Chapter

The World Economy

Author(s):
International Monetary Fund
Published Date:
January 1991
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World economic growth declined to 2 percent in 1990 from 3¼ percent in 1989. Growth slowed in the industrial countries, as well as in Africa, and economic activity declined in the developing countries of Eastern Europe, the Middle East, and the Western Hemisphere (Table 1). The crisis in the Middle East and restructuring in Eastern Europe affected the global economic picture. The rate of growth of world trade also slowed, falling to about 4 percent in 1990 from 7 percent in 1989. Consumer price inflation increased to 5 percent in 1990 from 4½ percent in 1989 in the industrial countries and rose from 80 percent to 90 percent in the developing countries, largely owing both to the temporary rise in oil prices and price developments in a small number of high-inflation countries in Eastern Europe and the Western Hemisphere. Oil prices surged in August and September 1990 and then dropped rapidly in January. Net external borrowing of the net debtor developing countries rose to some $60 billion in 1990.

Table 1.Overview of the World Economy, 1987-90(Annual changes in percent, unless otherwise noted)
1987198819891990
World output3.44.53.32.1
Industrial countries3.34.53.32.5
United States3.44.52.51.0
Japan4.36.24.75.6
Germany (west)1.53.73.84.5
Developing countries3.74.53.10.6
Africa1.32.93.31.9
Asia8.19.05.55.3
Europe2.84.31.8-2.9
Middle East0.14.73.2-1.5
Western Hemisphere2.40.21.5-1.0
Memorandum
Eastern Europe1 and the U.S.S.R.2.54.31.9-3.8
Eastern Europe1.61.2-0.9-8.6
NIEs212.19.56.96.8
World trade volume6.59.17.13.9
Commodity prices
Oil328.7-20.521.528.3
Non-fuel48.623.5-0.3-7.9
Inflation
Industrial countries3.03.34.44.9
Developing countries32.052.679.590.5
Six-month LIBOR57.38.19.38.4

Eastern Europe is defined to include Bulgaria, the Czech and Slovak Federal Republic, Hungary, Poland, Romania, and Yugoslavia.

The newly industrializing Asian economies (NIEs) include Hong Kong, Korea, Singapore, and Taiwan Province of China.

Simple average of U.K. Brent, Dubai, and Alaska North Slope spot crude oil prices.

In U.S. dollars based on world trade weights.

London interbank offer rate on six-month U.S. dollar deposits.

Eastern Europe is defined to include Bulgaria, the Czech and Slovak Federal Republic, Hungary, Poland, Romania, and Yugoslavia.

The newly industrializing Asian economies (NIEs) include Hong Kong, Korea, Singapore, and Taiwan Province of China.

Simple average of U.K. Brent, Dubai, and Alaska North Slope spot crude oil prices.

In U.S. dollars based on world trade weights.

London interbank offer rate on six-month U.S. dollar deposits.

1. Global Economic Setting

The global economic setting in 1990 was marked by the crisis in the Middle East and associated developments in world oil prices, and by restructuring in Eastern Europe and unification in Germany, as well as the continuation of the debt crisis. After the invasion of Kuwait by Iraq, crude oil prices rose from an average of about $16 a barrel in July 1990 to a peak of more than $38 in October 1990 (Chart 1). As the loss of oil exports from Kuwait and Iraq began to be offset by increased production by other oil producers, the price of petroleum fell, and by December it averaged $25.70 a barrel. On January 17, 1991, the day after the outbreak of the war, oil prices posted a record one-day drop of approximately $10 a barrel as market participants concluded that there would be no significant damage to oil fields outside Kuwait and Iraq; by April 1991, oil prices had fallen to $17.80 a barrel, considerably below the average price of $22 a barrel in 1990.

Chart 1.Average Petroleum Spot Price1

(U.S. dollars a barrel)

1 The average petroleum spot price is defined as the average of the monthly spot prices of U.K. Brent (light), Dubai (medium), and Alaska North Slope (heavy).

The direct economic effects of the surge in oil prices that followed the Middle East crisis appear to have been small for the majority of industrial and developing countries, largely because the increase was short-lived; with the return of oil prices to precrisis levels, these adverse effects have already begun to be reversed. The temporary rise in oil prices is estimated to have raised the level of consumer prices in the industrial countries by ½ of 1 percent in 1990 and reduced the level of GNP by ¼ of 1 percent. As discussed below, indirect effects, including a rise in uncertainty and reductions in business and consumer confidence, may have slowed output growth further, especially in those countries where growth was already weak. Developments in the Middle East are estimated to have reduced real GNP in the oil importing net debtor developing countries by ½ of 1 percent in 1990. The largest losses in developing countries were, of course, in Iraq and Kuwait, where destruction from the war was extensive. A number of countries in the Middle East and other regions suffered losses in workers’ remittances and exports of goods and services as a direct result of developments in the Middle East. Oil exporting net debtor developing countries, including Ecuador, Indonesia, Mexico, Nigeria, and Venezuela, benefitted from the temporary rise in oil prices.

In most countries in Eastern Europe—and to a lesser extent in the Union of Soviet Socialist Republics—a broad consensus has emerged on the need to move toward market-based economic systems, and there was a general trend in 1990 to accelerate the reform process. However, the majority of these countries face severe economic difficulties as traditional central planning has largely collapsed and market-based mechanisms are only beginning to develop. At the same time, regional trade has declined with the deterioration in economic performance, especially in the U.S.S.R., and with the dissolution of the trade arrangements of the Council for Mutual Economic Assistance (CMEA). This development, together with the temporary increase in world oil prices, resulted in a considerable terms of trade shock in 1990 for the Eastern European countries.

Box 1.World Economic Outlook

The May 1991 edition of the World Economic Outlook provides a comprehensive analysis of developments in the world economy, including a discussion of alternative medium-term economic scenarios. It is the product of a comprehensive interdepartmental review by the Fund’s staff, which is conducted twice a year and draws on the staff’s consultations with member countries as well as on its econometric modeling techniques. This publication is available from the Fund’s Publication Services (price $30.00). The next World Economic Outlook, comprising revised projections by the staff, will be published in October 1991 (price $30.00).

Non-fuel commodity prices declined sharply in 1990 (Chart 2). In U.S. dollar terms, the price of non-fuel commodities (based on world trade weights) fell by an estimated 8 percent, reflecting decreases in all major commodity groups, with the largest year-to-year drops recorded in tropical beverages (12½ percent) and minerals and metals (9½2 percent). These declines, along with the rise in oil prices, contributed to an estimated 3 percent deterioration in the terms of trade of the oil importing developing countries.

Chart 2.Non-Fuel Commodity Prices1

(1980-100)

1 The total is based on world trade weights.

The aggregate current account deficit of the developing countries declined from $14 billion in 1989 to $8 billion in 1990, as increased surpluses in the net creditor countries more than offset larger current account deficits in the net debtor developing countries. These deficits were accompanied by a large increase in net external borrowing, including exceptional financing. Total external debt of all developing countries increased in 1990 by 6 percent to $1,306 billion, which reflected the net effect of new borrowing, valuation adjustments on account of the depreciation of the U.S. dollar against major currencies, and the impact of debt reduction operations and debt forgiveness.

2. Domestic Economic Activity and Policy

Industrial Countries

In the industrial countries economic growth slowed from 3¼ percent in 1989 to 2½ percent in 1990. The slowdown reflected mainly the recession that began during the year in North America and the United Kingdom and slower growth in a number of European countries, which offset considerably stronger growth in Japan and west Germany. The slowdown in 1990 can be attributed to several factors, including the lagged effect of a tightening of monetary policy in North America and the United Kingdom, the temporary rise in oil prices, and increased uncertainty related in large measure to the conflict in the Middle East and to oil market developments. It is noteworthy that following the invasion of Kuwait, consumer confidence dropped sharply in several major industrial countries and then rebounded following the cease-fire in the Middle East.

The slowdown that had started in mid-1989 in the United States became more pronounced in the second half of 1990. Sharp declines in residential construction, business investment, and consumer expenditures on durables and nondurables resulted in a 1½ percent decline (at an annual rate) in GNP in the last quarter of 1990, and a further decline of 2¾ percent in the first quarter of 1991. Net exports contributed to growth in 1990, reflecting a slowing of demand growth in the United States relative to some of its main trading partners and an improvement in competitiveness, including the effects of the real effective depreciation of the dollar from mid-1989 through 1990. Interest rates in the United States had been falling for more than a year prior to the downturn in the fourth quarter. This decline followed a tightening of monetary policy in 1987-88 aimed at dealing with a rise in inflation. While the direct effect of the increase in oil prices on the U.S. economy was negative, it was not large enough to explain the full magnitude of the downturn. Other factors that appear to have played a role include heightened uncertainty regarding developments in the Middle East and the associated drop in consumer and business confidence, and perhaps the “credit crunch” that may have resulted from a tightening in bank lending practices.

In the United Kingdom, output fell in the third and fourth quarters of 1990 as private consumption and investment declined sharply in response to an earlier anti-inflationary tightening of monetary policy. Export growth remained strong until mid-1990, but subsequently weakened owing partly to some loss of competitiveness resulting from sterling’s strength and from increases in unit labor costs above the average of other countries participating in the exchange rate mechanism (ERM) of the European Monetary Systems (EMS). The Canadian economy entered a relatively deep recession in the second quarter of 1990 as private consumption weakened and investment declined sharply.

In Japan and west Germany, output expanded at an unusually rapid pace in 1990. Real GNP increased 4½ percent in west Germany, reflecting the stimulus to domestic demand associated with unification, and the unemployment rate fell by more than a full percentage point from the end of 1989 to April 1991, despite substantial immigration. There was, however, a sharp decline in output in east Germany reflecting the difficult initial phases of the unification process, and the proportion of the labor force that was officially registered as unemployed reached 9½ percent in April 1991, while the number of short-time workers rose to more than 2 million or approximately 25 percent of the labor force. In Japan, output increased by 5½ percent in 1990; investment was strong, partly reflecting the installation of new technologies to economize on scarce labor.

Growth in France and Italy slowed in 1990 to 2¾ percent and some 2 percent, respectively, reflecting in part weakness in business investment and expenditures on consumer durables. Despite increased exports to Germany, the contribution to growth from the external sector was slightly negative in both countries in 1990, owing to a loss of competitiveness outside the ERM area and to weaker demand from North America and the United Kingdom. Among the smaller industrial countries, Australia, New Zealand, Finland, and Sweden entered recessions last year, reflecting in part the impact of tight policies in the late 1980s, adverse cost developments, and the slowdown in the growth of world trade.

For the industrial countries as a group, the rate of increase in consumer prices rose from 4½ percent in 1989 to 5 percent in 1990, reflecting in part the impact of higher oil prices in the last half of 1990 (Chart 3). However, inflation was already rising in some industrial countries before the invasion of Kuwait by Iraq, and the effects of higher oil prices were offset to some extent by a significant decline in non-fuel commodity prices and, in the case of Japan and many European countries, by currency appreciation against the U.S. dollar during 1990.

Chart 3.Industrial Countries: Consumer Price Indices

(Percent change from four quarters earlier)

1 Increases in indirect taxes raised consumer prices in 1989 in Canada, west Germany, Japan, and Italy, and again in the first quarter of 1991 in Canada.

2 Annual observations.

In the United States, consumer prices increased by nearly 5½ percent in 1990. Before the rise in oil prices in August, wage and price inflation had declined somewhat owing in part to the slowing of growth; in addition, import prices, which increased by only 1 percent in 1990 in spite of the 6½percent drop in the effective value of the U.S. dollar and the rise in oil prices, also contributed to lower inflation. In Canada, the rise in consumer prices declined slightly in 1990 to 4¾ percent from 5 percent in 1989, but the introduction of the Goods and Services Tax in January 1991 will increase consumer prices by an estimated 1¼ percent and result in a higher inflation rate this year. In Japan, consumer prices (excluding fresh food and energy, and the impact of the consumption tax introduced in April 1989) increased at an annual rate of about 4 percent in the latter part of 1990, despite the appreciation of the yen, owing in part to higher wages associated with tight labor market conditions; this compared with a rise of 1½ percent during 1989.

The strengthening of the ERM currencies against the U.S. dollar during 1990, together with the decline in non-fuel commodity prices, helped offset the impact on inflation of higher oil prices in Europe. For example, in 1990 the domestic currency price of imports declined by about 2 percent in both France and west Germany. Among the major European economies, the increase in consumer prices in 1990 was largest in the United Kingdom (91/2 percent, due in part to the high initial level of community charges and higher mortgage interest rates) and smallest in west Germany (2¾ percent), although German inflation picked up during the course of the year. Inflation declined slightly in France in 1990, remaining ¾ of 1 percentage point higher than in Germany, while in Italy inflation rose to 6½ percent.

Fiscal policies in the major industrial countries in 1990 were broadly neutral or moderately restrictive, with the notable exception of Germany where higher spending related to unification and the third stage of tax reform pushed the borrowing requirement of the territorial authorities (including the Unity Fund) to 3½ percent of GNP. To avoid a further weakening in the budgetary position, the German Government announced a budgetary package in January and tax increases in February 1991. In the United States, a five-year deficit reduction package was adopted in 1990 in the face of high deficits. In Canada, the Government announced a new program that is intended to reduce significantly the federal deficit over the medium term.

Since mid-1990, differences in monetary policies and monetary conditions among the major industrial countries have become more pronounced as the divergences in cyclical positions discussed above became more apparent (Chart 4). In Canada, the United Kingdom, and the United States, short-term interest rates generally declined during 1990, reflecting weakening economic activity and reduced resource pressures in these countries. From April 1990 to April 1991, the federal funds rate in the United States dropped by more than 2 percentage points, with the decline intensifying in the last quarter of 1990 and early 1991 as economic activity, especially in the interest-sensitive sectors, declined. Over the same period, short rates fell markedly in Canada (4 percentage points) and the United Kingdom (3¼ percentage points). Monetary policy in the United Kingdom also took account of the entry of sterling into the exchange rate mechanism of the EMS in October 1990. In Australia, monetary policy was restrictive in 1989, but short-term interest rates fell considerably in 1990 as the economy moved into recession.

Chart 4.Major Industrial Countries: Output Gaps1

(In percent)

1 Actual and projected GDP/GNP as a percentage deviation from estimates of potential output; composites are based on 1988-90 GDP/GNP weights.

In Japan and west Germany, price pressures intensified in 1990 as aggregate demand expanded rapidly, prompting a tightening of monetary policy and short-term interest terms rose by 1-1½ percentage points over this period. In Italy, there were substantial declines in short-term interest rates from late 1989 to October 1990, when the need to defend the lira within the narrow band of the ERM, together with higher inflation, prompted sharp increases in Italian interest rates in the last quarter of 1990. Monetary policies in the smaller industrial countries in Europe have generally followed the tightening in the larger European countries, although in some instances the tightening was more pronounced.

Long-term interest rates (as measured by government bond yields) generally rose during the first quarter of 1990. With the invasion of Kuwait in August, long-term interest rates rose sharply—by roughly ½ of 1 percentage point in most countries—as the surge in oil prices generated expectations of rising inflation, and as the general uncertainties surrounding the crisis encouraged investors to move into relatively more liquid assets.

Yields in most countries reached a peak in late September, in line with rising oil prices. They subsequently fell back, particularly in mid-January when oil prices plunged following the start of hostilities.

While the Middle East crisis clearly affected long-term rates, cyclical developments were also important in determining both the predominantly downward trend since mid-1990 and the differences in the magnitude of the decline among the major industrial countries. The largest declines tended to be in countries where economic activity had weakened the most and where the easing of monetary policy was most pronounced. From April 1990 through April 1991, yields on long-term government bonds fell by 2-2½ percentage points in Canada and the United Kingdom, by ¾-1 percentage point in France, Italy, and the United States (where rates had tended to fall since mid-1989), and only slightly in Germany and Japan.

The differing cyclical developments and the policy responses to them led to contrasting movements in short-term interest rates, which in turn contributed to exchange rate pressures (Chart 5). In particular, continued shifts in interest differentials favorable to non-dollar assets in 1990 contributed to a further depreciation of the U.S. dollar in relation to most other major currencies. However, the dollar recovered sharply after the conclusion of hostilities in the Middle East and by the end of April it had regained about three fifths of its decline from mid-1989 levels. This appreciation of the U.S. dollar appeared to reflect a change in market expectations about the likely course of economic activity in the United States.

Chart 5.Major Industrial Countries: Effective Exchange Rates

(1985 = 100)

The current account imbalances of the three largest industrial countries narrowed in 1990, reflecting previous exchange rate movements, growth differentials, and, in the cases of Germany and Japan, higher oil prices. In Germany, the process of unification contributed to a surge of imports in 1990, particularly from France and Italy. In the United States, the current account deficit narrowed in 1990 because of the effects of the improved competitive position of U.S. producers and continued market growth, although these were partly offset by the rise in oil prices and a slowdown in the growth of exports from the very high rates in the two previous years. In Japan, the real trade balance continued to decline in 1990, albeit at a slower pace, with import volumes expanding in line with domestic demand. In the United Kingdom, where the external position deteriorated sharply from 1987 to 1989, there was a substantial reduction in the current account deficit in 1990, owing partly to the country’s relatively weak cyclical position. In the other industrial countries, the aggregate current account deficit widened in 1990 by $10 billion to $32 billion, reflecting mainly larger deficits in Finland, New Zealand, Spain, and Sweden.

Developing Countries

For the developing countries as a group, the fall in real GDP growth was more pronounced than in industrial countries, declining from 3 percent in 1989 to ½ of 1 percent in 1990 (Chart 6). Economic activity continued to increase rapidly in Asia, but growth slowed in Africa and output fell in the other regions. The continued decline in non-fuel commodity prices, as well as the temporary rise in oil prices, resulted in a sharp deterioration in the terms of trade for the majority of developing countries. Moreover, as noted above, many developing countries were adversely affected by the crisis in the Middle East. Inflation in the developing countries picked up sharply in the past two years reflecting developments in a few high inflation countries in Eastern Europe and in the Western Hemisphere (Chart 7).

Chart 6.Developing Countries and Regions: Real GDP Growth1

(Percent change)

1 Composites are arithmetic averages of country growth rates weighted by average U.S. dollar value of GDPs over the preceding three years.

Chart 7.Developing Countries and Regions: Consumer Prices1

(Percent change)

1 Composites are geometric averages of consumer price indices measured in local currencies for individual countries weighted by the average U.S. dollar value of their respective GDPs over the preceding three years.

The pace of economic activity in Africa slowed in 1990 owing to the effects of a drop in the prices of non-fuel primary commodities—particularly tropical beverages (coffee, cocoa, and tea), which fell to their lowest level since 1980; in addition, the temporary rise in oil prices contributed to the slowdown. Sluggish growth in Africa was accompanied by average inflation of about 15 to 20 percent. The exchange arrangement of the CFA Franc Zone (see page 35) contributed to the containment of inflation, although in 1990 it also resulted in a real appreciation vis-à-vis the U. S. dollar resulting from the nominal appreciation of the French franc.

Differences in the stance of policies resulted in considerable variations in economic performance. In Cameroon, Liberia, Somalia, Sudan, and Zaïre, for example, the economic situation deteriorated during 1990 owing in part to the inability of the authorities to implement needed stabilization policies and structural reforms, and, in some cases, to social and political conflicts. In contrast, policies were tightened in late 1990 to strengthen the stabilization program in Madagascar. In Ghana, Kenya, Nigeria, Togo, and Tunisia, structural reforms and stabilization policies have been successfully carried out and real growth increased.

The majority of countries in Africa are oil importers, and they experienced a decline in real income partly resulting from the rise in oil prices. In addition, Sudan suffered from the disruption of trade with Kuwait and Iraq and from the loss of workers’ remittances, although less so than some countries in the Middle East and Asia. Although Africa’s major fuel exporters—Algeria, Cameroon, Gabon, and Nigeria—benefitted from the oil price increase, all but Nigeria experienced negative or sluggish growth, in some cases because of unfavorable weather conditions (Cameroon and Gabon) or because of the short-run costs associated with the removal of structural distortions.

The sustained increase in real per capita output in the developing countries of Asia during the 1980s is in sharp contrast to the stagnant or declining trend in other regions. However, the impressive performance of Asia as a whole masks considerable differences among countries and territories within the region. Growth has been stronger and more sustained in China, Hong Kong, Indonesia, Korea, Malaysia, Singapore, Taiwan Province of China, and Thailand than in the rest of Asia. The strength of activity in these economies can be attributed in part to the adherence to market-oriented policies—or, in the case of China, to market-oriented reform—coupled with a relatively stable macro-economic environment, and to the adoption of an outward orientation that encourages external trade.

Economic activity in Asia weakened slightly in 1990 as growth fell to 5¼ percent, owing to higher energy costs as well as to declining export demand in the newly industrializing economies of Asia (NIEs).1 In these economies and in Indonesia, Malaysia, and Thailand, growth was sustained by strong domestic demand and by large inflows of foreign investment. Growth in China increased from 3½ percent in 1989 to 5 percent in 1990, as industrial activity accelerated in the second half of the year and agricultural production rose. In most of South Asia, favorable weather contributed to a strong recovery of agriculture that helped to offset the negative impact of a further decline in the terms of trade. In the Philippines, GDP growth declined from 5½ percent in 1989 to 2½ percent in 1990, as macroeconomic imbalances were compounded by earthquake damage, drought, and the adverse effects from the crisis in the Middle East.

Inflation in Asia fell from about 12 percent in 1989 to 8 percent in 1990. This decline in the average rate of inflation mainly reflected adjustment policies and price controls in China that reduced the rate of inflation (annual average) from about 18 percent in to 2½ percent in 1990. In the most rapidly growing Asian economies, however, inflation was higher in 1990 due to the rise in energy costs and strong growth of domestic demand, particularly in Korea and Singapore. In India, Pakistan, and the Philippines, policy factors contributed to an increase in inflation.

The Eastern European countries are in the process of implementing wide-ranging systemic reforms, including in many cases steps toward privatization, and have introduced comprehensive macroeconomic stabilization programs. In response to a sharp acceleration of inflation, Poland and Yugoslavia adopted stabilization programs in 1989-90 that combined tight fiscal and monetary policies with fixed exchange rates and controlled wages as nominal anchors. Hungary tightened its policies in 1990. In late 1990 and early 1991, Bulgaria, the Czech and Slovak Federal Republic, and Romania began to implement stabilization programs to contain the impact of price and external sector liberalizations on inflation and the external balance, as well as of the collapse of CMEA trade, and in the cases of Bulgaria and Romania to achieve fiscal consolidation and reduce excess liquidity.

In most of these countries, the tightening of fiscal and monetary policies was accompanied by a growing reliance on market-based instruments of monetary control affecting the cost and availability of central bank refinancing,2 and there have been far-reaching structural changes in government finances, such as sharp cuts in consumer and producer subsidies, that generally have been reflected in substantial declines in government expenditures and revenues as a percentage of GDP. Macroeconomic imbalances remained severe in the U.S.S.R., despite a reduction of the fiscal deficit from 11 percent of GDP in 1988 to around 6-7 percent in 1990.

Following virtual stagnation in 1989, output in Eastern Europe and the U.S.S.R. declined by 3¾ percent in 1990. The decline affected all countries in the region and reflected a combination of domestic and external factors, including the dislocations resulting from the disintegration of the existing economic system, the restructuring necessitated by substantial changes in relative prices and greater exposure to foreign competition, the short-run effects of tight fiscal and monetary policies, falling exports to other CMEA countries, disruptions in oil supplies from the U.S.S.R., and the economic impact of the events in the Middle East. Output losses in 1990 were particularly severe in Bulgaria, Poland, Romania, and Yugoslavia. By contrast, in Hungary strong growth of convertible currency exports partly offset the contraction of ruble exports and domestic demand, while in Czechoslovakia growing domestic demand helped to contain the decline in output in the face of adverse external developments. Based on official estimates, output losses in 1990 were relatively moderate in the U.S.S.R., although a rapid expansion of nominal incomes was accompanied by persistent shortages.

The average rate of inflation in Eastern Europe and the U.S.S.R. rose in 1990 on a year-over-year basis, mainly reflecting large price increases in late 1989 and early 1990 in Poland and Yugoslavia; in both countries, however, inflation declined considerably during 1990. All countries in the region have adopted some form of incomes policy and measured real wages stagnated or declined in 1990, except in Romania and the U.S.S.R., where nominal wages rose considerably faster than the official retail price index.3 In Poland and Yugoslavia, a sharp compression of real wages in early 1990 was later partially offset by substantial wage increases. Since late 1989, all Eastern European countries and the U.S.S.R. substantially depreciated their nominal exchange rates, in most cases to boost competitiveness and support external sector liberalization. However, in Poland, Yugoslavia, and Hungary, subsequent increases in consumer prices outpaced the magnitude of the nominal devaluations and the real effective exchange rate appreciated significantly. Wages, however, increased less than prices and hence the impact on competitiveness may have been less severe than indicated by real exchange rate indices based on consumer prices.

The economies of the Middle East were severely affected by the crisis that began with the invasion of Kuwait by Iraq on August 2, 1990. War damage in Iraq and Kuwait was extensive, and economic activity in large areas of these countries came to a virtual halt during the crisis. Principally affected were Egypt, Jordan, and Turkey (classified among the developing countries of Europe), which suffered substantial losses of workers’ remittances, tourism receipts, and other export earnings. Refugee problems imposed a heavy financial burden on the Islamic Republic of Iran and Turkey. The oil exporting countries (other than Iraq and Kuwait) benefitted from temporarily higher oil prices and an increase in oil production, but some oil exporting countries close to the area of conflict, like Saudi Arabia and the Islamic Republic of Iran, faced increased expenditures associated with the war—including defense outlays and economic aid to other countries—that are expected to exceed the rise in oil revenue.

Output in the Middle East is estimated to have declined by 1½ percent in 1990 reflecting mainly a sharp contraction in Iraq, Kuwait, and Jordan. Economic activity accelerated in some of the other countries of the region as the terms of trade for oil exporting countries improved and oil production increased. Inflation in the Middle East declined from an average of 14½ percent in 1989 to 13¼ percent in 1990. The impact of the increase in oil prices on inflation was minimal because most countries did not raise domestic fuel prices. This has contributed to a worsening of fiscal deficits in some of the oil importing countries in the region.

In a number of Middle Eastern countries, structural reforms that were being implemented with moderate success before the crisis have been put on hold. Moreover, there were significant macroeconomic imbalances in some countries even before the crisis, and fiscal and current account deficits have increased in these countries and elsewhere in the region. In several countries, the pressure on aggregate demand from expansionary fiscal policies was countered by a tightening of monetary policies, which was only partially successful in restraining demand, and therefore the balance of payments tended to weaken.

Output in the developing countries of the Western Hemisphere declined by 1 percent in 1990, following a modest rise in 1989, while inflation continued at a very high level. These developments primarily reflected the combination of severe recession and extraordinarily high inflation in Argentina, Brazil, and Peru. However, economic activity also was sluggish and inflation increased slightly in most other countries of the region, reflecting the deterioration in the terms of trade for producers of non-fuel primary commodities and drought in parts of South America. The main exceptions were Ecuador, Mexico, and Venezuela, where growth in the last quarter of 1990 was boosted by higher oil output. Although average inflation in the Western Hemisphere increased to about 770 percent in 1990—largely because of extraordinarily high inflation in Brazil and Argentina and the large weight of these two countries—the median rate of inflation fell slightly to 9¾ percent. Inflation remained high in some countries (Argentina, Brazil, Nicaragua, and Peru) because of widespread indexation practices, excess liquidity, and delays and slippages in policy implementation.

In some countries the weakness in economic activity in 1990 reflected in part the transitional adjustments associated with stabilization policies and structural reforms, rather than destabilizing macroeconomic policies that had been the primary factor in previous years. Monetary and fiscal policies were tightened to strengthen stabilization efforts in Bolivia, Chile, and Venezuela. New stabilization programs were implemented in Argentina, Brazil, and Peru to halt extraordinarily high inflation, and in El Salvador, Guyana, Honduras, and Jamaica to restore external and internal balance. In many of these countries, as well as in Colombia, structural reforms have also been introduced, and in some cases—including Argentina, Bolivia, Brazil, Chile, Colombia, Mexico, and Peru—the reforms have been far-reaching. As a result of these policies, Chile has achieved sustained growth since 1984 and Mexico has resumed growth after a long recession, contained inflation, attracted substantial capital inflows, and re-entered the international bond market.

3. External Financing and Debt in Developing Countries

The current account deficit of the developing countries fell from $14 billion in 1989 to $8 billion in 1990, or less than 1 percent of their exports of goods and services.4 However, the current account deficit of the net debtor developing countries widened to $33 billion in 1990 and was accompanied by a large increase in net financial inflows (from $76 billion in 1989 to over $110 billion in 1990). This increased financing included a sharp rise in net external borrowing to an estimated $60 billion, largely reflecting increased borrowing by creditworthy countries in Asia and exceptional financing (including the accumulation of arrears) in the Western Hemisphere. The increase in net financial inflows allowed all developing countries to boost official reserves by $35 billion in 1990. The rise in official reserves was concentrated in Asia and in the group of 15 heavily indebted countries that boosted their ratio of reserves to imports of goods and services to 23 percent.

The accumulation of $8 billion in arrears accounted for about a quarter of the external financing for countries with recent debt-servicing problems, even though the number of countries experiencing such arrears declined from 59 in 1987 to 53 in 1990, with the bulk of the arrears concentrated in a small subset of countries. In some cases, payments were suspended while negotiations were under way for the full regularization of creditor-debtor relations. In several other countries, the total stock of payments arrears (including principal) declined in 1990 as a result of reschedulings, debt forgiveness by some bilateral official creditors (including a few developing countries), and debt-and debt-service-reduction operations with commercial banks. Several countries that account for a large share of total payments arrears have already made marked progress toward normalizing relations with external creditors. A commitment to the process of privatization as part of public sector reform in many indebted countries, combined with debt-equity transactions, has contributed to improved debt management and has attracted additional foreign direct investment flows.

During 1990 and early 1991, several developing countries concluded debt-restructuring agreements with creditors (see page 39), and since June 1990 Niger, Uruguay, and Venezuela have completed debt-and debt-service-reduction packages with commercial banks, while Nigeria has reached an agreement in principle. The agreement with Niger, the first package involving a low-income debtor country, will be supported by official funding from the World Bank’s International Development Association Debt Reduction Facility. In addition, Chile signed a multiyear rescheduling agreement and Senegal concluded an agreement to reschedule repayment of its debt over ten years. As regards official bilateral debt, several low-income countries, including Guyana and Niger, benefitted from concessional options in Paris Club reschedulings. Several proposals were made in 1990 to increase the concessionality of Paris Club reschedulings for indebted low-income countries. Steps were also taken to reduce bilateral debt or interest payments for certain middle-income countries. In September 1990, the Paris Club agreed to provide longer maturities and grace periods in the reschedulings for the lower middle-income countries, as well as limited bilateral debt conversions on a voluntary basis; and in April 1991, Paris Club creditors agreed on a menu of options to reduce the present value of the stock of Poland’s official bilateral debt by 50 percent in two stages.

Staff estimates indicate that the external debt of all developing countries (excluding Fund credit) increased by nearly 6 percent in 1990 and reached $1,306 billion by the end of the year (Chart 8). The increase resulted from aggregate net new borrowing ($50 billion) and from valuation adjustments reflecting the depreciation of the U.S. dollar vis-à-vis other major currencies ($51 billion), partly offset by the impact of various debt reduction operations and debt forgiveness by official bilateral creditors ($29 billion).

Chart 8.External Debt

(In billions of U.S. dollars and percent)

Alphabetical listing

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

These instruments are, however, only at an early stage of development, and most countries continue to use direct credit ceilings or moral suasion to keep monetary conditions appropriately tight.

It should be noted that in the presence of widespread price controls and shortages, developments in real wages do not adequately reflect changes in purchasing power. Moreover, measured real wages do not include income from secondary employment in the private sector, which increased rapidly in most Eastern European countries.

The data in this section exclude Bulgaria, the Czech and Slovak Federal Republic, and the U.S.S.R.

Consultations with some members occur every 18 months or every 24 months.

Reviewing the Fund’s enlarged access policy in June 1990, the Board agreed to leave access limits under the policy unchanged and to review the policy before the increase in quotas under the Ninth General Review becomes effective and, in any event, not later than the end of 1991

See Board of Governors’ Resolution No. 45-2, adopted June 28, 1990 (Annual Report, 1990, page 103).

Reserve tranche purchases were made by three members in 1989/90 (SDR 62 million) and by four members in 1990/91 (SDR 707 million). Since such purchases represent members’ use of their own Fund-related assets, they do not constitute use of Fund credit.

Of this total, SDR 0.1 billion consisted of early repurchases made by Mauritius and Thailand, whose balance of payments and reserve positions continued to improve during 1990/91. Such repurchases were made in accordance with the guidelines for early repurchases, Executive Board Decision No. 6172-(79/101), adopted June 28, 1979.

Access in most arrangements in 1990/91 did not raise the Fund’s holdings of currency above 200 percent of quota and therefore the policy on enlarged access did not apply.

These prescribed holders of SDRs are the African Development Bank, African Development Fund, Andean Reserve Fund, Arab Monetary Fund, Asian Development Bank, Bank of Central African States, Bank for International Settlements, Central Bank of West African States, East African Development Bank, Eastern Caribbean Central Bank, International Bank for Reconstruction and Development, International Development Association, International Fund for Agricultural Development, Islamic Development Bank, Nordic Investment Bank, and Swiss National Bank.

Executive Board Decision No. 9549-(90/146) G/S, adopted October 5, 1990 (see Appendix IV, pages 115), and Executive Board Decision No. 6631-(80/145) G/S, adopted September 17, 1980 (Selected Decisions, Sixteenth Issue, pp. 376-77). The 1980 decision states that, unless the Fund decides otherwise, the SDR valuation basket be revised with effect on January 1, 1986 and on the first day of each subsequent five-year period. This decision provided that the SDR basket is to include the currencies of the five countries with the largest exports of goods and services during the five-year period ending one year prior to the date of the revision, which in the present revision is the period 1985-89.

In accordance with the guidelines in the Executive Board’s Decision No. 8574-(87/64) of April 24, 1987 (Selected Decisions, Sixteenth Issue, page 207), the level of the Fund’s SDR holdings in the General Resources Account are to be maintained within the approximate range of SDR 0.75-1.25 billion. Following the quota increases under the Ninth General Review, it is expected that the SDR holdings of the Fund in the General Resources Account will increase substantially and that the Executive Board will review its policy on the appropriate level of its SDR holdings.

One other member (Cambodia) has had overdue obligations to the Fund since 1975, but has not been declared ineligible.

The system of special charges on overdue financial obligations to the Fund entered into effect on February 1, 1986 with the purpose of recovering from late-paying members the direct financial costs to the Fund of overdue obligations.

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