The world economy is in the springtime of recovery, Raghuram Rajan, IMF Economic Counsellor and Director of the Research Department, observed at an April 21 press conference releasing the April 2004 World Economic Outlook (WEO). “The tentative buds of six months ago are now blooming in many parts of the world,” he added, citing a strong rebound in world trade; a robust U.S. recovery; continued exceptionally strong growth in emerging Asia, especially China; and the strongest showing for the Japanese economy since 1996.
Global recovery has strengthened and broadened, led by the U.S. and Asia
Note: Shaded areas indicate projections.
1Australia, Canada, Denmark, euro area, Japan, New Zealand, Norway, Sweden, Switzerland, the United Kingdom, and the United States.
2Hong Kong SAR, Korea, Singapore, and Taiwan Province of China.
3Indonesia, Malaysia, the Philippines, and Thailand.
4Bulgaria, Czech Republic, Estonia, Hungary, Israel, Latvia, Lithuania, Pakistan, Poland, Romania, Russia, Slovak Republic, Slovenia, South Africa, Turkey, and Ukraine.
5Argentina, Brazil, Chile, Colombia, Mexico, Peru, and Venezuela.
Amid multiplying signs of a vibrant global economy, the WEO raised its forecast for global growth in 2004 by about 0.5 percentage point to 4.6 percent, and projected growth of 4.4 percent in 2005, Rajan said, noting that “if all goes as expected, we are in for the best two-year period in over a decade”
Among the industrial countries, the United States has led the way. Most forward indicators point upward, and the WEO projects U.S. growth for 2004 at 4.6 percent. Japan’s recovery also shows remarkable strength, Rajan observed, with strong external demand, notably from China, accompanied by rising investment and, recently, a pickup in consumption. The WEO projects Japanese GDP will grow by 3.4 percent in 2004—the highest rate since 1996. In response to a question, Rajan said Japan had moved from export-led growth to investment, and there were signs of consumption picking up, which led the WEO team to believe that there may be greater strength in this recovery than in the false dawns of the last decade. There has been a fair amount of restructuring on both the corporate and banking sides, and this has helped Japan. At this juncture, however, getting rid of deflation remains a fundamental macroeconomic objective, and the WEO counsels Japan to keep its expansionary monetary policy in place until deflation is history.
The euro area, however, is still experiencing wintry conditions, Rajan said, with prospects much less favorable than in the United States and Japan. Only a modest expansion, of 1.7 percent, is projected for the euro area in 2004. Rajan told reporters that there might be room for a further interest rate cut by the European Central Bank, though such a step would not perform magic on the region’s economies. Other important steps—notably, structural reforms—are critical.
Strong growth in emerging Asia
Moving to emerging markets and developing countries, Rajan pointed to the particularly strong performance of emerging Asia, where China’s growth—projected to be 8.5 percent in 2004—has been key. Asked whether the IMF had been aggressive enough in encouraging China and other Asian economies to move to more flexible exchange rates, Rajan underscored that the IMF had been pointing out that more flexibility would be in these countries’ own interests, putting a lid on inflation and encouraging more rational investment decisions. But it is an open question whether currency appreciation would completely cure excessive investment in China; traditional methods of limiting bank loans for such investment might not work because some decisions are not being made on the basis of profitability.
Exchange rate flexibility should be a goal, but full convertibility at this point would be a mistake, Rajan explained. “China needs to deal with the problems in its financial system and clean them up before it moves to full convertibility,” he said.
Elsewhere in Asia, India—with 7.4 percent growth in 2003 and 6.8 percent projected for 2004—is booming, too. Growth in Latin America, notably in Brazil, remained weak in 2003, but recovery is expected to consolidate in 2004, underpinned by strengthening domestic demand and global growth. The Middle East is projected to experience slightly slower GDP growth in 2004 than in 2003, at some 4.1 percent.
The Commonwealth of Independent States (CIS) grew strongly in 2003, underpinned by robust upturns in Russia and Ukraine. Growth in the CIS is projected to slow slightly to 6 percent in 2004. In Central and Eastern Europe, growth is projected to pick up but is constrained by the relatively weak performance of its chief trading partner, the euro area, and by the need for fiscal consolidation in some countries.
As for sub-Saharan Africa, GDP growth is expected to strengthen somewhat in 2004 to 4.2 percent, based on a combination of improved macroeconomic fundamentals, higher commodity prices, increased political stability, and better weather conditions.
Oil prices could pose risk to growth
In this rosy picture there remain risks to the short-term outlook, Rajan cautioned. Oil prices will have a negative effect on global growth if they remain at current levels or increase further. Every increase of $5 a barrel, if maintained for one full year, would lower global growth by about 0.3 percentage point, according to IMF staff estimates. But a lot depends on what causes the higher oil prices, Rajan noted. So far, oil price increases have resulted from strong demand, which itself would not derail recovery. What is worrisome is that there is not enough slack in supplies to withstand the withdrawal of a single major producer, which could happen because of geopolitical tensions in the Middle East or elsewhere.
There are other risks, too, Rajan continued. Expansionary monetary and fiscal policies have helped reduce the economic impact of the collapse of the asset bubble, the 9/11 attacks, and Severe Acute Respiratory Syndrome (SARS), but the policy options that helped then have been used up, leaving the world with limited insurance against fresh downside shocks. And global imbalances resulting in part from the use of these policy options have heightened the vulnerability of the world economy.
Oil prices rising; production steady
1Average petroleum spot price of West Texas Intermediate, U.K. Brent, and Dubai crude.
2Five-day weighted average of NYMEX Light Sweet Crude, IPE Dated Brent, and implied Dubai Fateh.
Data: International Energy Agency; Bloomberg Financial, LP; and IMF staff estimates.
The growing integration of China and India into the world economy over the medium term, the longer-term integration of Africa, and the aging populations of the industrial countries will create both opportunities and challenges. Given that global uncertainties cannot be controlled, the answer is to be prepared, Rajan warned. The WEO advocates rebuilding policy options wherever possible and focusing on reducing vulnerabilities. In the medium term, economies must increase their flexibility: the ability to adapt to change is the best form of insurance. Specifically, given the current strong growth, most monetary authorities should start preparing the ground for higher policy interest rates, as some have already begun to do.
The United States is not the only economy that needs to consolidate its fiscal position, but it is the most important, Rajan noted, and the faster this consolidation is undertaken, the better. Fiscal tightening will also help reduce global imbalances—a significant vulnerability at this point. Stronger budgetary health will also prepare the United States to meet the pension needs and medical costs of the aging baby-boom generation.
Economies also need to become more flexible through structural reform, Rajan said. Chapter 3 of the WEO points out that the current period of recovery is a good time to embark on such reforms. Desirable structural reforms range from building stronger financial systems in Asia and creating greater labor market flexibility in Europe to reforming health care in the United States. These would help citizens the world over see coming changes as opportunities rather than threats. This would alleviate protectionist pressures, helping everyone secure a brighter future, Rajan predicted.
While Rajan said he did not see protectionism as being focused in just one country, the size of the U.S. economy means that an increase in U.S. protection would be of broad concern. Also, with the U.S. service sector newly subject to foreign competition through overseas outsourcing, a former champion of free trade is now getting worried. The threat of terrorism could also take its toll on trade, David Robinson, Deputy Director of the Research Department, added, since it makes moving goods across borders that much more difficult and time consuming.
All in all, Rajan concluded, the world has emerged from the winter of recession, but “the message of the latest WEO is that, instead of dancing the spring and summer away, we should make provisions for the future. Being the ant is boring, but it is prudent economics”
Copies of the April 2004 World Economic Outlook are available for $49.00 ($46.00 for academics) each from Publication Services. See page 121 for ordering information. The full text of the World Economic Outlook is also available on the IMF’s website (http://www.imf.org), as is the full text of the World Economic Outlook press conference held on April 21.
Elisa Diehl Christine Ebrahim-zadeh Jacqueline Irving
Niccole Braynen-Kimani Maureen Burke
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