Journal Issue

World Economic Outlook: Fastest growth in decades in 2004, but in 2005 oil prices will weigh

International Monetary Fund. External Relations Dept.
Published Date:
October 2004
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The IMF forecasts global growth of 5 percent for 2004—the fastest in decades (see table) announced Raghuram Rajan, Economic Counsellor and Director of the IMF’s Research Department, at a September 29 press conference. Higher oil prices are likely to dampen growth next year, however. The newly released September 2004 World Economic Outlook (WEO) lowers its forecast for 2005 growth slightly, to 4.3 percent, with further reductions possible if volatility continues in oil markets.

The United States, which led the way out of the global recession, recently hit a “soft patch,” said Rajan. Fading fiscal stimulus and higher oil prices are weighing on consumption, so continued employment growth is essential. The measured withdrawal of monetary accommodation should continue. But on the fiscal side, despite recent revenue buoyancy, the IMF sees red ink stretching into the future.

As for Japan, the IMF recently raised its growth forecast despite recent softness in that economy, Rajan announced. But it is not enough for Japan to simply emerge from its stagnation of more than a decade. The rapid aging of its population has raised the bar, and Japan now has to recover some of its past vitality, by subjecting its domestic and financial sectors to the same competitive forces that have made its export sector thrive.

The recovery in the euro area has gained momentum, Rajan observed, though growth there is still the lowest among developed regions and, especially in Germany, remains dependent on external demand. European leaders have enacted key reforms, but there are signs that people are experiencing reform fatigue.

Global growth at 5 percent in 2004(annual percent change)
Current projections
World output3.95.04.3
Advanced economies2.13.62.9
United States3.04.33.5
Euro area0.52.22.2
Newly industrialized
Asian economies3.05.54.0
Developing countries6.16.65.9
Central and eastern Europe4.55.54.8
Commonwealth of
Independent States17.88.06.6
Developing Asia7.77.66.9
Middle East6.05.14.8
Western Hemisphere1.84.63.6

Mongolia, which is not a member of the Commonwealth of Independent States, is included in this group for reasons of geography and similarities in economic structure.

Data: IMF World Economic Outlook, September 2004

Mongolia, which is not a member of the Commonwealth of Independent States, is included in this group for reasons of geography and similarities in economic structure.

Data: IMF World Economic Outlook, September 2004

Will China land?

Growth has been particularly strong in emerging Asia, Rajan noted, with China picking up speed again. “The question increasingly is not a hard or soft landing,” he said, “but whether China will land at all. In its own long-term interests, we strongly believe it must land.” India’s growth will soften a bit because of the vagaries of the monsoon, and the country has to improve its infrastructure even while bringing overstretched government budgets back into balance.

Elsewhere, Latin American growth has rebounded, with Brazil’s reforms finally paying dividends, according to Rajan. Domestic demand has picked up across the region on the strength of improving confidence. But Latin America’s problem has never been achieving growth; it has been sustaining growth. Reform efforts have to continue so that adverse debt dynamics do not play the spoiler as they have done so often in the past.

Higher oil prices are benefiting the Middle East as well as countries in the Commonwealth of Independent States. The critical task for all these countries, Rajan noted, will be to use their budgetary windfalls wisely, while diversifying sources of growth. Emerging Europe continues to thrive, with most economies experiencing rising domestic demand and strong export growth. But many of these countries have high fiscal and current account deficits that need attention, especially given rising oil prices.

Particularly encouraging, said Rajan, is the stronger growth expected in sub-Saharan Africa. This is a result of improving macroeconomic fundamentals; higher commodity prices, including oil windfalls; somewhat better access to industrial country markets; and reduced external debt burdens. He cautioned, however, that sub-Saharan African countries must build on these gains by creating the institutions they need for continued growth.

Risks ahead

Turning to risks in the global economy, Rajan noted that long-term trends eventually, and often unexpectedly, become short-term policy concerns. For instance, the phenomenal growth of China could have run a few more years without weighing on global energy resources. But because it accompanied the global recovery and has now combined with the loss of oil production in various quarters and the targeting of oil supply by terrorists, oil prices have risen sharply.

Just how much of the current pressure on oil prices results from increasing demand in strong emerging economies in 2004? Quite a bit. According to Rajan, China accounted for 30 percent of the increased demand and India approximately 8–10 percent. In response to a reporter’s question about the price level at which one should start worrying, he explained that the IMF’s rule of thumb is linear—a $5 annual increase in oil prices results in a 0.3 percent dip in global growth. Whether the effect would at some point become nonlinear was difficult to say.

But Rajan also strove to put the recent increase in a historical perspective. Current oil prices in real terms (see chart), he said, are still far below what they were in the 1970s, adding that oil reliance in the developed economies is now much less than it was in the 1970s. The inflation-fighting credibility of central banks is also much higher now than it was—an important ingredient in the overall picture, since one of the most important ways in which oil prices affect growth is by leading to an inflationary spiral that then has to be counteracted by very tight monetary policy, which then creates a downturn. Given all of the features of the current environment, Rajan concluded that “we are in a much better situation now than we were in the 1970s.”

While Rajan declined to be an alarmist, he said the world needs to take the oil situation as a wake-up call. In the long run, without dramatic technological change, it will simply be unsustainable for every Chinese or Indian household to consume as much energy as inefficiently as the average U.S. suburban household. All countries have to increase incentives for both conservation and energy efficiency, while removing unnecessary impediments to exploration and production.

In the short run, WEO models indicate that the direct effects on growth and inflation of oil prices at current levels are likely to be moderate for developed countries, Rajan said. But monetary authorities have to be vigilant. If central bankers are forced to raise interest rates in a hurry, overstretched housing markets in some developed countries could be affected, while some emerging markets with significant public and external debt could face difficulty.

In real terms, oil prices are still comparatively low

(1995 = 100)

Note: Shaded areas indicate projections.

Data: World Economic Outlook, September 2004

Finally, Rajan reminded reporters that while downside risks have increased, global growth is still robustly above trend. Countries should use the relatively benign environment the world is now enjoying to recreate the room for policy maneuver that was given up in ensuring the recovery.

And there is no better time for reform than the present, when recent adversity reminds citizens of the cost of standing still while better times help ease the pain of reform. Domestic reforms in many cases can also contribute to reducing global imbalances. However, people will need to be convinced that the benefits of reform are worth the costs. That will require real leadership, which Rajan hoped would continue to emerge in the years to come.

Copies of the September 2004 World Economic Outlook are available for $49.00 each ($46.00 academic price) from IMF Publications Services. The full text of the latest issue of the World Economic Outlook is available on the IMF’s website (

Laura Wallace


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