I Recent Developments and Short-Term Prospects

International Monetary Fund. Research Dept.
Published Date:
January 1992
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Recent months have been characterized by flagging consumer and business confidence, weaker-than-expected economic activity—especially in Europe and Japan—and considerable tensions in foreign exchange markets. Despite encouraging signs of increased growth in the United States, these developments have cast new doubts on the prospects for recovery in the industrial world after what has already been two years of weak growth or recession in many countries. There are two main reasons for the pervasive sluggishness of growth. The most important is the deflationary impact in a number of countries of balance sheet adjustments by the private sector following the recent correction of inflated asset prices. An additional factor is the negative effects of high interest rates in Europe, stemming from the strong fiscal expansion that accompanied German unification, and inadequate progress toward inflation convergence and budgetary consolidation in a number of countries. The persistent currency turbulence since September, growing tensions over trade, and other indications of a reduced commitment to international policy cooperation in the major industrial countries have contributed to increased uncertainty. In these circumstances, there is a critical need for confidence-building economic policies to strengthen the prospects for growth without jeopardizing financial market stability or the considerable progress that has been achieved in reducing inflation.

Exchange Market Developments

The events in foreign exchange and financial markets associated with the crisis in the exchange rate mechanism (ERM) of the European Monetary System (EMS) have been among the most important since September 4, the last day for which information was available for the October 1992 issue of the World Economic Outlook (see the Box for a chronology of these developments). As noted then, pressures within the EMS had been building over the course of the summer. These pressures and their underlying causes have still not been fully resolved, and tensions were reduced only temporarily after the realignment in September of the Spanish peseta within the ERM and the suspension of the Italian lira and the pound sterling from the mechanism. Strains in the ERM intensified again in November—resulting in a second realignment of the peseta along with a realignment of the Portuguese escudo—and continued into December.

Tensions had been growing in the summer, following the Danish referendum rejecting the Maastricht treaty in early June and the subsequent strengthening of the deutsche mark within the ERM. The lira and sterling experienced particularly strong downward pressures. For the lira, market concern over the country’s high level of public debt and its excessive budget deficit contributed to these pressures, especially in view of the risk that progress toward economic and monetary union (EMU), with its convergence requirements, would now be more difficult. In the United Kingdom, the continued recession and a weak current account position influenced market perceptions that the pound sterling might be devalued within the ERM, given the apparent constraints on interest rate policy in that country. The rise in the Bundesbank discount rate on July 16 and further declines in short-term interest rates in the United States added to the tensions by putting upward pressure on the deutsche mark relative to other EMS currencies.

Strains in the ERM during the summer were partially countered by intervention, particularly in support of the lira by the Bank of Italy.1 Tensions were also partially absorbed by increases in interest rates outside Germany (Charts 1 and 2) and by a strengthening of the deutsche mark against other ERM currencies (Chart 3).

Chart 1.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 of three-month prime corporate paper; and for other countries, three-month interbank deposit rates. Weekly averages of daily observations are plotted for all countries other than Italy and Canada. For Italy, results of fortnightly treasury bill auctions are shown. For Canada, weekly observations are plotted.

21987 GDP weights.

Chart 2.Major Industrial Countries: Long-Term Interest Rates1

(In percent a year)

1Yields on government bonds with residual maturities of ten years or nearest.

21987 GDP weights.

Chart 3.European Monetary System: Positions in the ERM1

1 ERM is the exchange rate mechanism of the EMS. Weekly averages of daily data, except for the rightmost panel, which contains daily data. For any pair of currencies shown in the chart, the vertical distance between them measures the percentage deviation from their bilateral central rate. The pound sterling and Italian lira left the ERM on September 16–17. The Portuguese escudo and Spanish peseta were devalued within the ERM on November 23.

From the end of August, anticipation of the French referendum on the Maastricht treaty on September 20 led to a further intensification of pressures within the ERM as opinion polls began to show a significant risk of rejection. At the same time, other developments added to tensions and triggered market speculation that some currencies might be devalued. The dollar declined to a historic low against the deutsche mark early in September as the U.S. Federal Reserve moved to lower interest rates further in response to weak domestic activity. Later, after a decision by Finland to float the markka, the Swedish krona came under intense pressure, leading the authorities to raise official rates on excess drawings on the central bank in steps up to 500 percent to defend the peg to the European currency unit (ECU).

Box:Chronology of Events Preceding and Following the September 1992 Crisis in the European Monetary System

June 2. Danish voters reject (by 50.7 percent) the Maastricht treaty. Subsequently, tensions within the ERM increase significantly, leading to sharp increases in short-term interest rates in Italy, in particular, as the lira comes under downward pressure.

June 3. France announces a September 20 national referendum on the Maastricht treaty.

July 2. The U.S. Federal Reserve Board reduces discount rate by ½ of 1 percentage point, to 3 percent, and eases reserve pressures by a similar reduction in the federal funds rate.

July 16. Bundesbank raises discount rate by ¾ of 1 percentage point, to a record high of 8¾ percent, but leaves the Lombard rate at 9¾ percent. The short-term interest rate differential between Germany and the United States widens to 6¾ percentage points and puts further downward pressure on the dollar.

July 20. Major industrial countries intervene to prevent the U.S. dollar from declining further.

July 27. Bank of Japan lowers discount rate by ½ of 1 percentage point, to 3¼ percent.

August 14. Pound sterling falls to a new low against the deutsche mark.

August 20. Unexpectedly high growth in German M3 announced. Sterling falls to within 1 pfennig of its ERM floor (DM 2.788), and the U.S. dollar reaches an all-time low against the deutsche mark.

August 27. Record levels of intervention fail to lift sterling significantly.

August 28. Italian lira dips below its ERM floor for the first time, reflecting growing concern over the budgetary situation and the loss of reserves.

September 3. The Bank of England augments reserves by borrowing $14.5 billion in deutsche marks, lifting the value of pound sterling above DM 2.8.

September 4. The U.S. dollar drops almost 4 pfennigs to new historic low against the deutsche mark as the Federal Reserve lowers its target for the federal funds rate by ¼ of 1 percentage point, to 3 percent, in response to unexpectedly poor employment data. The Italian lira remains below its ERM floor despite large-scale intervention and increases in the Italian discount rate and in the Lombard rate of 1¾ percentage points (the largest increase in eleven years), to 15 percent and 16½ percent, respectively.

September 5–6. Meeting in Bath of EC ministers of finance and central bank governors to discuss contingency plans in the event of a negative French vote on Maastricht treaty, German monetary policy, and ERM tensions. Participants agree to a four-point official statement including a strong reaffirmation of the existing EMS parities and a pledge by the Bundesbank not to raise interest rates “in present circumstances.”

September 8. Finnish authorities float the markka, which declines 13 percent against the deutsche mark. Swedish central bank raises marginal lending rate to 25 percent and then to 75 percent. Weaker ERM currencies depreciate further against the deutsche mark. U.S. dollar appreciates.

September 10–11. Italian lira remains below its ERM floor despite massive intervention by the Bundesbank and the Bank of Italy.

September 12–13. Official discussions about ERM tensions lead to a decision and announcement on September 13 by the EC monetary committee that the Italian lira would be devalued 7 percent and that there was a commitment by the Bundesbank to lower interest rates.

September 14. Bundesbank lowers discount rate by ½ of 1 percentage point, to 8¼ percent, and lowers the Lombard rate by ¼ of 1 percentage point, to 9½ percent. Devaluation of the lira and the reduction in German interest rates move the lira to the top of the EMS grid, and sterling appreciates. Swedish central bank cuts marginal lending rate from 75 percent to 20 percent.

September 15. Italian lira drops below new central ERM parity, and sterling falls to a new low against the deutsche mark. Spanish peseta drops below central ERM rate, which had been the intervention level for the Bank of Spain.

September 16. Heavy pressure on sterling leads to an early morning increase in the Bank of England’s minimum lending rate from 10 percent to 12 percent. A further increase to 15 percent is announced but does not take effect. Despite heavy intervention by the Bank of England, the Bundesbank, and the Banque de France, sterling falls nearly 3 pfennigs below its ERM floor at the close of trading in London. In the evening, the government announces that participation in the ERM will be temporarily suspended on September 17. Intervention in support of the Italian lira fails to hold the currency above its new ERM floor. Sweden raises its marginal lending rate to 500 percent.

September 17. The lira’s participation in the ERM is suspended, with the intention of rejoining soon. The Spanish peseta is devalued by 5 percent within the ERM. The French franc, Danish krone, and Irish pound all fall to their ERM floors. The Bank of England cuts its minimum lending rate from 12 percent to 10 percent. The Bank of Ireland intervenes to support the Irish pound.

September 18. Pressure against ERM currencies continues. Overnight rates in Ireland reach 300 percent. The value of the pound falls further. In Italy, the government enacts the bulk of the fiscal package for 1993 through a set of emergency decrees.

September 19. The United Kingdom announces that it will not return to the ERM until the ERM has been reformed and until Denmark clarifies how it will proceed after its rejection of the Maastricht treaty.

September 20. France narrowly (by 51.1 percent) affirms the Maastricht treaty. The French franc rises against the deutsche mark.

September 21. Closeness of the vote in France raises doubts about Maastricht treaty. The French franc falls to near the bottom of its ERM band despite concerted intervention by the Banque de France and the Bundesbank. Italy announces that the lira will not immediately rejoin the EMS. Sweden lowers marginal lending rate from 500 percent to 50 percent.

September 22. Further pressure on the French franc, Irish pound, Spanish peseta, and Portuguese escudo. Spain intervenes for the first time since the devaluation of the peseta. The Bank of England cuts minimum lending rate from 10 percent to 9 percent. The Bank of Ireland intervenes to support the Irish pound, which trades below its ERM floors against the deutsche mark, the Dutch guilder, and the Belgian franc.

September 23. Pressure on the French franc intensifies. The Banque de France raises short-term repurchase rate by 2½ percentage points, to 13 percent, and German short-term market rates decline by about 50 basis points. The Banque de France and the Bundesbank engage in massive intramarginal intervention. Spain introduces exchange controls to defend the peseta. The Bank of Ireland repeatedly intervenes to support the Irish pound, which continues to trade below its ERM floors against the Dutch guilder and the Belgian franc.

September 24. The French franc stabilizes above its ERM floor. Ireland and Portugal introduce new exchange controls. Swiss National Bank cuts its discount rate by ½ of 1 percentage point, to 6 percent. The Bank of Ireland intervenes to support the Irish pound, which continues to trade below its ERM floors against the Dutch guilder and the Belgian franc.

September 25. The Bank of Ireland intervenes to support the Irish pound.

September 28. Ireland raises base rate by 3 percentage points to 13¾ percent. Pound sterling drops to a new low against the deutsche mark (in London) of DM 2.508.

September 30. Swedish central bank cuts marginal lending rate by 16 percentage points, to 24 percent, in response to an all-party agreement to reduce public spending in 1993 by SKr 20 billion. Canadian banks raise prime lending rates by 2 percentage points, to 8¼ percent, in reaction to the Bank of Canada’s efforts to support the Canadian dollar.

October 1. Italian cabinet approves the 1993 budget calling for spending cuts and revenue increases of Lit 93 trillion (5.8 percent of GDP) relative to trend. Banque de France weekly report indicates that the central bank spent about Fr 80 billion to defend the franc during the currency crisis.

October 2. Italian government begins discussions with EC partners about a stand-by loan of ECU 9 billion to strengthen the lira and to sustain confidence in returning the lira to the ERM. Pound sterling closes the week at a new low against the deutsche mark of DM 2.43.

October 5. Spain lifts some of the exchange controls imposed in September. Pound sterling closes the trading day in London below DM 2.40.

October 7–31. Official interest rates are gradually reduced in most countries affected by the crisis, although rates remain somewhat above pre-crisis levels.

October 14. Finnish government announces plans to cut spending by Fm 54.2 billion ($11.6 billion) over the next three years and to restore calm in exchange markets following the floating of the markka on September 8. Portuguese government unveils a budget for 1993 that provides for a reduction of the deficit to less than 4 percent of GDP.

October 20. Italian parliament begins debate on spending cuts and tax increases worth Lit 93 trillion (including a freeze of public sector pay in 1993, a tax on luxury goods, stiffer tax scales for salaried employees, and a minimum tax for the self-employed), and the government asks EC partners for a special stand-by loan of ECU 8 billion ($11.2 billion), the maximum funding possible from its partners to offset the loss of reserves from intervention in September.

October 21. The Bundesbank announces a reduction of 15 basis points in the minimum securities repurchase rate, to 8¾ percent, which is smaller than widely expected. Bond yields rise in the United States, Japan, and Germany and fall in France and the United Kingdom.

October 23. The Italian parliament approves four mandate laws aimed at implementing structural reforms in key areas of public expenditure. The Bank of Italy reduces the discount rate by 1 percentage point, to 14 percent.

November 1–30. Official interest rates are reduced further in countries affected by the crisis, although they remain above pre-crisis levels.

November 5. Banque de France lowers short-term repurchase rate by 2½ percentage points, to 10½ percent, reversing the September 23 increase and coinciding with the full recovery of reserve losses sustained during the crisis.

November 19. Swedish central bank increases marginal lending rate, from 11½ percent to 20 percent, to defend the krona. Later in the day, the Swedish authorities float the krona, which declines 9 percent against the deutsche mark, and the Swedish central bank reduces the marginal lending rate to 12½ percent.

November 22. The Spanish peseta and Portuguese escudo are devalued by 6 percent within the ERM, effective November 23. Spain lifts special capital controls imposed during the September crisis.

November 23. The Norwegian central bank raises the overnight lending rate from 17 percent to 25 percent. The Bank of Ireland raises its short-term facility rate from 13¾ percent to 30 percent. The Bank of Spain raises its money rate from 13 percent to 13¾ percent.

November 26. Central bank of Ireland raises its overnight rate to 100 percent.

December 2. Central bank of Ireland cuts its overnight rate from 100 percent to 30 percent.

December 3–14. Continued market pressures against the French franc, the Danish krona, and the Irish pound. Official interest rates reduced further in Belgium, the Netherlands, Norway, and Sweden.

December 10. Bundesbank announces that it will raise its target range for growth in M3 in 1993 to 4½ to 6½ percent from the target range in 1992 of 3½ to 5½ percent. Norwegian authorities float the Norwegian krona, which declines 5 percent against the deutsche mark. The central bank of Norway cuts its key overnight lending rate by 5 percentage points to 11 percent.

December 13. EC heads of state meet in Edinburgh and adopt a growth initiative, including ECU 5 billion for the European Investment Bank and ECU 2 billion in capital for a new European Investment Fund that will guarantee bank loans to private industry. Participants also agree to grant Denmark legally binding exemptions from the Maastricht treaty.

By the second week of September, massive intervention by European central banks was required to prevent the Italian lira from falling below its ERM floor, despite a substantial increase in short-term interest rates. On September 12 the lira was devalued within the ERM, by 7 percent, and the Bundesbank agreed to lower its official interest rates, albeit only marginally. In the following week, however, the lira remained under pressure, and the Spanish peseta fell from the top to the bottom of the wide band. On September 16 the pound sterling became the focus of market attention, and massive intervention was required to keep it from falling below its ERM floor. Market pressures overwhelmed both this intervention and an increase from 10 percent to 12 percent (and an announcement of a further increase to 15 percent) in official U.K. interest rates on September 16. Later that day, sterling was withdrawn from the ERM (effective September 17), and official rates were moved back to 10 percent on September 17. Because intervention failed to hold the lira above its new ERM floor, the lira was also suspended from the ERM on September 17, and the Spanish peseta was devalued by 5 percent.

Pressures also mounted against the Danish krone, Irish pound, and Portuguese escudo, with the authorities of Ireland, Spain, and Portugal all putting temporary exchange control measures in place to curb capital outflows. After the exit of the pound sterling and the lira from the ERM and the positive, but very close, result of the French referendum on the Maastricht treaty, the French franc came under a particularly strong speculative attack, and the Banque de France and the Bundesbank publicly mounted a joint defensive operation. This operation included increases in overnight interest rates in France by 2½ percentage points on September 23; declines in short-term market rates in Germany by some 50 basis points, in part a result of unsterilized intervention before the ERM limits were hit; and an official joint statement indicating that the German and French authorities regarded the franc-deutschemark exchange rate as fully consistent with economic fundamentals and as not requiring adjustment. In the event, the pressures subsided, official interest rates were gradually reduced, and further parity changes within the ERM were avoided until the end of November. From early September to mid-December, sterling depreciated by about 15 percent, and the Italian lira by about 16 percent, in nominal effective terms; the French franc and deutsche mark were little changed (Chart 4).2

Chart 4.Major Industrial Countries: Nominal Effective Exchange Rates1

(Indices, 1980 = 100; logarithmic scale)

1Constructed using weights based on the IMF’s Multilateral Exchange Rate Model; weekly averages of daily data.

After the September crisis, significant pressures re-emerged in European currency markets in November. The Swedish krona came under renewed selling pressure in mid-November, triggering heavy foreign exchange intervention and an increase in official interest rates; this increase was then reversed when it was decided on November 19 to float the krona. Pressures spilled over to the peg of the Norwegian krone to the ECU (outside the EMS) and to the French franc, the Danish krone, the Irish pound, the Spanish peseta, and the Portuguese escudo, requiring heavy intervention and sharp increases in official interest rates in most of these countries. On November 23 the escudo and the peseta were devalued within the ERM by 6 percent. For a while, pressures again abated against other currencies that had been under downward pressure. However, under renewed selling pressure, the Norwegian authorities decided to allow the krone to float on December 10, and tensions within the ERM have continued.

Financial markets in Canada experienced their own episode of turbulence beginning in September because of uncertainties related to the October 26 constitutional referendum. As a result, the Canadian dollar weakened, and domestic interest rates rose sharply. Market pressures eased in the weeks just before and after the referendum. The Canadian dollar firmed, and interest rates fell, until a re-emergence of exchange market pressures in November again prompted increases in interest rates. Downward pressures on the Canadian dollar have eased since early December, and interest rates have again begun to decline. From the end of August to mid-December, the Canadian dollar depreciated by 6½ percent against the U.S. dollar.

Developments in Europe and Canada were accompanied by significant increases in nominal effective exchange rates in the United States and Japan, with the dollar appreciating by 11 percent, and the yen by about 7 percent, from early September to early December. The effective strengthening of the U.S. dollar mirrored significant gains against the Canadian dollar, and even more against sterling and the lira, in addition to a reversal of its earlier depreciation against the deutsche mark and closely linked currencies. The yen’s strength was marked by appreciations against all major currencies except the U.S. dollar.

Stance of Monetary and Fiscal Policies

Monetary Policies

Monetary conditions in the industrial countries generally eased after early September, in part because of accumulating evidence of slowing growth and weak inflationary pressures. In Europe, the crisis in the EMS caused a temporary tightening of monetary conditions in several countries in late September and into October, but there was subsequently a general easing. In the major industrial countries as a group, the stance of fiscal policy has been largely unchanged, implying a small removal of stimulus in both 1993 and 1994.

In the United States, the Federal Reserve’s discount rate has been unchanged since it was last cut to 3 percent in early July, but the federal funds rate was lowered in early September by ¼ of 1 percentage point, to 3 percent. Long-term interest rates rose slightly between September and November. M2 growth has remained below the Federal Reserve’s target range, but other indicators suggest that monetary conditions are somewhat easier than would be implied by the broader aggregates (see the Annex). The current policy stance is expected to be an important factor underlying the moderate recovery of economic activity that is projected.

In Japan, the official discount rate was cut in late July from 3¾ percent to 3¼ percent, where it has remained. From July to early December, short- and long-term interest rates declined by about ¼ of 1 percentage point. As in the United States, interest rates have declined substantially over the past twelve months. Nevertheless, the growth of both narrow and broad monetary aggregates has slowed as economic activity has weakened. There are indications that the financial sector is coming under increasing pressure as a consequence of a sharp rise in nonperforming loans that followed the decline in real estate prices.

Since September, changes in monetary conditions in Europe have been dominated by the EMS crisis. As the currencies of Italy, the United Kingdom, Spain, Ireland, and France came under downward pressure, monetary authorities in those countries and in Germany responded by intervening heavily in exchange markets. In addition, interest rate differentials relative to Germany were allowed to widen. Outside the EMS, downward pressures on the currencies of Finland, Sweden, and to a lesser extent Norway—all of which were pegged to the ECU—prompted exchange market intervention and increases in official and short-term market interest rates. In Germany, monetary conditions were eased somewhat as official and market short-term rates fell during the September crisis. By contrast, the countries whose currencies came under downward pressure were all forced to raise interest rates during September, in some cases sharply. As the September crisis passed, rates fell again, and by mid-November they had approached levels that prevailed in early August. In the third week of November, however, the renewed intensification of exchange market tensions again led to a temporary widening of interest differentials relative to Germany in many countries. Only in the United Kingdom have short-term rates fallen significantly below earlier levels and below those in Germany as the authorities used the increased room to maneuver, after the exit of sterling from the ERM, to attempt to stimulate activity through easier monetary conditions.

Monetary conditions in Canada eased significantly in the past year, reflecting the deep recession and the increasing realization that the official target for inflation in 1992 (3 percent) would be easily achieved. After the sharp increase in interest rates to support the Canadian dollar in late September, short-term interest rates declined to about 6¼ percent by end-October. More recently, however, interest rates have again risen as the Canadian dollar has come under renewed downward pressure.

Fiscal Policies

Fiscal policies in most countries have allowed the automatic stabilizers to work, but in almost all countries there has been little room for discretionary easing. In the United States the federal deficit has risen sharply since 1989, although at $290 billion in FY 1992 (5 percent of GDP) it was much smaller than the administration had predicted in January.3 Fiscal policy has maintained a broadly neutral stance through the recession, however, and the deterioration in large part is attributable to the slowing of growth and the operation of automatic stabilizers. A substantial structural deficit nevertheless remains and must be dealt with in the years ahead, in part because of the strong growth in the cost and volume of health-related outlays. Fiscal policy has also been broadly neutral in France, although automatic stabilizers increased the general government deficit to about 3 percent of GDP in 1992 from a deficit of 1½ percent of GDP in 1990.

The fiscal situation in Italy has become critical, as the pressures on the lira in the recent crisis demonstrated. In the absence of strong policy action, the general government deficit was projected to rise sharply from its level of 10½ percent of GDP in 1992. The recently announced program of fiscal restraint has the objectives of broadly stabilizing the deficit-GDP ratio in 1993 and of reducing the fiscal deficit to 3 percent of GDP by 1996. However, projections indicate that the program, even if fully implemented, will leave the deficit above 5 percent of GDP by 1996. The debt-GDP ratio is projected to stabilize in 1994 and to fall thereafter, but this outcome depends crucially on a decline in interest rates in Italy, which is assumed to come about as markets gain confidence that the authorities have control of the fiscal situation.

In Germany, the federal authorities intend to reduce the deficit, which has widened sharply since 1990 because of the costs of unification, primarily through expenditure restraint. Several factors, however, may undermine this effort. Expenditures by the Länder and by local authorities have been growing rapidly, as have “off-budget” liabilities, particularly those of the privatization agency, the Treuhand. Moreover, the rapid increase in wages in east Germany, which has not been matched by productivity gains, threatens to raise unemployment further. Therefore, the need may intensify for transfers in the form of social expenditures or subsidies to firms in the east. In the short run, efforts to reduce fiscal imbalances will be made more difficult by the slowdown in economic growth.

In Japan, the economic package announced in August contained stimulative measures equivalent to 2¼ percent of GDP.4 Budgetary consolidation undertaken during the 1980s has left the authorities with scope to take such actions in response to the cyclical slowdown even though the fiscal deficit of the central authorities still exceeds the official medium-term target. In Canada and the United Kingdom, deep recessions have placed considerable pressures on public finances. In Canada, despite efforts to limit federal government expenditures, the deficit is expected to overshoot the 1992–93 target because of the weakness of the economy and lower-than-expected revenues. The deficit also has expanded sharply in the United Kingdom, and it is expected to widen further in 1993. Although a major part of this deterioration can be attributed to cyclical factors, there has also been some discretionary easing of fiscal policy over the past two years. In both countries, efforts will be required to reduce deficits as economic recovery strengthens.

Revised Projections: Industrial Countries

Real GDP in the industrial countries is estimated to have risen by 1½ percent in 1992 and is projected to rise by 2 percent in 1993 (Tables 1 and 2). Compared with projections in the October 1992 World Economic Outlook, growth has been reduced by ½ of 1 percentage point in 1992 and by 1 percentage point in 1993. The changes for 1993 include downward revisions of 2 percentage points for Germany; 1 to 1¾ percentage points for Japan, France, Italy, and Canada; and ¾ of 1 percentage point for the United Kingdom.

Table 1.Overview of the Projections(Annual percent change unless otherwise noted)
19901991Current ProjectionsDifference from October 1992 Projections
World output2.–0.2–0.8
Industrial countries2.–0.4–0.9
United States0.8––0.1
United Kingdom0.5–2.2–1.01.3–0.2–0.8
Seven countries above2.–0.2–0.9
Other industrial countries2.–0.9–1.1
Memoranda: European Community2.–0.3–1.3
West Germany5.–0.3–1.7
Developing countries3.–0.1–0.6
Middle East and Europe5.59.98.6–0.1
Western Hemisphere––0.1–1.9
Memorandum: Developing countries excluding Middle East and Europe3.–0.2–0.7
Former centrally planned economies–3.1–9.7–17.2–5.4–0.4–0.9
Eastern Europe1–7.1–13.7–10.42.1–0.7–0.4
Former U.S.S.R.–2.3–9.0–18.6–7.6–0.4–1.1
World trade volume4.–0.5–1.0
Industrial country import volume4.–0.4–1.2
Developing country import volume6.–0.3–0.1
Commodity prices
In U.S. dollars a barrel22.0618.3118.4218.110.10–0.11
Consumer prices
Industrial countries4.–0.1–0.2
Developing countries80.242.746.340.73.912.9
Former centrally planned economies21.295.71,104.5154.5–87.9
Eastern Europe1142.2134.9797.448.81.06.7
Former U.S.S.R.5.489.21,181.8197.3–114.4
Six-month LIBOR (in percent)–0.1–0.4
Note: Real effective exchange rates are assumed to remain constant at the levels prevailing during October 12–23, 1992, except for the bilateral rates among the ERM currencies, which are assumed to remain constant in nominal terms. This implies an effective appreciation of the U.S. dollar by about 2½ percent relative to the assumption underlying the October 1992 World Economic Outlook.

The countries in Eastern Europe comprise Bulgaria, the former Czech and Slovak Federal Republic, Hungary, Poland, Romania, and the former Yugoslavia (covering the territory of Yugoslavia as it existed in 1990).

Simple average of the U.S. dollar spot price of U.K. Brent, Dubai, and Alaska North Slope crude oil; assumptions for 1992 and 1993.

In U.S. dollars; based on world export weights.

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

Note: Real effective exchange rates are assumed to remain constant at the levels prevailing during October 12–23, 1992, except for the bilateral rates among the ERM currencies, which are assumed to remain constant in nominal terms. This implies an effective appreciation of the U.S. dollar by about 2½ percent relative to the assumption underlying the October 1992 World Economic Outlook.

The countries in Eastern Europe comprise Bulgaria, the former Czech and Slovak Federal Republic, Hungary, Poland, Romania, and the former Yugoslavia (covering the territory of Yugoslavia as it existed in 1990).

Simple average of the U.S. dollar spot price of U.K. Brent, Dubai, and Alaska North Slope crude oil; assumptions for 1992 and 1993.

In U.S. dollars; based on world export weights.

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

Table 2.Industrial Countries: Economic Indicators(Percent change unless otherwise noted)
All industrial countries
Real GDP3.
Real total domestic demand3.
GDP deflator3.
Current account balance1–0.5–0.1–0.2–0.3
General government balance2–1.5–2.5–3.5–3.4
Major industrial countries
Real GDP3.
Real total domestic demand3.
GDP deflator3.
Current account balance1–0.5–0.1–0.2–0.4
General government balance2–1.4–2.3–3.4–3.3
United States
Real GDP2.4–
Real total domestic demand1.7–
GDP deflator4.
Current account balance1–2.1–0.1–1.0–1.5
General government balance2–2.0–3.4–4.4–3.4
Real GDP5.
Real total domestic demand6.
GDP deflator1.
Current account balance12.
General government balance22.
Real GDP4.
Real total domestic demand3.
GDP deflator2.
Current account balance14.0–1.2–1.1–0.8
General government balance2–1.3–3.2–3.2–3.3
Real GDP3.
Real total domestic demand3.
GDP deflator3.
Current account balance1–0.6–0.5–0.1–0.1
General government balance2–1.4–2.1–2.9–3.0
Real GDP3.
Real total domestic demand3.22.31.4–0.4
GDP deflator6.
Current account balance1–1.1–1.8–1.4–1.9
General government balance2–10.5–10.2–10.4–10.1
United Kingdom
Real GDP2.3–2.2–1.01.3
Real total domestic demand3.5–
GDP deflator6.
Current account balance1–3.6–1.1–2.1–2.5
General government balance20.2–2.7–6.3–7.3
Real GDP2.2–
Real total domestic demand2.9–
GDP deflator4.
Current account balance1–3.3–4.3–4.4–3.5
General government balance2–3.2–6.1–6.5–6.0
Other industrial countries
Real GDP3.
Real total domestic demand3.
GDP deflator5.
Current account balance1–1.9–0.3–0.20.4
General government balance2–0.8–3.8–4.6–4.5
European Community
Real GDP3.
Real total domestic demand3.
GDP deflator4.
Current account balance10.1–0.9–0.9–0.8
General government balance2–3.4–4.6–5.3–5.4

In percent of GDP.

In percent of GDP on a national accounts basis.

In percent of GDP.

In percent of GDP on a national accounts basis.

The revised projections are based on exchange rates prevailing in mid-October.5 Although the new exchange rate assumptions alone have little net effect on the outlook for the industrial countries as a group, they do have a significant impact on the projections for Italy and the United Kingdom. The revised projections also incorporate recent changes in monetary policy and are based on somewhat lower assumptions for interest rates and for oil prices. The most important reasons for the downward revisions, however, are a reassessment of the impact of asset price deflation and balance sheet adjustments on private spending and lending decisions (particularly in Japan, the United Kingdom, and several smaller industrial countries), the effects of persistent high real interest rates in Europe and Canada, and heightened uncertainty from turmoil in European exchange markets. For these reasons, the previously expected recoveries in the United Kingdom and Canada have not yet materialized, and the slowdowns in continental Europe and Japan have been sharper than expected.

The outlook for the United States is essentially unchanged from the October 1992 World Economic Outlook. Real GDP rose at an annual rate of about 3½ percent in the third quarter of 1992, which was stronger than expected, in part because of special factors. Recent indicators—including industrial production, housing starts, orders, retail sales, and consumer confidence—have generally been encouraging (Table 3), but a key factor preventing a more buoyant U.S. recovery remains the weak financial position of the household sector. Nevertheless, activity is expected to strengthen in 1993 as households return to more normal spending patterns, as financial positions improve, and as the economy responds to the lowest short-term interest rates in thirty years (Chart 5).

Table 3.Major Industrial Countries: Cyclical Indicators
Industrial production (percent change from previous year)
United States–2.8–2.1–
United Kingdom–5.9–2.2–0.8–1.3–0.2–0.6–1.5–0.1–0.2
Unemployment rates (percent of labor force)
United States6.
United Kingdom7.
Consumer price index (percent change from previous year)
United States4.
United Kingdom6.

Chart 5.Industrial Countries: Real GDP1

(Percent change from four quarters earlier)

1Shaded areas indicate staff projections; for Canada, west Germany, Japan, and the United States, actual data for the third quarter of 1992 are used.

2Annual observations, since quarterly data are not available for some countries.

Following the slowdown in the first half of 1992, economic conditions in Japan have weakened further, as indicated by slow wage growth, declines in automobile sales and other consumer durables, and a decline in the ratio of job offers to job seekers. The growing need for consolidation in the financial sector has depressed confidence and might further restrain lending by financial institutions and spending by households and businesses. The fiscal stimulus package announced in mid-August, efforts to safeguard the stability of the financial system, and an end to inventory adjustments should, however, limit the decline in growth.

The recovery in Canada has been weakened by the delayed recovery in the United States, the uncertainty surrounding the Canadian constitutional referendum, low levels of consumer confidence resulting from massive cost-cutting efforts of the business sector, and the substantial increases in interest rates required to limit the depreciation of the Canadian dollar. However, underlying economic conditions are favorable for a sustained economic expansion based on the lowest inflation among the major industrial countries, the expectation of lower interest rates, improved competitiveness, and productivity gains from structural reforms. Real output in Canada is expected to increase by 2¾ percent in 1993, with the recovery gathering momentum during the course of the year.

Short-term prospects in Europe have been affected by the recent turbulence in European currency markets and by the associated changes in exchange rates and monetary policies. Growth has generally weakened during the course of the year and is now projected to average only 1 percent in both 1992 and 1993. In west Germany, real output is estimated to have declined by 1¾ percent (seasonally adjusted annual rate) in the third quarter of 1992, and a further decline is expected in the fourth quarter, owing to a decline in business confidence and spending, further declines in production in the tradable goods sector, and some destocking. Meanwhile, the recovery in east Germany has been much weaker than expected. Growth in west Germany is expected to begin to strengthen in the course of 1993, reflecting the projected gradual recovery in other industrial countries, more moderate wage growth, and somewhat lower interest rates due to reduced demand pressures and lower inflation. Even with this improvement during the year, however, real output in unified Germany is projected to rise by only ½ of 1 percent in 1993.

In France, the external sector accounted for half of the rise in real output in 1992, but this contribution is expected to drop sharply in 1993 because of weaker export market growth and the recent appreciation of the franc vis-à-vis several other European currencies. Economic growth in 1993 is expected to be somewhat higher than in the rest of Europe as production is reoriented to meet an expected moderate strengthening of domestic demand.

Recent developments in currency markets have highlighted the growing economic imbalances in Italy, where short-term prospects are likely to be influenced heavily by the government’s ability to forge a political consensus for serious and long-lasting fiscal consolidation. Fiscal consolidation will also be essential if Italy is to benefit from the depreciation of the lira. In the short run, however, the beneficial impact on growth of the depreciation of the lira is likely to be offset by the necessary efforts to cut the government deficit and by the high level of interest rates that are likely to prevail pending more substantial progress on deficit reduction.

In the United Kingdom, a major factor delaying recovery has been the continued restructuring of private sector balance sheets. This has restrained consumer spending and depressed business confidence considerably more than earlier expected. Thus far, there is little evidence that these adjustments have ended, and high levels of indebtedness are likely to continue to restrain demand in 1993. However, the depreciation of sterling and the further reduction in interest rates since sterling was withdrawn from the ERM are expected to stimulate both external and domestic demand during the course of 1993, although the timing of the expected recovery remains uncertain.

For the group of smaller European countries, economic conditions weakened considerably during the second half of 1992. In 1993, growth in all countries is expected to remain subdued or weaken further (Table 4). A further output loss is likely in Finland and Sweden in 1992, with only a moderate recovery in Finland in 1993.

Table 4.Smaller Industrial Countries: Real GDP and Consumer Prices(Annual percent change)
Real GDPConsumer Prices
Smaller industrial countries0.
Smaller European countries

Reflecting the widespread weakness in economic activity, the unemployment rate in the industrial countries is projected to rise sharply to 7¾ percent in 1992, followed by a further increase to 8 percent in 1993 (Chart 6). As the recovery gains momentum in the United States and Canada, unemployment rates are expected to decline slightly or level off. By contrast, the unemployment rate in the European Community (EC) is expected to rise to 11 percent in 1993, reflecting an increase to 8½ percent in Germany and to between 10½ percent and 11½ percent in France, Italy, the United Kingdom, and the smaller industrial countries as a group. In many European countries, unemployment is projected to rise close to, or above, previous cyclical peaks.

Chart 6.Industrial Countries: Unemployment Rates1

(In percent of labor force)

1Shaded areas indicate staff projections.

2Aggregation based on labor force weights.

The weakness of economic growth in 1991 contributed to a significant reduction of inflation in the industrial countries in 1992—a continuation of the general trend during the past decade and a reversal of the tendency for inflation to edge up in the late 1980s (Chart 7). Despite the relatively large margins of idle productive capacity and high unemployment, average inflation in the industrial countries is expected to decline only slightly, to 3 percent, in 1993 (Chart 8). For many countries the risks in the inflation projections would appear to be mostly on the downside.

Chart 7.Industrial Countries: Consumer Price Indices1

(Percent change from four quarters earlier)

1Shaded areas indicate staff projections.

2Increases in indirect taxes raised consumer prices in 1989 in Canada, west Germany, Japan, and Italy, and in 1991 in Canada and west Germany. The projected decline in inflation in Italy in 1992 is related to a change in wage indexation in that year; the change is expected to result in a one-time reduction in inflation.

3Excluding mortgage interest payments.

4Annual observations, since quarterly data are not available for some countries.

Chart 8.Major Industrial Countries: Output Gaps1

(In percent)

1The output gap is calculated as the percentage difference between actual or projected GDP and staff estimates of potential output; composites are based on 1988-90 GDP weights. The shaded area indicates staff projections.

In Italy, the depreciation of the lira is expected to boost consumer prices, although inflation measured by the GDP deflator is expected to decline to 5 percent in 1993. In the United Kingdom, despite the depreciation of sterling, the rise in consumer prices (excluding the impact of mortgage interest rates) is projected to slow to 4¼ percent in 1993, in part reflecting the margin of slack in the economy after two years of recession. Canada now has the lowest inflation rate among the major industrial countries—1½ percent in 1992—although the depreciation of the Canadian dollar is expected to lead to slightly higher price increases next year. Inflation in west Germany is projected to drop to an annual rate of 2½ percent by the fourth quarter of 1993.

After narrowing considerably since 1986, the current account imbalances of the two largest industrial countries are expected to widen somewhat in 1992 and 1993 as cyclical positions become less divergent or are reversed. The current account deficit of the United States dropped sharply in 1991—largely because of temporary factors that have now been reversed—but is now projected to widen to 1 percent of GDP in 1992 and to 1½ percent of GDP in 1993. Japan’s current account surplus nearly doubled, to 2¼ percent of GDP, in 1991 and is projected to average 3 percent of GDP in 1992–93. The widening of the surplus in Japan from 1990 to 1992 reflects a sharp decline in purchases of gold investment certificates, large terms of trade gains, and the slowdown in domestic demand growth. The current account deficit in Canada is expected to narrow, from 4½ percent of GDP in 1992 to 3½ percent of GDP in 1993. In Germany, the current account deficit is expected to remain at about 1 percent of GDP in 1992 and to decline only slightly in 1993. In both Italy and the United Kingdom, despite the substantial currency depreciations, the external deficits are projected to widen slightly in 1993.

Despite the downward revisions, there still appear to be downside risks to the projections for activity, especially in Europe and Japan. For the United States and Canada, domestic demand now seems poised for recovery, but the weakness of foreign demand will be a restraining influence. The most important element of uncertainty is the extent to which asset price deflation will continue to erode confidence, increase financial fragility, and further impede economic recovery, primarily in Japan, the United Kingdom, the United States, and several of the smaller industrial countries. For Europe, the recent exchange market turbulence and continued uncertainty about ratification of the Maastricht treaty may adversely affect confidence and delay recovery until the prospects for EMU become clearer. An additional important downside risk is the possibility of a failure to conclude the Uruguay Round of multilateral trade negotiations.

Revised Projections: Developing Countries and Former Centrally Planned Economies

The adverse impact on the developing countries of the slower growth now projected for the industrial countries in 1993 and of weaker world commodity prices is expected to be partially offset by the beneficial effects of lower world interest rates and, for oil importing countries, by somewhat lower oil prices. On balance, economic growth in the developing countries is now projected at 5¾ percent in 1993 (Table 5 and Chart 9), ½ of 1 percentage point lower than in the October 1992 World Economic Outlook.6 The outlook for several Eastern European countries appears to be improving, whereas the economic situation in the former Soviet Union has continued to deteriorate.

Table 5.Developing Countries: Economic Indicators(Annual percent change unless otherwise noted)
Developing countries
Real GDP3.
Consumer prices69.042.746.340.7
Consumer prices (median)
Investment ratio (in percent of GDP)24.123.324.324.4
Export volume8.
Terms of trade0.1–3.9–1.60.6
Current account (in billions of U.S. dollars)–17.8–78.2–47.1–45.7
Debt (in billions of U.S. dollars)11,281.01,361.01,428.01,470.0
Debt (in percent of exports)2125.6126.3122.7114.0
Debt service (in percent of exports)15.914.014.214.1
Real GDP2.
Consumer prices18.127.128.318.0
Consumer prices (median)
Investment ratio (in percent of GDP)21.019.819.620.4
Export volume4.
Terms of trade–0.9–6.2–6.0–0.8
Current account (in billions of U.S. dollars)–6.2–3.5–8.8–7.1
Debt (in percent of exports)2221.3230.5238.0231.4
Debt service (in percent of exports)25.325.930.828.6
Real GDP6.
Consumer prices13.
Consumer prices (median)
Investment ratio (in percent of GDP)30.230.331.131.3
Export volume9.712.39.910.9
Terms of trade–0.3–0.40.3
Current account (in billions of U.S. dollars)3.6–3.5–8.8–7.1
Debt (in percent of exports)269.168.666.863.7
Debt service (in percent of exports)
Middle East and Europe
Real GDP2.79.98.6
Consumer prices18.922.116.416.3
Consumer prices (median)
Investment ratio (in percent of GDP)19.715.718.417.4
Export volume7.
Terms of trade1.7–12.4–2.91.1
Current account (in billions of U.S. dollars)–6.7–50.5–6.1–3.4
Debt (in percent of exports)2122.7134.3135.0124.5
Debt service (in percent of exports)14.813.612.612.3
Western Hemisphere
Real GDP0.
Consumer prices416.1165.3212.2179.4
Consumer prices (median)14.821.411.88.0
Investment ratio (in percent of GDP)
Export volume6.
Terms of trade–0.1–4.8–2.01.9
Current account (in billions of U.S. dollars)–8.5–19.9–23.9–24.7
Debt (in percent of exports)2252.0265.1256.4232.2
Debt service (in percent of exports)30.428.831.633.7

End of period.

Total debt at year-end in percent of exports of goods and services in the year indicated (for 1988–90, in percent of 1990).

End of period.

Total debt at year-end in percent of exports of goods and services in the year indicated (for 1988–90, in percent of 1990).

Chart 9.Industrial and Developing Countries: Economic Growth1

(Annual percent change)

1Shaded area indicates staff projections.

In Asia, real output is projected to increase 6½ percent in 1993, roughly similar to average growth over the past five years. The rapid growth can be traced to a general surge in consumption and investment in the newly industrializing economies and in most of the Association of South-East Asian Nations (ASEAN) and to a sharp increase in exports, largely to other countries within the region. In China, economic growth has gathered momentum as a result of the implementation of bold reform policies in recent years, and output is projected to increase by nearly 9 percent in 1993.

The largest revisions have been in the Western Hemisphere, where real output is now projected to increase by only 2 percent in 1993, roughly half of what was projected in the October World Economic Outlook. This mainly reflects a sharp downward revision for Brazil attributable to political difficulties in implementing a macroeconomic stabilization program. Smaller revisions for Argentina, Mexico, and other countries reflect the weaker outlook for the industrial countries and, in some cases, an erosion of competitiveness, declining terms of trade, and a slowdown in direct investment and other capital inflows. The medium-term outlook for the region, however, remains favorable because of recent debt reductions and the pursuit of sound policies by many countries.

For Africa and the Middle East and Europe region, the outlook is largely unchanged compared with the earlier projections. Growth in Africa in 1991–92 has been restrained by weak external demand; by a deterioration in the terms of trade of nearly 12 percent, reflecting a sharp decline in commodity prices; by continuing political unrest in several countries; and by the drought in southern Africa. Real output is projected to increase by 3¼ percent in 1993 because of the somewhat improved external environment, including an end to the sharp terms of trade declines that occurred in 1991 and 1992, and because of the beneficial effects of continued structural adjustment efforts in several countries. On a per capita basis, however, only a marginal rise in output is expected. In the Middle East and Europe, improved security conditions following the recent conflict in the area, as well as the introduction of more market-oriented policies in several countries, are expected to provide a considerable boost to activity.

The weaker prices now expected for both oil and non-oil commodities and the slower increase in prices in the industrial countries generally imply somewhat lower inflation in most developing countries compared with the earlier projections. The important exception is the Western Hemisphere, where the inflation projection for 1993 has been revised upward because of sharply higher inflation in Brazil stemming from growing macroeconomic imbalances.

Despite the weakness in industrial country activity, developing country export volumes are likely to increase by 8¼ percent in 1992 because a sharp increase in intraregional exports in Asia—primarily from China, India, and Korea—has more than offset a slowdown in export growth elsewhere. The increase in intra-Asian exports in the past three years, in part owing to increasing direct investment and specialization within Asia, has meant that exports by developing countries have grown considerably faster than imports by industrial countries (Chart 10). Export performance, however, varies widely among developing countries. Export volumes increased by about 10 percent in 1992 in developing countries that export mainly manufactures, whereas volumes rose by 6½ percent in countries that export mainly primary products. Assuming increased import demand from industrial countries, continued buoyant intraregional trade in Asia, and a resolution of recent tensions over trade, developing countries’ exports are expected to increase 9 percent in 1993.

Chart 10.Industrial and Developing Countries: Trade Volumes1

(Annual percent change)

1Shaded area indicates staff projections.

The combined current account deficit of the developing countries is projected to narrow to about $46 billion in 1992 and 1993, compared with a deficit of $78 billion in 1991. The smaller deficit is attributable mainly to normalization of oil production in the Middle East. In contrast, the external deficits of many other developing countries in Asia and the Western Hemisphere are expected to increase, in part as a response to capital inflows. The decline in world interest rates will tend to lower debt-service ratios in the developing countries in 1992 and 1993. The average debt-export ratio is expected to be virtually unchanged in 1992, at 123 percent, and is projected to decline to 114 percent in 1993.

In Eastern Europe, the contraction of industrial output now appears to have stopped in the former Czech and Slovak Federal Republic, Hungary, and Poland. Although recent data suggest somewhat weaker growth in 1992 in Poland and Hungary than was previously expected, this mainly reflects the impact of a drought and larger-than-expected inventory reductions. The substantial increase in the three countries’ exports to convertible currency markets has continued, and some industries are beginning to compete successfully with imports. In contrast, output continues to contract in the other Eastern European countries because of the slowness of the transformation process and, in the former Yugoslavia, because of civil war. In 1993, moderate growth is expected in Eastern Europe as a whole for the first time since 1988 (Table 6). With the completion of price liberalization programs in 1990 and 1991, inflation in most countries in the region fell in 1992 and is expected to fall further in 1993 (the civil war in the former Yugoslavia, however, has resulted in hyperinflation, significantly raising the regional average).

Table 6.Former Centrally Planned Economies: Economic Indicators(Annual percent change unless otherwise noted)
Former centrally planned economies
Real GDP1.1–9.7–17.2–5.4
Consumer prices15.595.71,104.5
Consumer prices (median)11.889.249.4
Investment ratio (in percent of GDP)29.829.027.827.2
Export volume–6.9–22.5–12.412.7
Terms of trade1.5–2.1–1.4–0.3
Current account (in billions of U.S. dollars)–6.1–9.7–18.6–24.6
Debt (in percent of exports)189.8122.3153.8152.3
Debt service (in percent of exports)13.819.812.812.4
Eastern Europe
Real GDP–2.1–13.7–10.42.1
Consumer prices99.3134.9797.448.8
Consumer prices (median)16.4115.747.830.4
Investment ratio (in percent of GDP)
Export volume–4.7–
Terms of trade–0.9–
Current account (in billions of U.S. dollars)2.4–6.4–2.9–4.2
Debt (in percent of exports)1146.4166.8162.8150.7
Debt service (in percent of exports)
Former U.S.S.R.
Real GDP1.8–9.0–18.6–7.6
Consumer prices2.789.21,181.8
Export volume–7.8–24.1–23.517.0
Terms of trade2.5–0.4–5.9–1.1
Current account (in billions of U.S. dollars)–8.5–3.3–15.7–20.4
Debt (in percent of exports)153.284.9142.8154.1
Debt service (in percent of exports)

Total debt at year-end in percent of exports of goods and services in the year indicated (for 1988–90, in percent of 1990).

Total debt at year-end in percent of exports of goods and services in the year indicated (for 1988–90, in percent of 1990).

The aggregate current account deficit of Eastern Europe is projected to narrow, from $6½ billion in 1991 to just under $3 billion in 1992. The narrowing of the deficit can be explained by relatively strong exports from Poland, the former Czechoslovakia, and Hungary as well as by weak domestic demand and continued financing constraints in several countries. Direct foreign investment played an important role in 1992 in Hungary and the former Czechoslovakia, but it remained low in most other countries. The total external debt in Eastern Europe is projected to remain broadly unchanged in 1992–93 as the impact of the debt-restructuring agreement between Poland and the Paris Club offsets the region’s increased borrowing from official sources.

Economic conditions in the former Soviet Union have continued to deteriorate. The output decline in the Russian Federation accelerated in the third quarter, with a significant further drop in industrial production. This drop reflected, in part, a hardening of budget constraints because enterprises were required to pay for inputs on delivery rather than by running up arrears, as had been the case in the first half of the year. In addition to the drop in output, some of which may be regarded as a prerequisite for restructuring, progress toward a market-based economy has been hindered by large-scale government support to specific sectors and enterprises, including budgetary subsidies and credits extended at heavily subsidized rates.

Outside Russia, the general fall in output has been somewhat steeper than previously expected. In addition to the hardening of enterprise budget constraints in some countries and the widespread impact of the drought on agricultural production, output in the net oil importing countries has been restrained by higher-than-expected oil prices and tightening oil supplies. A notable exception is Kazakhstan, where agricultural output increased in 1992 and the energy balance is close to zero. Output in Ukraine is expected to fall by 18 percent in 1992. In the Baltic states, output is expected to drop by 30 percent in 1992, mainly because of shortages of petroleum products imported from Russia and a very large deterioration in the terms of trade.

In Russia, retail prices are estimated to have increased more than fourteenfold in 1992. The very high inflation was fueled by a large budget deficit in the third quarter and by excessive credit expansion by the central bank to Russian commercial banks and to central banks in other states of the ruble area. The relaxation of macroeconomic policies has resulted in a worsening of inflation expectations, which has led to a steep depreciation of the ruble, from 113 rubles to the dollar at the beginning of June to 418 rubles to the dollar in the second week of December. In other states of the former Soviet Union, the inflation outlook has also generally worsened because of higher oil prices, easier credit conditions in the ruble area overall (attributable mainly to widespread bailouts of enterprise arrears over the summer), and upward adjustments in administered prices as governments attempt to contain the cost of budgetary subsidies.

The higher oil prices and relatively easy credit conditions in the oil importing states have caused payments imbalances to worsen sharply among the countries of the former Soviet Union. Russia has attempted to limit its financing of interstate deficits by imposing restrictions on the acceptance of interstate ruble payments. This has led to a de facto separation of national noncash rubles and a rationing of Russian rubles in the deficit states. Markets are emerging in national rubles, and more states have chosen to adopt independent national currencies (Lithuania and Ukraine have now joined Estonia and Latvia in instituting national currencies).

Exports from Russia to countries outside the territory of the former Soviet Union are reported to have fallen 35 percent in the first nine months of 1992, largely because of supply constraints. There are indications, however, that a growing fraction of exports may not be reflected in official trade and payments statistics. Imports are estimated to have fallen by 17 percent. The combined current account deficit for the 15 countries of the former Soviet Union is expected to be $15¾ billion in 1992 and is projected to be $20½ billion in 1993. These projections are, of course, highly uncertain and are conditional on sizable external financial support.

Market reports also indicated intervention in support of their currencies by the Bank of Spain and, mostly in late August, by the Bank of England.

Early September refers to the average for the first week; mid-December refers to December 14, the data cutoff for this World Economic Outlook.

Part of the better-than-expected outcome is due to a delay in the approval of legislation to assist failing savings and loan institutions; to some extent, the associated outlays may be shifted to FY 1993.

The package comprises increased government expenditure on goods and services (¥6.3 trillion), land purchases for public works (¥1.6 trillion), increased lending by the housing loan corporation (¥0.8 trillion), and increased lending by other public financial institutions (¥2.1 trillion).

Because the reference period for the exchange rate assumption is October 12–23, 1992, the latest ERM realignment and other recent exchange rate changes have not been taken into account. Compared with the assumptions underlying the previous projections, the U.S. dollar is 2½ percent higher in nominal effective terms, and the Japanese yen and the deutsche mark are 7¼ and 2 percent higher, respectively. By contrast, the Italian lira is 8½ percent lower in nominal effective terms, and the pound sterling is 12¼ percent lower.

The revised projections for the developing countries and former centrally planned economies reflect a reassessment of the short-term outlook based on new information for only a small number of countries. For most of the other countries, the projections underlying the October 1992 World Economic Outlook have been updated incrementally, using the IMF’s adjustment model for developing countries, in light of the new assumptions and revised projections for the industrial countries. A more complete reassessment of the prospects for these countries will be provided in the next regular issue of the World Economic Outlook.

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