Chapter

II World Economic Situation and Short-Term Prospects

Author(s):
International Monetary Fund. Research Dept.
Published Date:
May 1993
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Following two years of slow economic growth, the recovery for the world economy in 1993 is projected to be sluggish (Table 1). A protracted slowdown in Europe and an unexpectedly sharp weakening of activity in Japan have contributed to significant downward revisions to the output projections for many countries for 1993.1 Against this background of recent setbacks there are, however, some encouraging developments: strengthening recoveries in North America; continuing progress and resilience in many developing countries; indications in some central European economies that reforms are starting to bear fruit; and significant reductions in inflation in a number of countries. There is also scope for improving economic prospects in 1994 and beyond through a cooperative growth strategy.

Table 1.Overview of the Baseline Projections1(Annual percent change unless otherwise noted)
19911992Current

Projections
Differences from

October 1992

Projections
1993199419921993
World output0.61.82.23.4–0.2–1.4
Industrial countries0.21.51.72.9–0.2–1.2
United States–1.22.13.23.20.20.1
Japan4.01.31.33.5–0.7–2.5
Germany1.02.0-1.31.70.2–3.9
France1.11.82.3–0.4–2.7
Italy1.30.90.31.9–0.4–1.3
United Kingdom–2.2–0.61.43.10.2–0.7
Canada–1.70.93.24.4–1.2–1.2
Seven countries above0.21.61.93.0–0.1–1.1
Other industrial countries0.60.80.62.1–0.9–1.7
Memorandum
European Community0.71.10.12.2–0.3–2.1
West Germany3.71.5-2.01.2–0.3–3.9
Developing countries4.26.15.15.1–1.0
Africa1.50.92.73.9–1.1–1.0
Asia5.87.96.76.60.4
Middle East and Europe2.19.95.03.50.1–4.2
Western Hemisphere3.12.32.32.6–0.6–1.6
Memorandum: Developing countries excluding Middle East and Europe4.55.65.15.3–0.5
Countries in transition–10.1–15.5-8.8-1.6–1.0–5.0
Central Europe2–13.5–7.5-1.52.6–2.8–4.5
Former U.S.S.R.–9.0–18.5–11.8–3.5–0.2–5.3
World trade volume2.34.25.25.6–0.3–1.4
Industrial country import volume2.44.03.94.7–0.1–1.2
Developing country import volume9.110.28.68.31.7–1.0
Commodity prices
Oil3–17.0–0.5–3.02.6–0.5–2.5
In U.S. dollars a barrel18.3018.2217.6718.13–0.10–0.55
Nonfuel4–4.5–0.11.33.1–1.6–1.6
Consumer prices
Industrial countries4.53.23.03.0–0.2–0.3
Developing countries35.738.733.620.03.510.8
Countries in transition100.5776.2416.249.8–56.8318.0
Central Europe2119.4196.6144.217.7–15.9113.3
Former U.S.S.R.94.71,201.8599.366.4–94.4464.8
Six-month LIBOR (in percent)5
On U.S. dollar deposits6.13.93.85.3–0.4
On Japanese yen deposits7.24.33.13.9–0.2–1.8
On deutsche mark deposits9.49.47.05.9–0.3–2.2
Note: Real effective exchange rates are assumed to remain constant at the levels prevailing during March 1993, except for the bilateral rates among ERM currencies, which are assumed to remain constant in nominal terms. These assumptions imply an effective appreciation of the U.S. dollar by about 10 percent relative to the assumption underlying the October 1992 World Economic Outlook.

This chapter presents baseline projections. The uncertainties in the outlook are illustrated by alternative scenarios discussed in Chapter III for the industrial countries and in Chapter IV for the developing countries.

Activity and Employment

In the industrial countries, economic growth increased modestly to an average of 1½ percent in 1992 following stagnation in 1991. Growth is expected to remain below potential in 1993 before strengthening to 3 percent in 1994 (see Table 1). Beneath the hesitant aggregate performance lie significant differences in cyclical positions among individual countries. The United States, the United Kingdom, and Canada were the first among the major industrial countries to move into recession in 1990 (Chart 3). Activity remained weak in the United Kingdom and Canada in 1992, but in the United States the recovery, which had begun early in 1991, strengthened markedly in the second half of the year.

Chart 3.Major Industrial Countries: Real GDP1

(Percent change from four quarters earlier)

1Blue shaded area indicates staff projections; data for Italy in the fourth quarter of 1992 are also projected.

The initial sluggishness of the recovery in the United States was largely due to restrained demand as households and businesses sought to lower debt burdens accumulated in the late 1980s. The associated weakness in housing and commercial property markets played an important role by depressing private sector net worth. Rising unemployment up to early 1992 has also contributed to significant caution on the part of consumers (Chart 4). By mid-1992 the lowering of interest rates had eased debt burdens significantly, supporting progressively stronger growth in the third and fourth quarters. Productivity gains were particularly significant in 1992, reflecting the benefits of considerable restructuring in many sectors. As the recovery gathers momentum, growth in 1993 and 1994 is projected to average 3¼ percent, in part on the basis of strength in residential construction and equipment investment.

Chart 4.Six Major Industrial Countries: Indicators of Consumer Confidence

Sources: For the United States, the Conference Board; for Canada, the Conference Board of Canada; and for the lower panel, European Community.

1Quarterly observations.

2Percent of respondents expecting an improvement in their situation minus percent expecting a deterioration.

The U.S. recovery will have positive effects on the Canadian economy, which registered only 1 percent growth in 1992. As in the United States, Canada’s growth in 1992 was much weaker than in previous recoveries. In part this is attributable to the interdependence of the U.S. and Canadian economies, along with balance sheet adjustment problems, as experienced elsewhere, and ongoing restructuring and cost cutting by businesses. Employment in Canada declined in 1992, and the unemployment rate rose by 1 percentage point over the year to over 11 percent (Chart 5). Supported by lower interest rates and stronger growth in the United States, there are recent signs of recovery, and the Canadian economy is expected to expand by 3¼ percent in 1993 and by 4½ percent in 1994.

Chart 5.Industrial Countries: Unemployment Rates1

(In percent of labor force)

1Blue shaded areas indicate staff projections.

2Aggregation based on labor force weights.

In contrast to recent developments in North America, recovery in the United Kingdom has remained elusive. Economic activity declined in 1992 by ½ of 1 percent, and unemployment rose to 10½ percent by the end of the year. In contrast to previous recessions, employment losses have been distributed more evenly across regions and across sectors of the economy. Balance sheet problems have been particularly severe and have only recently begun to ease in response to the reduction in interest rates since September. Recent indications of increased manufacturing output, stronger domestic demand, continued easing of debt burdens with lower interest rates, and the effects of the pound’s depreciation on the export sector point to improved prospects for 1993. Output growth for the year is projected at 1½ percent, and the recovery is expected to be firmly established by 1994, with growth projected at 3 percent. There are considerable uncertainties in the outlook, however, both for growth and for inflation.

Economic conditions have weakened considerably in Japan since the October 1992 World Economic Outlook. The boom in Japan’s equity and property markets during the expansion of the late 1980s supported high rates of investment and consumer spending on durable goods, but both of these components of demand have now retreated sharply following the decline in asset prices. Profits have fallen sharply, the previously tight labor market conditions have eased considerably, and consumer confidence is low. The banking sector has experienced a sharp rise in nonperforming loans, and strains in the financial system are likely to continue. The decline in interest rates and the two large fiscal stimulus packages should help to contain the recessionary forces, but substantial uncertainties remain. The 1992 stimulus package implies continued fiscal stimulus in early 1993, and the recently announced new fiscal package should result in an additional injection of stimulus in FY 1993. These measures are expected to sustain growth of 1½ percent in 1993, despite the recent appreciation of the yen. Growth is expected to recover to 3½ percent in 1994.

Developments in Germany in 1992 were dominated by increased strains from the expansionary fiscal policy following unification and the tight monetary policies required to contain inflation. Domestic demand has been restrained by high interest rates, which, along with cost pressures, also have weakened the export-oriented manufacturing sector and have contributed to a loss of competitiveness. Continuing strength in the construction and service sectors supported activity in eastern Germany, but the recovery of industrial output has been much weaker than expected, in part because of the pressures on costs resulting from rapid growth in wages relative to productivity. Activity in west Germany weakened sharply in the course of the year and in early 1993; as a result, real GDP in west Germany is projected to fall by 2 percent in 1993. Likely reductions in official interest rates during the period ahead are expected to ease the recession as the year proceeds, allowing the German economy to recover in 1994.

Other European countries have also been adversely affected by tight monetary conditions and by a general deterioration in the economic climate, although the downturn has not been as sharp as in Germany. Economic growth in France was 1¾ percent for 1992 as a whole, somewhat better than in 1991 but still weaker than expected.2 High real interest rates have discouraged real fixed investment, which declined by 2 percent during the year. Echoes of the property market problems and associated weaknesses in the financial sector experienced elsewhere have also contributed to domestic concerns. Although the export sector showed improvement early in the year, indicators of consumer confidence remained weak in 1992, and unemployment rose to historically high levels by the end of the year. Continued weakness is expected in 1993; unemployment is projected to exceed 11 percent, and output is expected to remain unchanged. The outlook for 1994 indicates a pickup in growth to 2¼ percent, as monetary conditions ease and activity strengthens in other industrial countries.

Increasing unemployment and declining consumer confidence have been features of recent developments in Italy as well. Uncertainty regarding the prospects for fiscal reform and the political situation has contributed to the decline in confidence. Domestic demand weakened in 1992, although this was offset somewhat by improved competitiveness of the export sector in the second part of the year as a result of an incomes policy eliminating wage indexation and following the lira’s withdrawal from the ERM. Industrial production remained weak, however, and overall output growth for 1992 was only 1 percent. High interest rates and the need for fiscal retrenchment limit prospects for improvement in the near term, and growth for 1993 is projected at just ¼ of 1 percent. Provided that recent gains in competitiveness are not eroded by inflation, a moderate recovery should be possible in 1994.

In the smaller industrial countries, average growth has been below 1 percent since 1990 and is unlikely to improve in 1993, although somewhat stronger prospects are emerging for 1994 (Table 2). Faltering demand in Germany and in most of Europe has weakened key export markets for a number of countries. Budgetary imbalances and other domestic difficulties have played an important role as well. Special problems related to financial sector developments and balance sheet difficulties contributed to output declines in 1992 in Sweden and Finland. The decisions to float their respective currencies have eased the financial tensions somewhat, although growth is expected to remain negative in both countries in 1993. Australia’s recovery is projected to continue in 1993, but the recession in Japan poses a risk to Australia’s exports and overall economic performance.

Table 2.Industrial Countries: Real GDP and Consumer Prices(Annual percent change)
Real GDPConsumer Prices
19911992199319941991199219931994
All industrial countries0.21.51.72.94.53.23.03.0
Major industrial countries0.21.61.93.04.43.12.82.9
United States–1.22.13.23.24.23.03.03.1
Japan4.01.31.33.53.31.71.01.5
Germany1.02.0–1.31.74.84.54.42.5
France1.11.82.33.12.82.02.5
Italy1.30.90.31.96.35.55.75.2
United Kingdom1–2.2–0.61.43.16.84.73.94.0
Canada–1.70.93.24.45.61.52.32.0
Other industrial countries0.60.80.62.15.54.13.93.4
Spain2.31.00.12.15.95.94.53.6
Netherlands2.21.50.51.83.93.72.02.8
Belgium1.40.81.93.22.42.62.7
Denmark1.21.11.12.32.42.01.72.0
Greece1.81.51.41.819.515.913.39.8
Portugal2.21.41.12.011.48.96.96.2
Ireland2.52.61.72.43.23.03.23.4
Sweden–1.7–1.7–1.51.29.32.36.54.0
Switzerland–0.4–0.60.21.65.84.13.32.4
Austria3.01.5–0.71.83.34.13.62.3
Finland–6.4–3.5–1.02.54.22.63.44.5
Norway–2.53.01.02.63.42.32.72.5
Australia–1.11.52.63.03.21.12.63.1
New Zealand–1.32.63.02.91.71.31.31.3
Memorandum
European Community0.71.10.12.25.24.43.73.6
West Germany3.71.5–2.01.23.54.03.82.1

Growth in the developing countries strengthened in 1992 to 6 percent, led in part by strong recovery in the Middle East, and is expected to moderate to a still satisfactory rate of 5 percent in 1993–94. For 1993, the downward revision by 1 percentage point relative to the October 1992 World Economic Outlook is due primarily to a slower pace of reconstruction in the Middle East and the adverse effects of policy slippages in Brazil (see Tables 1 and 3). The strong growth performance in the Middle East in 1992 was primarily due to recoveries following the 1990–91 regional crisis. Growth in Saudi Arabia, which had been at very high levels during the crisis as oil production adjusted, slowed markedly in 1992. In the Islamic Republic of Iran, structural reforms and liberalization in trade and exchange systems resulted in continued strong growth in 1992. The rate of expansion in Turkey recovered from 1 percent in 1991 to a robust 5½ percent, in part because of reforms to increase investment. For the region as a whole, rates of expansion are expected to average 5 percent in 1993 but then to slow to 3½ percent in 1994 as growth approaches the long-run trend for the region.

Table 3.Selected Developing Countries and Countries in Transition: Real GDP and Consumer Prices(Annual percent change)
Real GDPConsumer Prices
199119921993199119921993
All developing countries4.26.15.135.738.733.6
Africa1.50.92.732.240.216.8
Algeria0.23.0–2.522.832.015.2
Cameroon–6.0–5.6–3.5–0.62.0–4.5
Côte d’Ivoire–0.8–1.8–0.41.61.90.8
Kenya2.42.04.514.87.05.0
Morocco5.1–3.06.48.24.95.0
Nigeria4.54.64.513.045.223.0
South Africa–0.4–2.00.515.314.59.5
Sudan6.010.64.8123.6114.550.0
Tunisia4.08.63.87.85.54.3
Asia5.87.96.78.57.47.4
China7.812.88.52.75.37.0
India0.94.04.613.410.07.1
Indonesia6.66.06.09.37.56.4
Korea, Republic of8.44.76.09.56.04.5
Pakistan6.75.84.912.310.19.3
Philippines–1.0–0.33.113.18.16.0
Taiwan Province of China7.36.46.93.65.14.6
Thailand8.27.57.85.74.14.3
Middle East and Europe2.19.95.023.820.625.0
Egypt1.20.71.318.115.09.5
Iran, Islamic Republic of8.16.54.019.69.030.0
Israel5.96.44.319.012.010.0
Saudi Arabia9.73.01.14.5–0.43.0
Turkey1.05.44.766.070.165.0
Western Hemisphere3.12.32.3135.8169.9150.9
Argentina5.07.03.5171.725.09.3
Brazil1.0–0.9413.31,037.51,004.3
Chile6.010.46.021.815.411.9
Mexico3.62.73.022.715.38.0
Venezuela10.47.34.034.231.932.9
Countries in transition–10.1–15.5–8.8100.5776.2416.2
Former Czech and Slovak Federal Republic–15.9–8.557.710.8
Poland–7.21.02.070.343.040.0
Former U.S.S.R.–9.0–18.5–11.894.71,201.8599.3

In Asia, a dramatic rise in China’s growth rate in 1992, owing to strong increases in fixed investment, contributed to a substantial increase in regional trade and growth. Sound financial policies and ongoing structural reforms in Bangladesh, India, and Pakistan also contributed to the robust performance of the region. Economic conditions remain buoyant in the fastest-growing economies, but concerns about capacity constraints and overheating may require policies of financial restraint in several countries. Rates of expansion in 1993–94 are projected to average 6¾ percent.

In the developing countries of the Western Hemisphere, overall output growth slowed in 1992, mainly due to a significant and unexpected decline in output in Brazil associated with difficulties in defining an appropriate macroeconomic policy. Excluding Brazil, regional growth averaged 4 percent, with Argentina, Chile, Uruguay, Venezuela, and a number of smaller countries growing by 7 percent or more. In these countries, significant improvements in economic performance in recent years have reflected sound financial policies and sustained structural reform efforts. In view of the considerable uncertainty regarding the outlook for Brazil, growth in the region as a whole is expected to average only 2½ percent in 1993–94, roughly the same as in 1992.

In Africa, output growth slowed to just 1 percent in 1992. Adverse movements in terms of trade (particularly for exporters of minerals and tropical beverages), the ongoing effects of the drought in southern Africa, and disruptions from conflicts in a number of countries restrained economic activity. Growth in countries that had arrangements in 1992 under the IMF’s structural adjustment facility (SAF) or enhanced structural adjustment facility (ESAF) was somewhat above the average growth rate for the region. Continued reforms and cautious financial policies in countries with these arrangements during 1993–94 are expected to support average growth of 4¾ percent. For the region as a whole, growth is expected to strengthen somewhat in 1993–94, on the assumptions of some improvements in the terms of trade and a return to normal rainfall in southern Africa. Continuation of conflicts in countries currently suffering severe disruptions is a major risk in the outlook.

Economic conditions appear to have improved for some of the transition economies of central Europe during the past year. Following three successive years of output declines, there are preliminary indications of a turnaround in the former Czech and Slovak Federal Republic, Hungary, and Poland; growth in private sector activity and strong exports, especially to western Europe, now appear to have contained the fall in output. Economic activity continued to decline in Bulgaria and Romania in 1992, but the rate of decline slowed toward the end of the year. Economic performance in both countries has been adversely affected by disruptions caused by the civil war in the former Yugoslavia. Most central European countries in transition, however, are expected to achieve positive real growth in 1993–94 as market reforms deepen. The strength of the projected output gains will depend crucially on the ability of the reforming countries to contain fiscal deficits and inflation and on their continued access to, and success in, export markets.

Economic conditions in the former Soviet Union have continued to deteriorate. Real GDP in Russia is estimated to have fallen 19 percent in 1992, after a 9 percent decline in 1991. In many other countries of the region, output losses have been even larger. These declines reflect the adjustment difficulties during the early stages of the transition, high rates of inflation, the compression of imports, disruption in trade among the countries of the former Soviet Union, and uncertainties about the reform process itself. Large-scale subsidies are delaying industrial restructuring and are exacerbating the fiscal situation. A reversal of these adverse factors is not anticipated in the near term, and output is expected to decline further in 1993 in most of these countries.

Inflation and Commodity Prices

Improved inflation performance in a number of countries is a bright spot in the short-term outlook. The inflation projections for a number of the industrial countries have been revised downward since the October 1992 projections, with several countries now experiencing the lowest inflation rates in thirty years. Among the major countries, Italy had the highest inflation in 1992. Although inflation in Germany (including the eastern Lander) declined only slightly from 1991, to 4½ percent, price pressures are likely to abate significantly during 1993. In the United States, despite some improvement, inflation remains at 3 percent. Canada and Japan were close to price stability for 1992 as a whole, with measured inflation below 2 percent. In France and the United Kingdom respectively, late 1992 and early 1993 figures on inflation represented the lowest rates of price increase observed in decades. A number of the smaller industrial countries also attained significant reductions in inflation in 1992 (see Table 2). Although cyclical weakness has contributed to these gains, structural reforms facilitating price flexibility and the credibility of countries’ commitment to inflation reduction have played an important part. For most countries, progress in reducing inflation is expected to continue in 1993.

Average inflation in the developing countries in 1992 rose slightly above its 1991 level but is expected to decline again in 1993 (see Table 3). The median inflation rate, which is not distorted by the very high inflation rates prevailing in a few countries, presents a more favorable picture, showing a decline from 10 percent in 1991 to 9 percent in 1992, with a projected further decline to 6 percent in 1993. Inflation rates in most Asian countries declined in 1992 relative to the previous year, in part because of cautious financial policies. In China, however, signs of overheating point to the risk of higher inflation during the period ahead. In the Western Hemisphere, inflation fell in 1992 in many countries; the notable exception was Brazil, where a widening fiscal imbalance led to a tenfold rise in the price level. In Africa, the average inflation rate increased in 1992, in part because of the drought in southern Africa, although price performance improved in a number of individual countries. The countries of the Communauté Financière Africaine (CFA) are expected to register an average inflation rate of 1 percent in 1993–94, the lowest in the region.

In central European economies in transition, there were marked divergences in countries’ inflation performance in 1992. Following successive rounds of price liberalizations during 1991 and 1992, inflation has been brought under control in the former Czechoslovakia and has fallen substantially in Hungary and Poland. Inflation remained high in Romania and in Bulgaria, despite significant improvement in the latter, and hyperinflationary conditions prevail in much of the former Yugoslavia. The threat of hyperinflation also looms large in the former Soviet Union, which registered a twelvefold rise in prices in 1992. In Russia, price liberalization led to a jump in the price level in early 1992, after which inflation moderated until August. Lax fiscal and monetary policies, however, led to a sharp acceleration of inflation in the last quarter of 1992 and in early 1993. Inflation has surged in other countries of the region as well, with the exception of a marked deceleration of inflation in Latvia and in Estonia, following the introduction of the Estonian kroon, which is pegged to the deutsche mark.

As regards commodity prices, prices of crude petroleum fell from $18.94 a barrel in the fourth quarter of 1991 to $18.27 a barrel in the fourth quarter of 1992 (Chart 6). The decline was due to a combination of high levels of production, weak economic conditions, and unseasonably warm weather in Europe and North America. The decision by OPEC in February to restrain oil output in the second quarter of 1993 raised price expectations and market prices and may help to stabilize real prices during the period ahead, although dollar prices are likely to reflect the recent effective appreciation of the dollar. Increased future allocations for Kuwait may put further downward pressure on oil prices during the period ahead.

Chart 6.Consumer Prices and Commodity Prices

1 Three-month centered moving average of twelve-month inflation rates. Consumer prices are measured in local currencies and are averaged using GDP weights. The nonfuel commodity price index is an export-weighted average of 36 prices denominated in SDRs, including gold. The oil price is a simple average of the U.S. dollar spot prices of U.K. Brent, Dubai, and Alaska North Slope crude oil, equally weighted.

2 Nonfuel commodity prices deflated by the export price of manufactures of industrial countries.

Average nonfuel commodity prices remained at relatively low levels in 1992 because higher prices in dollar terms for agricultural raw materials were offset by significant price declines for beverages, metals, and minerals (see the Statistical Appendix, Table A25). Weak demand, high rates of production, and, in the case of metals, large exports by the former Soviet Union were the central factors. In the first quarter of 1993, prices of beverages and of metals fell further in dollar terms. Over the year as a whole, nonfuel primary commodity prices are expected to increase slightly in dollar terms, permitting a terms of trade gain for many commodity exporters. However, metals prices are expected to remain quite weak because of sluggish growth in industrial country demand, high inventories, and continued exports from the former Soviet Union.

Foreign Exchange and Financial Markets

Since conclusion of the last regular World Economic Outlook exercise, the ERM has experienced considerable turmoil, leading to a series of realignments and to the suspension of the lira and the pound sterling from the mechanism. Linked to these developments, three Nordic countries opted to float their currencies, which had been pegged to the ECU. These events were discussed in detail in the January 1993 Interim Assessment of the World Economic Outlook and are reviewed only briefly below. So far in 1993, foreign exchange markets have been characterized by several broad developments. Ongoing strains within the ERM were significant for part of the period, followed after early February by a marked reduction in visible tensions. The yen continued to appreciate against the European currencies and rose sharply in value against the dollar, reaching a record high in mid-April. The dollar continued to appreciate against the European currencies into March and remained well above the level reached at end-August 1992, despite some downward movement toward the end of the period.

The period of intense pressures within the ERM followed a buildup of strains in the weeks leading up to the referendum in France on the Maastricht Treaty. Since the withdrawal of the pound sterling and Italian lira from the ERM in September, the two currencies have depreciated in nominal effective terms by 14 percent and 23 percent, respectively (end-August 1992 through mid-April). Realignments involved depreciations of the Spanish peseta, the Portuguese escudo, and the Irish pound. Outside the ERM, significant depreciations followed the decisions to float the Finnish markka (on September 8) and the Swedish krona (on November 19); the Norwegian krone depreciated to a lesser extent following its floating on December 10.3 Financial markets in Canada experienced their own episode of turbulence, owing in part to the uncertainties in the run-up to the constitutional referendum in October.

Accompanying these developments, both the dollar and the yen appreciated markedly—by 10 percent and 17 percent, respectively—from end August 1992 through mid-April (Chart 7). During this period, projections for economic growth (by both official and private forecasters) were being scaled back for many European countries, while the economic recovery was looking increasingly robust in the United States. These developments justified expectations that interest differentials would narrow in favor of dollar-denominated assets. More recently, these expectations were reinforced by small reductions in official German interest rates in early January, early February, and again in March and early April; base rates were reduced in the United Kingdom in late January. The strength of the yen can be attributed in part to implications of the growing Japanese external current account surplus. In addition, expectations of reduced interest rate differentials in favor of assets denominated in European currencies, reinforced by the anticipation and eventual announcement of an additional fiscal stimulus package in Japan as mid-April approached, also played a role.

Chart 7.Major Industrial Countries: Nominal and Real Effective Exchange Rates1

(Indices, 1980 = 100; logarithmic scale)

1Defined in terms of relative normalized unit labor costs in manufacturing and constructed using trade weights based on 1980 trade data; monthly averages of daily data. Data for October 1991 through March 1993 are estimated on the basis of preliminary information on normalized unit labor costs.

2Constructed using same weights as real effective exchange rate indices.

Within the ERM, the Irish pound, the Danish krone, and the French franc continued to experience bouts of intense selling pressure early in 1993, with market participants seemingly focusing on the difficulties of sustaining high interest rates in the face of deteriorating domestic economic conditions and high unemployment. The Irish pound was seen by the markets to be vulnerable in the wake of the significant depreciation of the pound sterling after the September crisis, while the Danish krone was vulnerable as a result of the depreciation of other Scandinavian currencies.

In early January, the Irish authorities raised official interest rates as high as 100 percent to support the Irish pound; further support came from intervention by other central banks. The Banque de France intervened to support its currency and raised official interest rates, notably by introducing on January 5 a new facility for banks to borrow overnight at 12 percent; the Bundesbank reportedly also intervened in support of the French franc. Pressures in the ERM receded temporarily when the Bundesbank announced on January 7 that it would reduce its securities repurchase rate by about 15 basis points.

The period of relative calm was short-lived. Renewed pressures emerged near the end of January, starting with heavy selling pressure on the Irish pound after base rates in the United Kingdom were reduced by 1 percentage point on January 26 and the pound sterling fell to record lows against the deutsche mark. This selling pressure overwhelmed increased official and market interest rates in Ireland, as well as intervention by other central banks in support of the Irish currency. After a devaluation of the Irish pound within the ERM by 10 percent on January 30, the pressure again shifted to the Danish krone, pushing it to its ERM floor notwithstanding sharp increases in domestic interest rates and sizable foreign exchange market intervention. The pressure against the Danish currency eventually subsided after the February 4 reduction in official German interest rates—the Lombard rate by 50 basis points and the discount rate by 25 basis points.4 This action also relieved some of the pressure on the French franc, whose parity with the deutsche mark might well have been tested if the Danish krone had been devalued.

Box 1.Equity Markets in Southeast Asia

Equity markets in many Southeast Asian economies have developed rapidly over the past decade and are among the most mature in the developing countries, although they are still quite regulated by comparison with those in industrial countries. Foreign ownership is restricted in many cases; in Korea and Taiwan Province of China, for example, even limited direct foreign investment was allowed only in 1990. The remarkable increase in turnover in these markets has reflected the increased importance of equities in raising capital, and the privatization of public enterprises during the process of financial liberalization (see table). The largest and most volatile stock market in the region is in Taiwan Province of China. The stock markets in Hong Kong and Singapore are the most integrated into international capital markets, in part because both economies are important regional financial centers, with Hong Kong serving as an important link to China. Equity markets in Indonesia, Malaysia, Thailand, and elsewhere in Southeast Asia are becoming more open, and international investment is growing rapidly.1

The intensity of activity, as measured by the ratio of turnover to total capitalization, has risen during 1986–91 in all of these markets except for the Philippines. This contrasts with both the U.S. and Japanese stock markets, where intensity of activity fell during this period. Because the Asian markets are still relatively small, they are vulnerable to external events, scandals, and individual trades, which have contributed to high price volatility compared with stock markets in industrial countries. Further expansion and internationalization of these markets may reduce volatility.

Although many Southeast Asian stock markets are only gradually becoming integrated into the world capital market, their equity prices have been strongly influenced by developments in the world’s major stock markets and by the economic prospects of industrial country trading partners. For example, the sharp decline in equity prices in October 1987, the previous rise in stock prices in the United States and elsewhere, and the steep fall in equity prices in the United States during the second half of 1990 were all reflected in similar movements in Asian stock markets (see chart).

Developments in China have had an important influence on equity markets in Southeast Asia, particularly those in Hong Kong and Taiwan Province of China. The steep rise in Hong Kong stock prices between mid-1989 and late 1992 was related in part to market-oriented reform and robust economic growth in China. The increasing integration between Hong Kong and southern China has also removed some of the uncertainty surrounding the state of Sino-British relations and the transfer of sovereignty in 1997, contributing to the robust stock market performance. Stock market developments in Taiwan Province of China also increasingly reflect Chinese economic prospects, as ties between the two economies have strengthened.

Selected Economies: Stock Market Activity
Turnover
In billions of

U.S dollars
As percent

of GDP
As percent of

total

capitalization
198619911986199119861991Volatility1
Hong Kong15.343.0405328350.086
Korea10.985.5103078880.086
Malaysia1.310.65229180.079
Philippines0.41.510320150.109
Singapore2.718.1154716380.063
Taiwan Province of China18.1365.2242011172900.151
Thailand1.130.133240840.089
France51.5118.271034320.068
Germany135.7818.61549532080.067
Japan1,145.6995.9583062320.066
United Kingdom132.9317.9243130320.058
United States1,795.92,254.9404268540.049
Sources: International Finance Corporation, Emerging Stock Markets: Factbook (Washington, 1992) and Emerging Stock Markets data base; World Economic Outlook data base.

Selected Economies: Stock Market Indices

(In local currencies; logarithmic scale, January 1985 = 100)
1 See Pacific Basin Capital Markets Research, Vols. 1, 2, and 3, edited by S. Ghon Ree and Rosita P. Chang (Amsterdam and New York: North-Holland, 1990, 1991, 1992); and David Lynch and Bill Norton, “Asian Financial Markets” (North Ryde, N.S.W., Australia: Centre for Studies in Money, Banking, and Finance, Macquarie University, 1992).

Visible tensions have since subsided markedly, despite several factors that might have been expected to exert significant pressure on the ERM. These included parliamentary elections in France, a strengthening of the deutsche mark against the dollar since early February, reports of unfulfilled market expectations of further official interest rate cuts in Germany, budget difficulties in Belgium, and growing signs of recession and rising unemployment in many countries. Market uncertainty nevertheless remained evident in the persistence for some time of large interest rate differentials in a number of countries vis-à-vis interest rates in Germany. These premiums have recently narrowed significantly in many cases.

More generally, changes in short-term market interest rates in many European countries since August 1992 largely reflected exchange market developments as a number of authorities raised official interest rates in support of their currencies, but then allowed them to decline as exchange rate pressure eased. In countries that devalued within the ERM (Spain, Portugal, and Ireland) or floated their currencies (Italy, the United Kingdom, and the Nordic countries), short-term interest rates subsequently moved lower, led by reductions in official rates.5 Abstracting from the effects of the EMS crisis, it is clear that both short- and long-term interest rates have tended to decline in most of the industrial countries (Charts 8 and 9). Weak growth, declining inflation, and growing expectations of fiscal deficit reduction in several countries have been the principal factors supporting this trend. Short-term interest rates are expected to decline significantly during 1993 in Europe and Canada, to remain close to current rates in Japan, and to begin to firm in the United States as the recovery continues.

Chart 8.Major Industrial Countries: Short-Term Interest Rates1

(In percent a year)

1For the United States and Japan, three-month certificate of deposit rates; for Italy, three-month treasury bill rate; for Canada, rate on three-month prime corporate paper; and for other countries, three-month interbank deposit rates. Monthly averages of daily observations are plotted for all countries other than Italy and Canada. For Italy, monthly averages of results of fortnightly treasury bill auctions are shown. For Canada, monthly averages of weekly observations are plotted.

21987 GDP weights.

Chart 9.Major Industrial Countries: Long-Term Interest Rates1

(In percent a year)

1Yields on government bonds with residual maturities of ten years or nearest. Monthly averages of daily data.

21987 GDP weights.

In equity markets, the largest price increases were recorded in Italy and the United Kingdom, where prices in local currency have risen by 31 and 23 percent, respectively, since end-August 1992. Elsewhere, equity prices have risen 16 percent in France, 10 percent in Germany, and 6 percent in the United States. Over the period as a whole, equity prices in Japan have risen by 14 percent. The recent sharp increase of 20 percent since early March reflects both the anticipation and eventual announcement of additional fiscal stimulus measures. Expanding equity markets in Southeast Asian economies have mirrored some of the movements in stock prices in the major industrial countries, although other factors account for the greater volatility in these markets (Box 1).

External Payments, Financing, and Debt

The growth of world trade recovered in 1992 to 4¼ percent from 2¼ percent in 1991, spurred by the continued expansion of intraregional trade, particularly in Asia, and by somewhat higher import growth in the industrial countries. A further pickup in the growth of trade is expected for 1993–94 as industrial country activity continues to strengthen and as developing country output and trade links expand.

The current account balance of the United States again moved into a large deficit during 1992 as cyclical factors and war-related transfers that had contributed to the decline in the deficit in 1991 were being reversed or were no longer at work. Japan’s current account surplus increased steadily in 1992, reaching a record level in absolute terms (although not relative to GNP). Factors underlying this rise included sharp reductions in domestic demand during 1992; lower world commodity prices; and the appreciation of the yen in 1991–92, which raised the dollar value of exports. France also recorded a current account surplus for 1992 because of strong exports early in the year and slow domestic demand. Improved competitiveness in the United Kingdom associated with the depreciation of sterling should help to contain the large external deficit as recovery gets under way. The U.S. current account deficit is projected to widen further in 1993 and 1994; Japan’s surplus is expected to increase in 1993 and then decline somewhat in 1994 (Chart 10). A slight deterioration is expected for 1993 in Germany’s current account position, which moved into deficit in 1991. Some reduction in deficits is anticipated for Canada and Italy and for other industrial countries.

Chart 10.Three Major Industrial Countries: Current Account Imbalances

(In percent of GDP)

1Before July 1990, the current account balance of west Germany excluding the bilateral balance with east Germany; from July 1990, the current account balance of unified Germany. Blue shaded area indicates staff projections.

The aggregate current account deficit of the developing countries narrowed slightly, to $78 billion in 1992, primarily because of the substantial reduction of the current account deficit in the Middle East as the impact of the 1990–91 regional conflict subsided. In the same period there was a sharp increase in net financing flows to the Middle East region, which moved from a net outflow position in 1991 to an inflow of $22 billion in 1992 (Chart 11). Asset flows in 1992 returned to a more normal level, relative to the unusually large drawdown of foreign assets used to finance the 1990–91 conflict.

Chart 11.Developing Countries and Countries in Transition: Net External Financing Flows1

(In billions of U.S. dollars)

1The sum (with opposite sign) of balance on current account, excluding official transfers, change in reserves, asset transactions, and errors and omissions, net. See the Statistical Appendix, Table A32.

Other developing country regions saw their current account deficits widen as a result of relatively strong growth. In the Western Hemisphere region, reserve holdings grew despite the increase in the current account deficit, reflecting a sharp rise in portfolio investment inflows. Developing countries in Africa faced adverse terms of trade movements and the ongoing consequences of the drought, which expanded the regional current account deficit to almost $8 billion. Reserve accumulation slowed considerably during the year, and net external financing to the region remained essentially unchanged. Strong import demand led to an increase in the aggregate current account deficit of Asian developing countries in 1992, primarily owing to a reduced current account surplus in China and to a shift into external deficit in Taiwan Province of China. External financing flows declined from their high in 1991, and the average rate of reserve accumulation slowed as continued rapid increases in some countries were more than offset by much slower rates of increase in China and Taiwan Province of China. Net external financing to the developing countries overall is expected to decline to $106 billion in 1993 and then rise to $119 billion in 1994.

For countries in transition, the aggregate current account balance moved further into deficit, although experiences within the region differed considerably. The aggregate current account deficit in the countries of central Europe declined significantly during 1992 to only $0.5 billion, primarily because of increased exports to western Europe. A decline in exports by the countries of the former Soviet Union, particularly of oil, led to a widening of the aggregate current account deficit in 1992. Net external financing flows to central European countries in transition rose to $3½ billion in 1992 and are expected to reach $7½ billion this year, mainly because of continued long-term borrowing from official creditors; for most countries, direct investment flows and commercial bank lending are expected to remain subdued. For 1993, the aggregate current account deficit in central Europe is projected to widen because improving domestic conditions and continued capital inflows should generate higher import growth.6

Total debt in dollar terms (excluding IMF credit) of the developing countries as a percent of export earnings fell some 7 percentage points, to 120 percent, in 1992 (Chart 12). A further drop of 15 percentage points is expected by 1994, when the aggregate debt-export ratio is projected to have fallen to the level prevailing in 1982. The recent progress is encouraging, although many individual countries continue to face difficult debt problems. Aggregate debt of the countries in the Western Hemisphere rose only slightly in 1992, owing mainly to the impact of a number of debt-reduction operations. The debt-export ratio in the region fell 8 percentage points, to 250 percent. The improvement in debt-export ratios was also significant in Asian developing countries, where continued strong economic performance was combined with modest borrowing. Africa’s debt-export ratio fell only slightly, to 229 percent, mainly because of continued official lending to sub-Saharan countries. Total debt of the countries in transition increased to $186 billion and is expected to increase further in 1993, to some $209 billion (Chart 13).

Chart 12.Developing Countries: External Debt and Debt Service1

1Debt service refers to actual payments of interest on total debt plus actual amortization payments on long-term debt. The projections (blue shaded areas) incorporate the impact of exceptional financing items.

Chart 13.Countries in Transition: External Debt and Debt Service1

1Debt service refers to actual payments of interest on total debt plus actual amortization payments on long-term debt. The projections (blue shaded areas) incorporate the impact of exceptional financing items.

Significant debt-restructuring agreements were completed in 1992. They involved restructuring of commercial bank debt totaling $35 billion and a net reduction of arrears of $15 billion, a substantial amount of which was concentrated in the Western Hemisphere. Major agreements included a debtrestructuring package with the Philippines and an agreement to restructure Argentina’s foreign debt. These agreements are financed in part by the allocation of about $1 billion from the IMF in support of debt-reduction packages. Brazil reached an agreement on a term sheet for a comprehensive bank debt package, which was recently presented to creditors. Among low-income countries, Bolivia, Guyana, and Uganda have progressed significantly toward debt workouts.

In addition, progress has been made with official creditors offering debt relief under enhanced Toronto terms for several low-income developing countries, and several agreements have been concluded in the context of the Paris Club. Agreement has also been reached between Bulgaria and its official creditors to provide cash relief on debt-service obligations. Negotiations are under way between Paris Club creditors and the Russian Federation on the rescheduling of part of the debt of the former Soviet Union.

The revisions reported in Table 1 are relative to projections in the October 1992 World Economic Outlook, recalculated using PPP weights. Relative to projections in the January 1993 Interim Assessment of the World Economic Outlook, the largest downward revisions among the industrial countries have been for Germany, Japan, and France.

After the World Economic Outlook projections were completed, the French national statistics office revised down by about ½ of 1 percentage point GDP growth in both 1991 and 1992. Since growth in the fourth quarter of 1992 was only marginally revised, the revisions to the historical data would not necessarily have a major impact on the projection for 1993.

As of the end of 1992, these currencies had depreciated against the U.S. dollar by 26 percent, 15 percent, and 7 percent, respectively.

In addition to lowering official interest rates, the Bundesbank announced it would reduce reserve requirements on time liabilities and savings deposits from an average of 4.5 percent to 2 percent. Other types of deposits were not affected. It was indicated that the liquidity effect of this action would be neutralized by the introduction of new short-term investment instruments.

Recently, pressures on the Spanish peseta and Portuguese escudo have been countered with higher interest rates.

Owing to uncertainties about the underlying numbers, current account estimates for the former Soviet Union for 1992 and beyond are not reported.

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