Chapter

Main Developments in the World Economy

Author(s):
International Monetary Fund
Published Date:
January 1995
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The world economy rebounded strongly in 1994. Total output rose by 3¾ percent, in line with trend growth over the past two decades, and marking a significant improvement over the lackluster performance of 1990–93 (Chart 1). In addition to continued strong growth in much of the developing world, economic activity picked up in the industrial countries as expansions in North America and the United Kingdom gained further momentum and as recovery became firmly established in the continental European countries (Table 1).

Chart 1WORLD INDICATORS

(In percent)

1 Excluding trade among the Baltic countries, Russia, and the other countries of the former Soviet Union.

Table 1OVERVIEW OF THE WORLD ECONOMY1(Annual percent change unless otherwise noted)
1991199219931994
World output1.42.12.53.7
Industrial countries0.81.51.13.0
United States–0.62.33.14.1
Japan4.31.1–0.20.5
Germany2.82.2–1.12.9
France0.81.3–1.52.8
Italy1.20.7–1.22.2
United Kingdom–2.0–0.52.23.8
Canada–1.80.62.24.6
Seven countries above0.81.61.33.1
Other industrial countries1.01.00.22.8
Memorandum
European Union21.11.0–0.52.8
Developing countries4.95.96.26.3
Africa1.90.80.82.8
Asia6.48.28.78.6
Middle East and Europe3.15.53.80.6
Western Hemisphere3.52.73.24.6
Output per capita
Africa–0.7–1.7–1.9–0.2
Asia4.76.57.06.9
Middle East and Europe1.9–0.41.5–2.1
Western Hemisphere1.50.71.32.6
Countries in transition–11.4–15.8–9.6–10.3
Central and eastern Europe–10.7–12.0–6.8–4.9
Excluding Belarus and Ukraine–11.4–9.9–2.12.6
Russia–13.0–19.0–12.0–15.0
Transcaucasus and central Asia–7.7–17.6–11.8–14.9
World trade volume2.95.23.99.2
Import volume
Industrial countries32.34.31.510.3
Developing countries9.912.410.48.8
Export volume
Industrial countries32.84.21.58.6
Developing countries7.19.69.010.4
Commodity prices
Oil4–17.0–0.5–11.5–4.1
In U.S. dollars a barrel18.3018.2216.1315.47
Nonfuel5–4.4–0.2–3.712.4
Consumer prices
Industrial countries4.53.33.02.4
Developing countries33.335.942.948.1
Countries in transition97.1821.3769.6332.1
Six-month LIBOR (in percent)6
On U.S. dollar deposits6.13.93.45.1
On Japanese yen deposits7.24.33.02.4
On deutsche mark deposits9.49.47.05.4
Note: Data in the table are based on the latest information at the time of finalizing the Report. For this reason, data for individual countries may differ from the indicators provided in the section describing Article IV consultations with member countries.

Composite data for country groups are averages of data for individual countries weighted by GDP valued at purchasing power parities (PPPs) as a share of total world or group GDP.

Fifteen current members of the European Union.

Information on 1993 trade may understate trade volume because of reduced data coverage associated with the abandonment of customs clearance of trade within the European Union. Similarly, the strong rebound in trade volumes in 1994 may partly reflect improved data coverage.

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

Average, based on world commodity export weights, of U.S. dollar prices.

London interbank offered rate, annual averages.

Note: Data in the table are based on the latest information at the time of finalizing the Report. For this reason, data for individual countries may differ from the indicators provided in the section describing Article IV consultations with member countries.

Composite data for country groups are averages of data for individual countries weighted by GDP valued at purchasing power parities (PPPs) as a share of total world or group GDP.

Fifteen current members of the European Union.

Information on 1993 trade may understate trade volume because of reduced data coverage associated with the abandonment of customs clearance of trade within the European Union. Similarly, the strong rebound in trade volumes in 1994 may partly reflect improved data coverage.

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

Average, based on world commodity export weights, of U.S. dollar prices.

London interbank offered rate, annual averages.

Robust growth in industrial and developing countries and higher import demand in countries in transition led to a strong expansion in the volume of world trade of over 9 percent in 1994, well above the 5½ percent average growth rate of the past two decades. Trade among developing countries rose markedly, supported by trade liberalization and increased intraregional economic and financial ties. Although capital flows to developing countries remained at a very high level, on aggregate they subsided somewhat, owing largely to declines in flows to countries in the Western Hemisphere and the Middle East and Europe region. By the end of 1994, the Final Act of the Uruguay Round had been ratified by countries accounting for over 90 percent of international trade in goods and services; included among its provisions was the creation of the World Trade Organization (WTO).

Among the industrial countries, inflation eased further in 1994, and in many countries it was at levels closer to price stability than seen in three decades. Inflation rose somewhat in the developing countries, and it remained at high levels in many of the transition countries, although stabilization efforts progressed in a number of these countries and inflation for the group came down significantly from 1993 levels. Oil prices were lower on average, whereas nonfuel primary commodity prices registered a marked cyclical recovery that contributed to a small improvement in the terms of trade of nonfuel exporting developing countries.

Long-term interest rates in the industrial countries rose significantly, particularly in the early part of the year, owing to improved growth prospects, inflationary expectations, and the increased demand for funds stemming from the pickup in global activity. In some countries, market concerns about inflation prospects, budgetary imbalances, and political uncertainties led to a sharp increase in interest rate risk premiums and exchange market pressures. With the overall decline in the level of capital flows to developing countries, there was a downward correction in many emerging stock markets; both of these developments intensified in the wake of the financial crisis in Mexico in December.

Economic Activity and Employment

The recovery of world economic activity became firmly established during 1994, following the 1990–93 global slowdown. Among the industrial countries, where growth averaged 3 percent, the recovery took hold in continental Europe, although margins of slack in product and labor markets were still significant by early 1995 in most countries (Chart 2). In the United States, Canada, the United Kingdom, Australia, and New Zealand, where the upswings had started earlier and expansions had progressed the most, the strength of activity led to further increases in rates of capacity utilization, and unemployment rates declined. With only a weak recovery, Japan experienced a further increase in economic slack (Chart 3).

Chart 2MAJOR INDUSTRIAL COUNRES: UNEMPLOYMENT RATES

(In percent of labor force)

1 Aggregation based on labor force weights.

Chart 3MAJOR INDUSTRIAL COUNTRES: REAL GDP

(Percent change from four quarters earlier)

1 Through 1991, west Germany only; thereafter, Fund staff estimates for unified Germany.

In the United States, the broadly based, domestically driven expansion continued. Business investment was particularly buoyant in 1994 and more than offset a decline in net exports. Real GDP growth slowed in the first quarter of 1995, but unemployment fell to 5.5 percent, and capacity utilization reached the highest level since 1979. The recovery in Canada continued at a rapid pace as exporters benefited from strong external demand and the weakness of the Canadian dollar, while resource-based industries were helped by the rise in commodity prices. The pace of economic activity also picked up in the United Kingdom, as a surge in exports more than offset a slowdown in consumption growth in response to tax increases. In Australia and New Zealand, growth accelerated markedly on the strength of domestic demand.

The recovery was stronger than generally anticipated in continental Europe. In Germany, growth was initially export led, helped by the recovers’ of foreign demand and by improved competitiveness resulting from industrial restructuring and declining unit labor costs. The recovery became more broadly based as the year progressed, with business fixed investment strengthening in the latter part of 1994. Growth also firmed in France, as both domestic and foreign demand continued to strengthen, and unemployment began to decline toward the end of the year. In Italy, the economic recovery gathered momentum, with exports being boosted by the substantial depreciation of the lira and the recovery in partner countries, and with domestic demand gradually replacing net exports as the main contributor to growth; unemployment, however, remained high. Strong export growth also supported the recovery in the smaller industrial countries in Europe.

Japan’s economic performance has been weak despite a supportive stance of monetary policy and significant fiscal stimulus, including high public investment spending, an income tax cut, and other measures. The recovery’ marked time in the fourth quarter of 1994 as domestic demand contracted and net exports declined as a result of the substantial real appreciation of the yen in recent years. Moreover, real GDP grew only marginally in the first quarter of 1995, partly as a result of the January earthquake, which temporarily disrupted production and transportation.

A particularly positive aspect of the world economic situation in the past few years has been the continued rapid expansion in many developing countries, particularly in Asia and in some Latin American countries. The strong performance of these countries has reflected determined efforts at economic reform and improved macroeconomic policies, as well as the impact of substantial net capital inflows. In 1994, average growth in the developing countries edged up to 6¼ percent from 6 percent in 1993. This strong over all performance, however, masks substantial disparities among the various regions (Chart 4).

Chart 4DEVELOPING COUNTRIES: REAL GDP

(Annual percent change)

In Asia, the buoyant expansion continued, with over 8 percent growth for the third consecutive year. Strong investment demand boosted activity in Korea, Malaysia, the Philippines, and Thailand. In China, output continued to surge, and inflationary pressures intensified. Growth picked up in India and Pakistan, despite a cotton virus and drought in the latter country, and was sustained in Bangladesh.

Average growth in the developing countries of the Western Hemisphere rose to 4½ percent in 1994 from about 3 percent in 1993. Buoyant domestic demand, including investment, boosted activity in Argentina, Brazil, Peru, and Uruguay. In Mexico and Ecuador, activity recovered moderately, while growth slowed somewhat in Chile. In Venezuela, output contracted as the financial crisis adversely affected consumer and business confidence.

Growth in the developing countries in the Middle East and Europe region declined to less than I percent in 1994, largely as a result of developments in Turkey, where a severe financial crisis in the first half of the year contributed to a decline of output. In the oil exporting countries in the region, economic activity remained subdued, reflecting the further fall in oil prices in 1994.

Economic conditions remained difficult in Africa despite the cyclical recovery of commodity prices. Output increased by less than 3 percent, allowing for marginal increases in per capita incomes in only relatively few countries. However, with further moves toward reform, most notably exchange market liberalization, conditions for stronger growth continued to improve in many African countries. The CFA franc countries began to benefit from the currency adjustment in early 1994 in terms of improved opportunities for investment and exports, and a resumption of private capital flows. Growth strengthened to 3½ percent in the African countries that had arrangements under the Fund’s structural adjustment facility (SAF) or enhanced structural adjustment facility (ESAF) at the end of 1994. In South Africa, growth picked up slightly, and there were signs of increased stability and confidence. Output increased sharply in Morocco as production recovered from a two-year drought. In contrast, activity contracted further in Algeria as continued drought depressed agricultural production, and growth was adversely affected in Nigeria by political uncertainties and growing financial imbalances.

Economic conditions also improved in most of the transition countries in central and eastern Europe, including the Baltic countries, although the level of economic activity was still declining, albeit at a slower pace than in past years. The pace of expansion quickened in Poland, Romania, the Slovak Republic, and Slovenia and remained strong in Albania. Growth began in the Baltic countries and elsewhere in central and eastern Europe except for Belarus, Moldova, and Ukraine, where measured output contracted further. Apart from the Czech Republic and the Baltic countries, open unemployment has generally remained high—in the 10–20 percent range. Except for Armenia and Mongolia, the Transcaucasian and central Asian countries experienced continued output declines, and recorded GDP also contracted further in Russia. In all of these countries, however, the actual level of economic activity is probably higher than indicated by official statistics, which have not yet been fully adapted to capture the changing economic structure.

Consumer and Commodity Prices

A number of industrial countries recorded rates of inflation in 1994 that were consistent with reasonable price stability. In Japan, France, Canada, Denmark, Finland, Iceland, New Zealand, Norway, and Switzerland, consumer prices rose by less than 2 percent. In the United States, Germany, the United Kingdom, Australia, Austria, Belgium, Ireland, Luxembourg, the Netherlands, and Sweden, inflation was contained between 2 and 3 percent. The excellent inflation performance in the industrial countries constitutes the most successful aspect of the medium-term strategy pursued since the early 1980s. The strong anti-inflationary commitment of the monetary authorities was underscored by the pre-emptive tightening of monetary policy in 1994 in countries more advanced in the cycle. In countries in the early stages of recovery, significant margins of slack contributed to contain inflationary pressures.

Median inflation in the developing countries was 10 percent in 1994. Average inflation, which reflects very high levels of inflation in a relatively small number of countries, rose to 48 percent in 1994 from 43 percent in 1993. Although all regional groupings of developing countries experienced higher average rates of inflation, there were marked differences across and within regions. Average inflation in Africa increased to 34 percent, owing to a sharp rise to hyperinflation levels in Zaïre and higher rates of inflation in CFA franc countries stemming from the 50 percent devaluation of the CFA franc in January 1994. But in some countries, such as Kenya and Uganda, successful adjustment efforts resulted in considerably lower rates of inflation. Inflation in Asia rose to an average of 13 percent. The rise was widespread, but it was particularly marked in China and Viet Nam. In the Middle East and Europe region, inflation remained low in many countries, while it rose very sharply in Turkey and to a lesser extent in the Islamic Republic of Iran, pushing the average for the region to 32 percent. Inflation declined in most countries in the Western Hemisphere, reflecting a strengthening of adjustment policies. The notable exception was Venezuela, where inflation rose sharply in the wake of worsening financial conditions. In Brazil, inflation rose in the first half of 1994, hut it dropped very steeply in the second half of the year following the implementation of the third stage of a stabilization plan with the introduction of a new currency, the real, on July 1.

Inflation also tell in a number of countries in transition. Progress has been most marked in countries with strong macroeconomic policies, including Albania, the Baltic countries, the Czech Republic, Mongolia, Poland, Romania, the Slovak Republic, and Slovenia. By the end of 1994 inflation was at or approaching single-digit levels on a 12-month basis in Croatia, the Czech Republic, and the Slovak Republic. Russia made substantial progress toward stabilization during the first half of 1994, but inflation rose substantially later in the year. Most of the other countries of the former Soviet Union, which initiated reforms more recently and less forcefully, continued to suffer from very high rates of inflation.

Prices of nonfuel commodities registered a marked recovery in 1994, reversing a five-year declining trend. Coffee prices rose sharply during the year, owing to adverse weather in Brazil, but dropped somewhat in December. Prices of copper, nickel, aluminum, and other metals were up markedly because of strong demand in a number of countries and limited increases, or reductions in some cases, in production. Prices of a number of agricultural raw materials, in particular natural rubber, also increased substantially on strong demand, especially from China. Oil prices declined in the second half of 1994, largely as the result of a significant increase in world production and a decline in purchases due to unseasonably warm weather in the Northern Hemisphere.

Financial and Foreign Exchange Markets

Interest rate developments in 1994 and early 1995 generally reflected differences in cyclical positions across countries and, more recently, exchange market tensions. For countries that entered the third or fourth year of recovery, including the United States, the United Kingdom, Canada, Australia, and New Zealand, monetary conditions were gradually tightened during 1994 and in early 1995. In the United States, monetary policy became progressively less accommodating in response to the rapid pace of economic growth. From February 1994 to March 1995, the federal funds rate was increased by 3 percentage points to 6 percent, and short-term market interest rates rose by a similar amount.

In Japan, short-term interest rates rose slightly in late summer of 1994 and remained relatively stable through early 1995, with three-month rates at about 2¼ percent. At the end of March, with the recovery still weak and the yen appreciating strongly, the Bank of Japan signaled an easing of monetary policy in the form of a reduction in the objective for overnight interest rates. Following further appreciation of the yen in the first half of April, the discount rate was cut by 75 basis points to 1 percent, a record low, Short-term interest rates in Germany continued to decline in the first half of 1994 and stabilized at 5 to 5¼ percent until the end of March 1995, when they declined by about 50 basis points following a similar reduction in the discount rate. Interest rates in other continental European countries broadly followed those in Germany during the past year, but in recent months currency pressures led to some divergences.

Long-term interest rates generally rose in the largest industrial countries during the past year. Much of the rise was attributable to the strengthening of growth prospects and to inflationary expectations. More recently, long-term interest rates in several of the larger countries have again declined, as expectations of inflation have fallen. However, long-term interest rates rose or remained very high in many countries where market sentiment has been adversely affected by large budgetary imbalances or political uncertainties.

In foreign exchange markets, the major development over the past year has been the sharp weakening of the U.S. dollar and many other currencies against the yen and the deutsche mark. Exchange rate movements were particularly marked in the early months of 1995, with the dollar reaching record lows against the other two major currencies. The weakening of the U.S. dollar against the yen and the deutsche mark contrasted with its strength against the currencies of some other trading partners, especially the Mexican peso and the Italian lira. Against the Canadian dollar, the U.S. dollar remained fairly stable in the first part of 1995, although it has appreciated significantly in recent years. Thus, whereas from December 1994 to April 1995 the U.S. dollar declined by 16½ percent against the Japanese yen and by 12¼ percent against the deutsche mark, the dollar declined by only 5½ percent on a broad effective basis (in both real and nominal terms). As a counterpart to the dollar’s weakness, both the deutsche mark and the yen strengthened significantly in this period. In nominal effective terms, the yen appreciated by 15¾ percent, and the deutsche mark by 5½ percent, from December 1994 to April 1995.

The appreciation of the deutsche mark reflected not only its rise against the dollar, but also increases against the pound sterling and several European currencies perceived to be affected by political uncertainties, fiscal difficulties, or both, including especially the Italian lira, the Spanish peseta, and the Swedish krona. The French franc also weakened somewhat against the deutsche mark, but it appreciated slightly in effective terms. Pressures among the currencies participating in the exchange rate mechanism (ERM) of the European Monetary System (EMS) resulted in the devaluation of the central parity of the peseta by 7 percent and of the escudo by 3½ percent during the first weekend of March 1995. In the week that followed, currency pressures were also reflected in increased official interest rates in a number of other European countries; some of these interest rate increases were sub-sequently reversed when exchange market tensions abated. During this period, the Japanese yen appreciated against a range of currencies, including the deutsche mark and Swiss franc.

Several factors seem to have contributed to the strength of the yen and the deutsche mark and the weakness of the dollar: Japan’s large current account surpluses and concerns over recent and prospective U.S. current account deficits and their financing; uncertainties regarding the prospects of further reductions in the U.S. budget deficit; a growing perception in the market that U.S. short-term interest rates were near their cyclical peak; and the continuing economic crisis in Mexico and worries in the market about the situation in the rest of Latin America. In Europe, with several countries beset by political uncertainties and fiscal difficulties, the deutsche mark benefited considerably from increased demand from risk-conscious investors. General nervousness related to developments in several emerging market countries may also have played a role through flight-to-quality effects on both the deutsche mark and the Japanese yen.

External Balances, Financing, and Debt

Despite the weakness of the dollar against the yen and the deutsche mark, the U.S. current account deficit widened to $q56 billion (2¼ percent of GDI) in 1994 from $104 billion (1½ percent of GDP) in 1993 as domestic demand strengthened. Canada and Australia had current account deficits equivalent to around 4 percent of GDP in 1993; the deficit declined by 1 percent of GDP in 1994 in Canada and widened slightly in Australia. In Japan, the current account surplus declined slightly in dollar terms from S 131 billion to $129 billion despite rapid growth in import volumes. It declined relative to GDP by 0.3 of a percentage point, to 2.8 percent. By contrast, Germany’s deficit increased by $8 billion to $23 billion (1 percent of GDP) in 1994 as a rise in the trade surplus was offset by an increased deficit in nonfactor services. The current account was in surplus in France, Italy, the Netherlands, Belgium and Luxembourg, Denmark, Ireland, Switzerland, and Norway in 1993; in several cases, the surpluses widened further in 1994, reflecting export-led recoveries in a number of countries. Relatively small current account deficits in 1993 were reduced in 1994 (the United Kingdom, Spain, and Greece), or changed to surplus (Sweden and Finland).

In the developing countries, the combined current account deficit remained in the range of $90-100 billion in 1994, the same as in 1993, after widening sharply in recent years as a result of surges of capital flows into many countries. However, there were indications of some decline in net capital inflows during 1994 to developing countries in the Western Hemisphere and in the Middle East and Europe region (Chart 5).

Chart 5DEVELOPING COUNTRIES: NET CAPITAL FLOWS

(In billions of U.S. dollars)

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

The change in sentiment of investors was most dramatic in Mexico. Concerns about the current account deficit, which reached 8 percent of GDP in 1994, and political developments contributed to substantial reserve losses at times during 1994, eventually leading to the devaluation of the new peso in December and triggering a severe crisis of confidence. Contagion effects were felt in other emerging market countries, primarily in Latin America, and also in some industrial countries as a result of a general reassessment of risk factors. In Mexico and Argentina, as well as in several other emerging market countries, the authorities responded to the crisis by taking measures to reduce macroeconomic imbalances and restore the confidence of domestic and foreign investors.

The aggregate external debt of developing countries, in percent of exports of goods and services, declined in 1994. However, the rise in interest rates during the year increased debt-service ratios for sub-Saharan Africa and for countries in the Middle East and Europe region (Chart 6). Debt and debt-service ratios for developing countries in the Western Hemisphere declined relatively more than in other regions, although they remained well above the developing country average. Average debt ratios in Africa rose further, and the disparities among parts of the continent widened. In 1994, the ratio of external debt to GDP in sub-Saharan Africa was 3½ times the developing country average and more than 1½ times the average for all of Africa.

Chart 6DEVELOPING COUNTRIES: EXTERNAL DEBT AND DEBT SERVICE1

(In percent of exports of goods and services)

1 Debt service refers to actual payments of interest on total debt plus actual amortization payments on long-term debt.

Progress continued to be made with debt-restructuring agreements in connection with both Paris and London Clubs and on a bilateral basis. In December 1994, Paris Club creditors agreed on new “Naples terms” providing for 67 percent reduction of eligible debt for most low-income rescheduling countries. In addition, for countries where a good track record under rescheduling agreements and Fund programs had been established and where there was sufficient confidence in the debtor’s ability to respect the agreement, two new terms provided for concessional rescheduling of the stock of eligible debt (a stock-of-debt operation). By the end of April 1995, nine reschedulings had taken place under Naples terms, including a stock-of-debt operation for Uganda. In addition, between April and September 1994, Brazil, Bulgaria, and the Dominican Republic completed debt- and debt-service-reduction operations. Zambia concluded a debt buyback agreement under the aegis of a World Bank program to clear the debt of the world’s poorest countries. Bolivia completed a debt-for-aid swap organized by the Debt for Development Coalition. In August 1994, the Islamic Republic of Iran rescheduled short-term commercial bank debt, and Saudi Arabia obtained partial agreement on a two-year deferral of repayment on commercial bank balance of payments loans. In October 1994 and February’ 1995, Poland and Ecuador concluded commercial bank restructuring agreements. Algeria was also negotiating with its bank creditors and has reached a debt-restructuring agreement with the United States. Haiti has settled its debt arrears to multilateral lenders, but arrears to the United States and other bilateral lenders remain to be cleared; and South Africa wrote off debt owed by Namibia. Negotiations are also continuing with Nigeria and Venezuela on arrears and the management of outstanding debt. Croatia reached agreement with Paris Club creditors in March 1995, and London Club discussions were held with Croatia and Slovenia, The distribution of the commercial bank debt of the former Socialist Federal Republic of Yugoslavia among the successor states is a major issue yet to be resolved.

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