly different trends for individual countries and groups, which were determined by differential movements in both import and export volumes and in their terms of trade. Moreover, the balances expressed in nominal dollar terms present a misleading indication of the degree of adjustment that took place during the year; when expressed in other currencies, or relative to income, the changes are more significant.

Table 9Summary of Payments Balances on Current Account, 1980–871(In billions of U.S. dollars)
19801981198219831984198519861987
Industrial countries–58.1–15.9–19.9–17.3–58.4–48.0–16.4–43.3
Canada–1.0–5.12.32.52.1–1.4–7.6–8.0
United States1.96.9–8.7–46.3–107.0–115.1–138.8–154.0
Japan–10.74.86.920.835.049.285.887.0
France–4.2–4.8–12.1–4.7–0.80.62.9–4.4
Germany, Fed. Rep. of–13.8–3.65.15.39.716.539.345.0
Italy–10.0–9.1–6.21.5–2.5–3.72.6–1.0
United Kingdom7.113.77.85.72.74.20.2–2.6
Other industrial countries–27.4–18.7–14.9–2.22.51.7–0.8–5.4
Developing countries30.6–47.8–86.4–63.1–33.3–24.3–40.70.3
By region
Africa–2.2–22.2–21.5–12.1–8.0–0.2–8.8–5.0
Asia–14.5–19.1–17.4–14.8–4.3–13.55.120.9
Europe–15.6–13.7–8.0–5.1–2.9–3.0–2.00.9
Middle East92.550.03.0–20.2–15.7–2.8–18.2–5.2
Western Hemisphere–29.8–42.9–42.4–10.9–2.5–4.7–16.9–11.3
By analytical criteria
Fuel exporters96.434.8–18.2–19.6–5.42.3–32.1–3.9
Non-fuel exporters–65.8–82.3–68.2–43.5–28.0–26.6–8.64.3
Market borrowers–35.3–71.5–73.7–29.3–3.46.4–0.820.6
Official borrowers–9.1–12.0–10.5–8.4–9.7–9.5–8.7–9.8
Other countries20.8–3.42.73.14.82.33.15.7
Total3–26.7–67.1–103.5–77.3–86.9–70.0–54.0–37.3

Including official transfers.

Covers estimated balances on current transactions only in convertible currencies of the U.S.S.R. and nonmember countries of Eastern Europe.

Reflects errors, omissions, and asymmetries in reported balance of payments statistics on current account, plus balance of listed groups with countries not included.

Including official transfers.

Covers estimated balances on current transactions only in convertible currencies of the U.S.S.R. and nonmember countries of Eastern Europe.

Reflects errors, omissions, and asymmetries in reported balance of payments statistics on current account, plus balance of listed groups with countries not included.

Industrial Countries

The U.S. current account deficit widened from $139 billion in 1986 to $154 billion in 1987, despite a substantial increase in the volume of exports (which rose by 12 percent over 1986 levels) and slower growth in the volume of imports (which rose by 5 percent in 1987, compared with 15 percent in 1986). This reflected increased deficits both in oil trade, brought about by higher import prices in 1987 following the sharp fall in 1986, and in non-oil trade, reflecting the impact of a further weakening in the U.S. non-oil terms of trade. In addition, the balance on services deteriorated by some $6.5 billion, as a result of increased payments of interest and dividends on the foreign liabilities of the United States. Expressed as a percentage of GNP, the current account deficit rose to 3.4 percent in 1987, compared with 3.3 percent in 1986. However, there were signs of a reduction in this ratio in late 1987 and early 1988 as the effects on trade volumes began to work through (Chart 14).

Chart 14Major Industrial Countries: Payments Balances on Current Account, Including Official Transfers, 1980–First Quarter 19881

(Seasonally adjusted, in percent of GNP/GDP)

1 Data for Italy extend through the fourth quarter of 1987.

Japan’s current account surplus measured in nominal dollar terms was little changed in 1987 at $87 billion, compared with $86 billion in 1986. The volume of its exports increased slightly, while the volume of non-oil imports increased by 11 percent (following an increase of 12 percent in 1986). Nonetheless, a further small improvement in Japan’s terms of trade outweighed the volume adjustment in merchandise trade and the slight weakening of the balance on services and transfers. Similarly, in the Federal Republic of Germany, exports continued to grow in volume terms, but less rapidly than the volume of imports (the volume of non-oil imports rose by 7 percent). Germany’s merchandise terms of trade improved moderately, however, generating a rise in the trade surplus of $14 billion that was only partially offset by an increase of $8 billion in the deficit on services and transfers. As a result, Germany’s dollar current account surplus rose from $39 billion in 1986 to $45 billion in 1987.

It is misleading, however, to analyze the external positions of Japan and the Federal Republic of Germany only in terms of a numeraire such as the dollar, which depreciated substantially over the year. When the payments balances of the two major surplus countries are expressed as percentages of GNP, a rather different picture emerges. Japan’s current account surplus declined from 4.4 percent of GNP in 1986 to 4.0 percent of GNP in 1987, while Germany’s surplus fell from 4.2 percent of GNP to 3.9 percent of GNP. For both countries there was, during the year, a strong underlying trend toward lower surpluses, particularly in Japan. Although the imbalances were still large, the change in the trend in 1987 suggests that changes in macroeconomic policies and competitiveness have clearly begun to have an effect, particularly when associated with the more recent evidence of a reversal of the growth in the U.S. current account deficit as a share of GNP.

The scale of current account adjustments in nominal terms in other industrial countries during 1987 was generally smaller than among the three largest economies, but there were some significant real changes. In general, payments positions tended to weaken. Most marked was the swing in the French current account from a surplus of $3 billion in 1986 to a deficit of $4 billion in 1987, representing a deterioration equivalent to 0.9 percent of GDP. This reflected continuing strong growth in the volume of non-oil imports (which rose by 7 percent in 1987, despite a moderate slowdown in the growth of domestic demand), combined with only a modest recovery in exports. There was little change in the French terms of trade in 1987, a factor that had contributed to the stronger current account position in 1985 and 1986.

Italy’s balance of payments weakened significantly in 1987, with the current account moving into a small deficit, compared with a surplus of $3 billion in 1986 (equivalent to 0.4 percent of GNP). This development occurred despite a further improvement in Italy’s terms of trade, and was the result of a rapid acceleration in the growth of import volumes (which rose by almost 11 percent in 1987, compared with 8 percent in 1986; non-oil imports rose by 12½ percent). Imports were stimulated by buoyant domestic demand, stemming from strong growth in consumer expenditure and a recovery in fixed investment, while the volume of exports expanded at a relatively modest pace.

The current account balance of the United Kingdom also weakened, from approximate balance in 1986 to a deficit of $2½ billion in 1987 (0.3 percent of GDP). Most of the change occurred in non-oil trade, where import volumes grew strongly, reflecting the continuing strength of domestic demand, and slightly outpaced the growth of export volumes, which partly reflected the impact of earlier depreciations of sterling. The surplus on oil trade rose only slightly, to $7 billion, as a slowdown in the growth of export volumes was more than offset by the improvement in oil prices. Further growth in the United Kingdom’s surplus on services was largely balanced by a higher deficit on official transfers.

In contrast to the major countries in Europe, the Canadian current account deficit declined marginally as a percentage of GNP. The growth rate of exports increased compared with 1986, but remained below the growth in the volume of imports; a moderate improvement in Canada’s terms of trade offset, however, much of the volume effect.

The aggregate current account deficit of the smaller industrial economies rose from $1 billion in 1986 to $5 billion in 1987, an increase of 0.2 percent of GNP. The external position of Spain weakened as the current account surplus declined from 2.2 percent of GNP in 1986 to 0.3 percent of GNP in 1987 because of continuing strong domestic demand. The volume of imports rose by 22 percent in 1987, more than offsetting a significant improvement in export performance (the volume of exports rose by 7 percent, compared with a decline of 4 percent in 1986). The current account surplus of the Netherlands also declined markedly (by 1.1 percent of GNP), as a deterioration in the terms of trade offset an improvement in the real foreign balance. In contrast, Norway, Denmark, and Ireland substantially improved their current account positions between 1986 and 1987. In Norway the deficit fell from 6.5 percent of GNP to 5 percent of GNP, partly because of a recovery in oil export earnings together with a sharp curtailment of import demand as consumption and investment expenditures were cut back. In Denmark, the deficit declined from 5.2 percent of GNP in 1986 to 2.9 percent of GNP in 1987 as a result of contractions in both consumption and investment. Domestic demand was cut back in Ireland, although to a more modest extent; a sharp improvement in the real foreign balance changed the current account position from a deficit of 3.2 percent of GNP in 1986 to a surplus of 1.5 percent of GNP in 1987. Australia’s current account deficit also declined, from 6.1 percent of GNP in 1986 to 4.6 percent of GNP in 1987. This adjustment primarily reflected a sharp improvement in the terms of trade and the strong response of exports to gains in competitiveness in 1985 and 1986, and occurred despite a recovery in domestic demand.

Developing Countries

As the counterpart to the wider aggregate current account deficit in the industrial countries, the overall current account balance of the developing countries improved by $41 billion in 1987. This strengthening in the external position, which represents an adjustment equivalent to 1.4 percent of the developing countries’ aggregate GDP (or 6.3 percent of their exports of goods and services), affected most countries other than the exporters of minerals. Overall, the volume of developing country exports rose by 8½ percent in 1987, and their terms of trade recovered moderately, following the substantial deterioration of almost 20 percent in 1985–86. Import volumes also showed a recovery after significant compression in 1985–86. The aggregate deficit on services widened slightly in 1987, reflecting the impact of movements in world interest rates and the continued growth in the developing countries’ net foreign debt.

Much of the reduction in the current account deficit of the developing countries can be attributed to the strong recovery in the external position of the fuel exporting countries (Chart 15). Their current account balance had deteriorated by $32 billion (20 percent of exports) in 1986 as a result of the halving of oil prices in that year. In 1987, oil prices recovered partially, which led to an improvement of 12 percent in the fuel exporters’ terms of trade (compared with a deterioration of 49 percent in 1986). The fuel exporting countries also maintained the restrictive financial policies that had been introduced in 1986. These policies resulted in a small decline in their estimated GNP and a further reduction of 11 percent in import volumes (following a 22 percent cut in 1986). This strong adjustment effort led to a narrowing of the fuel exporters’ current account deficit to only $4 billion in 1987.

Chart 15Developing Countries: Trade and Current Account Balances, 1980–87

(In percent of exports of goods and services)

1 Excluding Nigeria and South Africa.

Current account adjustment was not limited to the fuel exporting countries, however. Non-fuel developing countries also consolidated the progress that they had made in each year since 1981 in strengthening their current account position. Their aggregate deficit of $9 billion in 1986 was turned into a surplus of $4 billion in 1987, an adjustment equivalent to 2.6 percent of exports. However, in contrast to the continued import compression and stagnant export growth in the fuel exporting countries, the improvement in the non-fuel exporters’ payments position was mainly the result of a strong growth of export volumes (12 percent) and occurred despite a marked increase in the volume of imports (almost 9 percent). The non-fuel exporting countries’ aggregate terms of trade were approximately stable in 1987 following two years of decline.

Significant disparities are evident in a regional breakdown of current account performances in 1987, although improvements were recorded almost everywhere. Countries in Asia recorded a surplus of almost $21 billion, compared with a surplus of $5 billion in 1986 and an average annual deficit of $14 billion in 1980–85. This turnaround reflected continued strong growth in the volume of exports, which rose by 16½ percent in 1987 following an increase of nearly 18 percent in 1986, and occurred despite a significant increase in the volume of imports. Asian countries also benefited from significant improvements in their terms of trade. The current account surplus of the four newly industrializing economies in Asia (Hong Kong, Korea, Singapore, and Taiwan Province of China) reached $30 billion in 1987, equivalent to about 11 percent of the combined GNP of this group. The current account deficit of the other Asian countries declined from $18 billion in 1986 to $9 billion in 1987, an adjustment amounting to 10 percent of exports.

The developing countries in Europe recorded a small current account surplus in 1987, following a deficit of $2 billion in 1986. An increase of 8 percent in the volume of exports of these countries was only partially offset by weaker terms of trade; the volume of imports grew by 5½ percent. In the Middle Eastern countries, the partial recovery in oil prices and reduced imports by some oil exporters contributed to the decline in the current account deficit from $18 billion (15 percent of exports) in 1986 to $5 billion (4 percent of exports) in 1987. The current account deficit of African countries also declined, from $9 billion in 1986 to $5 billion in 1987 (an adjustment equivalent to 6.1 percent of exports), mainly as a result of continued import compression (the volume of imports fell by 5 percent in 1987, following a reduction of 11 percent in 1986). However, the current account deficit of countries in sub-Saharan Africa (excluding Nigeria and South Africa) increased from $5 billion in 1986 to $6½ billion in 1987, the latter figure representing 23 percent of exports of goods and services.8 Export and import volumes for this group of countries changed little, but the terms of trade recorded a further decline of 6 percent, following a deterioration of 16 percent in 1986. The aggregate current account deficit of Western Hemisphere countries also declined, from $17 billion in 1986 to $ 11½ billion in 1987, representing an adjustment equivalent to 6½ percent of exports. This strong improvement resulted from a strengthening of real trade balances; the region’s terms of trade deteriorated slightly.

Regional trends largely reflected differing trade structures. Exporters of manufactures, which are concentrated in Asia and Europe, continued to benefit from buoyant import demand in the industrial countries, as well as from a recovery in import volumes in the non-fuel developing countries. The volume of their exports rose in aggregate terms by nearly 16 percent, following an increase of 13½ percent in 1986. Moreover, the strength of world trade prices for manufactures (which rose by 12½ percent in dollar terms in 1987, after increasing by 18 percent in 1986) contributed to a moderate improvement in their terms of trade. The terms of trade of non-oil primary product exporters, however, deteriorated for the third consecutive year, despite a rise in commodity prices in the latter part of the year. The cumulative decline amounted to 9 percent, which offset the continuing strong performance of real exports (export volumes of agricultural exporters have increased in each year during the 1980s and rose by 10½ percent in 1987). Many of the non-oil primary product exporters are located in Africa and the Western Hemisphere; these regions continue to experience particularly severe external financing difficulties.

Financing and Debt

The underlying financing position of the developing countries showed little change in 1987 from 1986, although there were some notable developments. The total external financing requirement rose slightly, from $75 billion in 1986 to $77 billion in 1987 (Table 10), with an increase in non-debt-creating flows being matched by a stabilization in the amount of accumulated arrears (which stood at an estimated $52 billion at the end of 1987) and an increase in net repayments to the Fund. Some 56 countries had external payments arrears outstanding at the end of 1987, compared with 58 at the end of 1986; the number of countries with arrears had previously been rising throughout the 1980s, having stood at 39 at the end of 1981. Net new credit provided by banks and other private lenders remained low (at only $8 billion), while official creditors maintained net flows of about $34 billion. The marked improvement in the aggregate current account position of the developing countries, together with the small increase in external financing, permitted a significant recovery in reserve accumulation (although this was concentrated in a small number of economies—principally Taiwan Province of China). The acquisition of nonreserve foreign assets, which for some countries is indicative of capital flight, continued to decline.

Table 10Developing Countries: External Financing, 1980–871(In billions of U.S. dollars)
19801981198219831984198519861987
All developing countries
Deficit on goods, services, and
private transfers–2555957344385615
Use of reserves50–12–4041518453
Other foreign asset accumulation, net28910476221917155
External financing requirement1141471319878737577
Non-debt-creating flows31221272221332736
Official flows flows42937423737303434
Private flows575834824152038
Arrears6–2513154–1011–1
Capital importing developing countries
Deficit on goods, services, and
private transfers761161076338424317
Use of reserves251–181019121746
Other foreign asset accumulation, net22231362117171310
External financing requirement1221481259474717376
Non-debt-creating flows32325252323333036
Official flows42937423734293233
Net credit from Fund73771150–3–6
Private flows57281442014199
Arrears6–2513154–1011–1

In contrast to the presentation in Table 9, official transfers are treated as a financing item in this table.

Net asset transactions by residents plus recorded errors and omissions (on the assumption that the latter reflect capital flight).

Official transfers, net direct investment, SDR allocations, valuation adjustments, and gold monetization.

Long-term borrowing from official creditors, use of liabilities constituting foreign authorities’ reserves, and use of Fund credit.

Residual. Mainly net external borrowing from private creditors and short-term flows.

Reflects involuntary “lending” by official and private creditors.

Includes use of Fund credit under General Resources Account, Trust Fund, and structural adjustment facility.

In contrast to the presentation in Table 9, official transfers are treated as a financing item in this table.

Net asset transactions by residents plus recorded errors and omissions (on the assumption that the latter reflect capital flight).

Official transfers, net direct investment, SDR allocations, valuation adjustments, and gold monetization.

Long-term borrowing from official creditors, use of liabilities constituting foreign authorities’ reserves, and use of Fund credit.

Residual. Mainly net external borrowing from private creditors and short-term flows.

Reflects involuntary “lending” by official and private creditors.

Includes use of Fund credit under General Resources Account, Trust Fund, and structural adjustment facility.

As in 1986, these overall developments masked the very different situations of specific groups of developing countries. In 1987 the financing positions of the two groups that adjusted their current account positions most successfully—the exporters of fuels and of manufactures—were markedly different from the positions of other developing countries (most of which are primary product exporters). In 1986 the fuel exporting countries ran down their gross reserve holdings by some $18 billion as oil prices fell sharply early in the year. The substantial current account adjustment made by this group in 1987 enabled them to replenish much of this reduction in reserves, while net external borrowing was reduced to $8½ billion. As for the exporters of manufactures, the significant rise in their current account surplus enabled them to increase their reserve assets still further (at the end of 1987 their reserves covered approximately 21 weeks of imports), and simultaneously to reduce their net borrowing requirement to $14 billion.

For other developing countries, however, there was little change in the tight external financing position that they had faced in 1986. Their aggregate current account deficit widened to $21 billion; reserve cover remained at only 13 weeks of imports; and net external borrowing, at $19 billion, was barely higher than the depressed level of 1986. Long-term financing provided by official lenders rose to $24 billion—the highest level it had reached during the 1980s—but repayments to private creditors continued to exceed private lending (even allowing for the substantial impact of the rescheduling of existing debt). Accumulation of arrears fell to $2 billion, compared with a record increase of $6 billion in arrears in 1986.

The stability of official financing flows (excluding credit from the Fund) to the developing countries is striking, especially in contrast to the sharp reduction in private flows. After allowing for the significant swings in short-term transactions between monetary authorities, which were designed to accommodate major financing adjustments in 1982–83, official flows to the capital importing countries in 1980–85 were in the range of $27–33 billion annually. In 1986–87 average disbursements rose to $36½ billion, reflecting the more coordinated approach to financing flows that was adopted following the Annual Meetings of the Fund and the World Bank in Seoul in October 1985.

The Fund played a major role in easing the external adjustment of developing countries in the immediate aftermath of the debt crisis. Net credit from the Fund, which had averaged $1 billion annually in 1978–80, rose to an annual average of $7½ billion in 1981–84. Because of the revolving nature of Fund resources, and the successful efforts of many countries to reduce their financing requirements, net borrowing from the Fund eventually was reversed and in 1985–87 developing countries made net repayments averaging $3 billion annually. As a result of the efforts of the Fund to encourage stronger adjustment in the developing countries, for example through programs under the SAF and the ESAF aimed at low-income countries and through the revitalization of the extended Fund facility, gross disbursements are again expected to increase significantly in 1988 and 1989.

The aggregate data show no evidence of a reversal of the precipitous drop in private financing flows to developing countries that occurred in 1982–84. As mentioned above, nonofficial lending to the capital importing countries rose to $9 billion in 1987 (from a negligible level in 1986), but this increase was entirely the result of increased disbursements under concerted financing arrangements; spontaneous net lending remained negative. Private lending after 1981 declined most for those countries that experienced debt-servicing problems; this group made net repayments to nonofficial creditors averaging $4 billion annually in 1983–86, compared with average inflows of $36 billion a year in 1979–82. Concerted borrowing arrangements provided an average of $8 billion annually in 1983–86, implying that repayments exceeded spontaneous inflows by an average of $12 billion annually in this period. In 1987 net repayments to private creditors by countries with recent debt-servicing problems declined to $3 billion, but there is little evidence that a substantial reversal of the negative resource flow is likely to occur in the near future. The decline in the negative resource flow in 1987 may have partly reflected the reduced commercial lending opportunities in countries that have not experienced recent debt-servicing problems; private lending to this group of countries declined from $16 billion in 1986 to $11 billion in 1987, in line with their stronger current account positions.

The total dollar value of developing countries’ outstanding debt rose by 10.4 percent in 1987 to $1,217 billion (Table 11)—equivalent to 39 percent of aggregate GDP. Two thirds of this nominal increase is estimated to have resulted from the impact of exchange rate movements on the dollar value of debt denominated in other currencies; the underlying increase in debt was some 4 percent, broadly in line with the increases in 1985 and 1986. The relatively strong growth of exports from the developing countries contributed to a reduction in the ratio of debt to exports from 169 in 1986 to 158 in 1987. However, debt-to-export ratios for all regions remained substantially above their levels in 1980, and were particularly high by historical standards in Africa and the Western Hemisphere. The growth in the ratio of debt to exports for countries with recent debt-servicing problems was striking, particularly given that the growth in nominal debt for this group was similar to that of countries without debt-servicing problems (Chart 16). For many countries the burden of existing debt remains a very serious constraint on economic development. This is especially true for the small, low-income countries and the heavily indebted, middle-income countries.

Table 11Developing Countries: Debt and Debt-Service Ratios, 1980–87(In percent of exports of goods and services, except where otherwise stated)
19801981198219831984198519861987
Total debt (in billions of U.S. dollars)6337448428949401,0161,1021,217
Debt ratio18295119133133150169158
By region
Africa92119155171171192239241
Asia717487928710110191
Europe127133141146144159167168
Middle East273446617183115110
Western Hemisphere183210272290273296352341
By miscellaneous criteria
Capital importing countries114129155164157173185173
Official borrowers156181219244257295325346
Countries with recent debt servicing problems153188241257248270310306
Debt-service ratio21316191819212220
By region
Africa1417212326292925
Asia910121111131414
Europe2522232122252625
Middle East456810101412
Western Hemisphere3342524141404538
By miscellaneous criteria
Capital importing countries1922252223242522
Official borrowers1416172023272523
Countries with recent debt servicing problems2733403334343630

Total debt at year-end as percentage of exports of goods and services in that year.

Actual payments of interest on total debt, plus actual amortization payments on long-term debt, as a percentage of exports of goods and services.

Total debt at year-end as percentage of exports of goods and services in that year.

Actual payments of interest on total debt, plus actual amortization payments on long-term debt, as a percentage of exports of goods and services.

Chart 16Developing Countries: Debt Stocks and Ratios of Debt to Exports, 1980–87

Nonetheless, the overall debt-service ratio of the developing countries fell from 22 percent in 1986 to 20 percent in 1987. In addition to the rise in export earnings, part of this adjustment was associated with the impact of debt-restructuring operations, which reduced the debt-service burden in 1987 by about 9½ percent of exports. (Such arrangements reduced average annual repayments by $40 billion annually in 1983–86 and by over $70 billion in 1987.) Once again, separate developing country groups faced sharply different circumstances. Countries in the Western Hemisphere continued to face particularly heavy debt-service payments (their debt-service ratio in 1987 was 38 percent), which reflected the large share of their debt that was held by commercial lenders. On the other hand, the seriousness of the debt-service burden of the small, low-income countries, many of which are situated in Africa, was more a reflection of the large absolute size of their debt relative to their export performance. It is noteworthy that, throughout the 1980s, the share of exports devoted to debt-service payments by countries with recent debt-servicing problems has been about twice that of the group of countries that have avoided such difficulties (debt-service ratios for the two groups in 1987 were 30 percent and 17 percent, respectively).

The scope for structural reforms in Japan was outlined in the Mayekawa Report (named after the chairman of the Prime Minister’s commission on structural adjustment), which was issued in April 1986. A follow-up report, which reviewed implementation and suggested further actions, was issued in May 1987.

Appendix I examines recent developments in international reserves in greater detail.

Since reserve assets denominated in dollars account for a larger proportion of non-gold reserves than the weight of the dollar in the valuation of the SDR, the SDR value of a given stock of reserves tends to increase when the dollar appreciates, as in 1983–84, and to decline when the dollar depreciates, as in 1985–87.

The currency composition of identified foreign exchange reserves is based on a Fund survey and on estimates derived mainly from official national reports. Since these figures are only approximations, they should be interpreted with caution. These identified reserves differ from total foreign exchange reserves, which also include foreign exchange reserves for which composition information is not available.

As a counterpart, the estimated shares of the deutsche mark and the Japanese yen in industrial countries’ reserves increased by 9 percentage points and 5 percentage points, respectively.

See Appendix Table II.1 for a classification of exchange arrangements as of March 31, 1988.

For an analysis of the main reasons for the global discrepancy on current account, see International Monetary Fund, Final Report of the Working Party on the Statistical Discrepancy in World Current Account Balances, 1987. See also page 18 of the 1987 Annual Report.

The current account deficit of Nigeria fell from $3.6 billion in 1986 to $1.5 billion in 1987; South Africa’s surplus was unchanged at some $3 billion.

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