- International Monetary Fund. Research Dept.
- Published Date:
- January 1985
The staff has reviewed the medium-term scenarios presented in the April 1985 World Economic Outlook to ascertain the continuing validity of the principal conclusions. A detailed country-by-country re-evaluation of the estimates has not been undertaken; rather, the approach was to adjust the earlier results for certain changes in the underlying environment and to investigate the sensitivity of the scenario outcomes to changes in the basic assumptions.
Medium-term projections for the capital importing developing countries are influenced both by changes in the short-term outlook for these countries themselves and by revisions in the anticipated medium-term evolution of the world economic environment. Both of these factors have been affected somewhat by developments since the April 1985 exercise. In part owing to downward revisions in growth projections for industrial countries during 1985, export volume growth is now expected to be substantially weaker for the capital importing countries during this year and next. Furthermore, an unexpected further weakening of commodity prices has contributed to what is now perceived as a marked decline in export unit values for these countries during this year. As a result, the most important change in the short-term outlook for the capital importing countries is a significant downward revision in their export earnings during 1985-86. At the same time, however, slower-than-projected industrial country growth has probably been an important factor contributing to a more favorable outlook for nominal interest rates than was assumed in the April World Economic Outlook exercise. The staff has revised its nominal interest rate projections downward for both 1985 and 1986.
The medium-term consequences of these revisions depend on whether the factors which produced them are likely to persist. In the staff’s view, a number of the factors which contributed to slower growth in the industrial countries in early 1985 were temporary, and growth in these countries will resume its medium-term pace in 1986. Consequently, the outlook for growth in industrial countries in the medium-term scenario (that is, from 1987-90) remains unchanged. At the same time, however, no allowance has been made for a medium-term recovery in the terms of trade losses now expected to be suffered by the capital importing developing countries during 1985-86. Finally, given the unchanged outlook for monetary and fiscal policies and the anticipated moderate increase in growth, the recent decline in nominal interest rates is reflected in the medium-term projections. The lower levels of nominal interest rates previously projected for the end of the decade are now assumed to be reached in 1986 and to persist during 1987-90.
With regard to the medium-term evolution of the world economic environment, developments during the first half of 1985 increased the uncertainty surrounding several of the key variables in the mediumterm scenarios. Nevertheless the staff is of the view that the central tendencies with regard to these variables do not warrant major adjustments in the assumptions underlying the baseline scenario.3 Thus revisions in the baseline scenario essentially reflect changes in the short-term outlook. Since these revisions leave the conclusions reached in the April 1985 World Economic Outlook broadly valid, these will not be repeated in detail here. In brief, the staff believes that, given the assumptions on which the baseline scenario is developed, it should be possible for capital importing countries to grow at a rate of 4¼-5 percent during 1987-90, and to reduce their external debt ratio by one fourth to one third by the end of the decade (Appendix Table 50). However, the higher debt and debt service ratios which are now in prospect for 1985–86 are reflected in higher values of these ratios throughout the decade in the present exercise as compared with the April projections. As shown in Appendix Table 50, debt and debt service ratios for the capital importing developing countries for 1990 are now expected to be 114 percent and 21¾ percent, respectively, somewhat higher than the levels of 108 percent and 20½ percent projected in the previous World Economic Outlook.
While the baseline projection has not changed much, the medium-term outlook is now more uncertain because of recent changes in the world economy, in particular the continued weakness of the world petroleum market, alterations in exchange rates between the U.S. dollar and other currencies, and reduced optimism about medium-term growth prospects for the industrial countries. Considerable interest, therefore, attaches to the implications for the baseline scenario should developments with respect to these variables differ from those postulated six months ago.
For example, in the absence of any straightforward alternative, the staff has continued to use the conventional assumption of unchanged oil prices (in U.S. dollar terms in the short term, and in real terms during the medium-term scenario period). Clearly, however, prices could well fall below the current level, and are not likely, for the time being, to rise above it. The staff has therefore conducted a sensitivity analysis to investigate how the scenarios would appear if oil prices were systematically 20 percent lower than assumed in April.
Significant uncertainties also apply to exchange rates, although it is less easy to be sure of the possible direction of exchange rate movements. For illustrative purposes, the staff has investigated the implications for the medium-term scenarios of a 20 percent drop in the exchange value of the U.S. dollar. Finally, given the uncertainties that exist about the strength and sustainability of recovery in the industrial countries, the consequences were examined of a moderate recession in 1987-88, followed by a recovery to no more than the trend rate of growth in 1989-90. This should not necessarily be taken to imply that growth is more likely to fall short of the staff’s projection than to exceed it; but the issues raised by lower growth are likely to be more troublesome than those created by growth that is more rapid than expected. The implications of these various changes in underlying assumptions for adjustment and growth in developing countries are briefly discussed here.
In analyzing the medium-term impact of a decline in oil prices, it is assumed that, after an initial decline of 20 percent, the price of petroleum would remain constant in U.S. dollar terms through 1986 and constant in real terms thereafter. Thus the price would be some 20 percent lower than in the staff’s baseline assumption throughout the period to 1990. For the capital importing developing countries as a group, the net impact of lower oil prices would not be great, because the group contains both oil exporting and oil importing countries. For this reason, it is more useful to examine the impact on the groups of net oil importing and net oil exporting countries separately. For the net oil importers, assuming no change in the volume of their external financing, the major impact of the once-for-all decline in oil prices is an increase of about ¼ of 1 percent in the average annual rate of growth of GDP during 1986-90, due to the greater foreign exchange available for non-oil imports. For the oil exporting countries, the consequences of a decline in oil prices are considerably greater, and depend in part on whether the adverse effects on their balance of payments can be handled without interrupting normal debt servicing. Assuming that transitional financing is available, the average reduction in growth for the fuel exporting countries (other than the major exporters in the Middle East) would be about 1 percentage point per annum.
The major effect of a depreciation of the U.S. dollar on the baseline scenario would be to reduce the ratios of outstanding external debt and of debt service to exports of goods and services. A change in currency relationships among industrial countries would have relatively little direct effect on the growth of aggregate demand in the industrial world as a whole, nor would it be likely to have a major impact on the terms of trade for developing countries. However, because a high percentage of external indebtedness is denominated in U.S. dollars, while a much smaller proportion of international trade is fixed in U.S. dollar terms, a depreciation of the dollar raises the dollar value of international trade by more than the dollar value of external debt. As a result, for the capital importing developing countries as a whole, the debt-export ratio would fall to 106 percent in 1990 under the assumption of a 20 percent lower value of the U.S. dollar, instead of to 114 percent in the baseline scenario; the corresponding figures for the debt service ratio are 20¼ percent and 21¾ percent, respectively. The reduction in debt service relative to exports is also reflected in a somewhat lower current account-GDP ratio (7 percent in 1990 against the baseline 8 percent).
A slowdown in economic activity in industrial countries would, not surprisingly, have major adverse implications for developing countries, even if the slowdown were not accompanied, as it well might be, by intensified protectionist pressures and reductions in concessional and nonconcessional capital flows. Again for illustrative purposes, the staff examined the consequences of a slowdown in industrial countries’ growth to ½ percent per annum in 1987 and 1988 followed by a weak recovery to 3 percent growth in 1989-90. The slower growth of output in industrial countries would retard the growth of exports from developing countries, which would increase by less than 3 percent a year in 1987-88, against a growth of almost 6 percent in the baseline. Given the financial constraints facing developing countries, the latter could be expected to cut back the growth of their imports by about half. This in turn would reduce the average growth of GDP in these countries from 4¾ percent to a little over 3½ percent for 1987-88. Moreover, because of the lower exports under this alternative assumption, the ratios of debt and debt service would be higher by 1990 than under the baseline scenario: 120 percent and 22¾ percent, respectively, instead of 114 percent and 2¾ percent. Under this scenario, average per capita incomes in certain major groups of developing countries, such as the Western Hemisphere and African regions, would stagnate over the next few years, and would be no higher in 1988 than they had been a decade earlier. Such a trend would severely strain the social consensus needed to maintain adjustment efforts in heavily indebted countries.