Chapter

Chapter I Current Situation and Short-Term Prospects

Author(s):
International Monetary Fund. Research Dept.
Published Date:
January 1990
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Global Overview

The pace of global economic activity is projected to moderate to 2 percent in 1990, reflecting a slowdown in growth in both industrial and developing countries and a contraction of output in Eastern Europe and the Union of Soviet Socialist Republics (Table 1). The staff projects that the growth of world output will increase to 2½ percent in 1991, about the same as the average rate of growth in the 1980s. The rate of expansion of world trade is expected to continue to decline, averaging about 5½ percent in 1990–91. As noted above, these projections are based on the assumption that world oil prices will average $26 per barrel for the remainder of 1990 and decline gradually to $21 per barrel in the fourth quarter of 1991.

For the industrial countries, the projections envisage moderate growth at 2½ percent in 1990 and 1991, with inflation increasing to 4¾ percent in 1990 and then falling back to 4¼ percent in 1991. Compared with the average for industrial countries, relatively high growth is projected in the Federal Republic of Germany and Japan, while relatively low growth is projected in North America, the United Kingdom, and a number of the smaller industrial countries.2

The contrasts in the growth projections for the developing countries are even sharper: continued rapid rates of growth of about 5 percent a year are expected for the Asian region in 1990–91; in the developing countries of Europe and the Western Hemisphere output is expected to decline in 1990, as many of these countries adopt or continue to implement anti-inflation financial policies, but a recovery is projected in 1991. The very large divergences in inflation performance among the developing countries are expected to persist in 1990: average inflation in excess of 100 percent is projected for the developing countries of Europe and the Western Hemisphere, compared with an average slightly above 10 percent in the other developing countries. In 1991, inflation differentials among the developing countries are projected to narrow substantially, assuming that a number of countries with high inflation sustain recently adopted stabilization programs.

Global economic prospects are clearly less favorable than was envisaged last spring. Growth is now expected to be lower and inflation higher primarily, but not exclusively, because of the higher oil price assumption upon which the current projections are based: oil prices are now assumed to be $3 a barrel higher in 1990 and $4½ a barrel higher in 1991 than was assumed in the May 1990 issue of the World Economic Outlook. The revised projections also indicate a somewhat different distribution of growth between the industrial and developing countries. Whereas growth in the developing countries was previously expected to exceed growth in the industrial countries in both years, it is now projected to fall short of growth in the industrial countries by ½ of 1 percentage point in 1990.

Among the industrial countries, the main revisions are higher projected growth in the Federal Republic of Germany (½ of 1 percentage point in 1990 and 1991), in part reflecting increased demand associated with economic unification with the German Democratic Republic; and lower growth in the United States (½ of 1 percentage point in 1990 and 1991) and Canada (½ of 1 percentage point in 1990 and 2 percentage points in 1991). In the developing countries, the growth projections for the Western Hemisphere have been reduced by about 1¾ percentage points in 1990 and by ½ of 1 percentage point in 1991. The projections for 1990 and 1991 for Eastern Europe and the U.S.S.R. have also been reduced substantially, reflecting new information on these economies, ongoing economic turmoil in the region, and, in some countries, the short-run effects of economic reform.

Table 1.Overview of the World Economic Outlook(Annual changes in percent, unless otherwise noted)
Current

Projections
Differences

from May 1990

Projections
198819891990199119901991
World output4.13.02.02.4-0.3-0.7
Industrial countries4.43.42.62.4-0.1-0.5
Developing countries4.23.02.24.2-1.0-0.3
Africa2.53.22.73.20.2
Asia9.05.05.05.4-0.4-0.3
Europe1.2-1.4-3.12.1-3.2-0.9
Middle East3.83.72.63.7-0.60.3
Western Hemisphere0.51.6-0.43.6-1.8-0.6
Memorandum
Eastern Europe1 and U.S.S.R.1.5-2.8-0.1-1.2-2.2
Of which:
Eastern Europe1.7–0.2–5.3–0.4–4.6–2.7
NIEs29.55.56.36.20.6-0.7
World trade
Volume9.17.35.45.3-1.2-0.5
Export prices of non-fuel primary
commodities (in U.S. dollars)23.5-0.3-8.1-0.42.0-2.5
Oil prices (in U.S. dollars)3,4-20.521.419.910.517.26.9
Inflation5
Industrial countries3.34.44.84.30.60.7
Developing countries70.6104.6104.816.133.81.8
Six-month LIBOR (in percent)68.19.38.48.0-0.2-0.3
Note: The current projections assume constant real effective exchange rates from the average level prevailing in August 1990. This assumption implies a real effective depreciation of the U.S. dollar of about 7 percent relative to the assumption underlying the May 1990 World Economic Outlook.

Eastern Europe is defined to include Bulgaria, Czechoslovakia, the German Democratic Republic, Hungary, Poland, Romania, and Yugoslavia. The first three countries and the U.S.S.R. comprise the “other countries” group in the Statistical Appendix.

The newly industrializing Asian economies (NIES) comprise Hong Kong, Korea, Singapore, and Taiwan Province of China.

Assumptions for 1990 and 1991.

Unweighted average of U.K. Brent, Dubai, and Alaskan North Slope crude oil spot prices.

Consumer prices, weighted average.

U.S. dollar interest rate.

Note: The current projections assume constant real effective exchange rates from the average level prevailing in August 1990. This assumption implies a real effective depreciation of the U.S. dollar of about 7 percent relative to the assumption underlying the May 1990 World Economic Outlook.

Eastern Europe is defined to include Bulgaria, Czechoslovakia, the German Democratic Republic, Hungary, Poland, Romania, and Yugoslavia. The first three countries and the U.S.S.R. comprise the “other countries” group in the Statistical Appendix.

The newly industrializing Asian economies (NIES) comprise Hong Kong, Korea, Singapore, and Taiwan Province of China.

Assumptions for 1990 and 1991.

Unweighted average of U.K. Brent, Dubai, and Alaskan North Slope crude oil spot prices.

Consumer prices, weighted average.

U.S. dollar interest rate.

Industrial Countries

Stance of Policies

Since mid-1988 there have been significant differences in the movements of interest rates most indicative of the stance of monetary policy in the three major countries (Chart 1). In the United States, the federal funds rate rose sharply over much of 1988 and then declined in 1989 as the growth of output slowed. It remained stable in the first half of 1990, but was reduced by the Federal Reserve by about ¼ of 1 percentage point in July 1990, which cited the need to offset the more restrictive credit practices on the part of banks, especially for real estate and takeover financing. By contrast, policy-related interest rates began to rise in mid-1988 in the Federal Republic of Germany and in early 1989 in Japan; this upward trend has not been reversed in the Federal Republic and is still evident in Japan, where the discount rate was increased by ¼ of 1 percentage point in late August.

Although in mid-1990 policy-related interest rates in the three major countries were well above their levels in 1987, reflecting the continued tight stance of monetary policy, official interest rates declined in several European countries. The Bank of France twice reduced the official intervention rates by ¼ of 1 percentage point in April 1990, when the French franc traded near the upper band of the exchange rate mechanism of the European Monetary System, although these interest rates had been increased by 1¼ percentage points at the end of 1989. In Italy, where there was also upward pressure on the lira, the discount rate was lowered by 1 percentage point to 12½ percent following the announcement in April 1990 of relatively ambitious medium-term targets for the government deficit. In the United Kingdom, by contrast, monetary conditions were tightened in the first half of 1990 to restrain demand. In Canada, monetary conditions were also tightened early in 1990, but then eased at mid-year as domestic demand growth weakened. Based on the usual technical assumption of unchanged policies, interest rates in the industrial countries are assumed to remain broadly stable at their August 1990 levels in the second half of 1990 and in 1991, except in some countries where significant changes in inflation are projected.

Chart 1.Three Major Industrial Countries: Policy-Related Interest Rates

(In percent a year)

In the staff’s projections, the stance of fiscal policy in the industrial countries is based on existing policies or, where appropriate, on proposed budget plans that are virtually certain to be adopted. Among the major industrial countries, this assumption implies expansionary fiscal policies at the general government level in the Federal Republic of Germany in 1990–91; restrictive policies in the United States in 1990 and in Italy and Canada in 1990–91; and a broadly neutral fiscal stance for Japan, France, and the United Kingdom in 1990, followed by a moderately restrictive stance in these countries in 1991 (Chart 2 and Appendix Table A17). The expansionary stance of fiscal policy in the Federal Republic of Germany reflects direct tax cuts in 1990 as part of the third stage of tax reform and additional expenditures associated with unification with the German Democratic Republic in both 1990 and 1991. For the smaller industrial countries as a group, the staff projects a decline of ¼ of 1 percentage point in the general government deficit as a share of GDP by 1991.

Chart 2.Three Major Industrial Countries: General Government Fiscal Indicators1

(In percent of GNP)

1 A positive fiscal impulse indicates an expansionary policy.

It is noteworthy that over the past few years the major industrial countries have been at different cyclical positions and hence have adjusted policies at different times. This contrasts with the situation in the early 1980s when most of these economies were near full employment and there was a general shift toward more restrictive policies to reduce inflation. In the current situation, the divergences in cyclical positions are likely to reduce the chances of a sharp, generalized slowdown or a major recession in any single country.

Interest Rate and Exchange Rate Developments

Since early 1989, movements in short-term interest rates have been mixed, with trends differing markedly among the major industrial countries, and there has been a remarkable convergence of short-term rates in the three largest economies (Chart 3). This follows a period of more than a year prior to early 1989 when short rates in most countries rose sharply as monetary policy was tightened. Short-term rates peaked in the United States in the spring of 1989, and then declined by almost 2 percentage points during the remainder of the year as the Federal Reserve eased reserve pressures. In the other major industrial countries except Canada, however, short-term interest rates continued to rise during 1989. From the beginning of 1990 through July, short-term interest rates fell somewhat in France and Italy, continued to rise in Japan and Canada, and remained roughly unchanged in the other major countries. After the invasion of Kuwait by Iraq in early August, short-term rates rose somewhat in France, the Federal Republic of Germany, Italy, and Japan, remained roughly unchanged in the United States and the United Kingdom, and declined in Canada as the authorities eased monetary conditions.

After increasing by ¾ of 1 percentage point early in 1990, long-term interest rates in the United States fell in June with indications of a weaker economy. Long-term government bond yields increased by 1¾ percentage points in both Japan and the Federal Republic of Germany between the fall of 1989 and the spring of 1990. In the Federal Republic, long-term rates stabilized in the second quarter, reflecting, in part, the market’s reassessment of the inflation and budgetary implications of unification. In the spring of 1990, for the first time since the early 1970s, long-term interest rates in the United States and the Federal Republic were at comparable levels. In Japan, the increase in long-term interest rates since late 1989 coincided with rises in short-term rates, although the steepening in the yield curve in early 1990 and again at midyear may have reflected revisions in market expectations of inflation. Following the invasion of Kuwait by Iraq, long-term interest rates rose significantly in all the major countries and yield curves steepened, reflecting expectations of higher inflation and tighter monetary policies as well as heightened uncertainty. By early September, long-term government bond yields were 7¾ percent in Japan and 9 percent in both the Federal Republic of Germany and the United States.

Chart 3.Major Industrial Countries: Short- and Long-Term Interest Rates

(In percent a year)

1 See Statistical Appendix Table A15, note 2, for the definition of short-term interest rates.

2 Canada, France, Italy, and the United Kingdom; composite is the average of the interest rates for individual countries weighted by the average U.S. dollar value of their respective GNPs in 1988.

3 See Statistical Appendix Table A15, note 3, for the definition of long-term interest rates.

4 Difference between the long- and short-term rates shown in the upper panels, except that for the United States and United Kingdom three-month treasury bill rates are used as short rates.

Chart 4.Major Industrial Countries: Equity Yield Gaps1 and Stock Market Prices

(In percent a year; January 1985 = 100)

Source: For stock market prices and equity yields, Data Resources, Inc.

1 The equity yield gap is defined as the difference between the yield on long-term government bonds and the inverse of the price-earnings ratio of stocks.

Real Effective Exchange Rate Indices Based on Relative Normalized Unit Labor Costs—Revised Method of Normalization

In the World Economic Outlook, changes in international competitiveness among the industrial countries are usually measured in terms of movements in real effective exchange rate (REER) indices based on relative normalized unit labor costs (RNULC) in manufacturing. These indices are calculated by the IMF and are published in International Financial Statistics, along with five other REER indices for the industrial countries, based on (non-normalized) relative unit labor costs (RULC), relative value-added deflators, relative wholesale prices, relative export unit values, and relative consumer prices. The indices based on RNULC are, in principle, the most useful for assessing changes in industrial countries’ competitiveness because of the advantages of cost-based, as opposed to price-based, competitiveness measures, and because of the sensitivity of current (non-normalized) unit labor costs to cyclical changes in hourly labor productivity.1 The normalization of unit labor costs aims at removing distortions arising from cyclical movements in labor productivity, which occur largely because changes in hours worked do not correspond closely to changes in the effective use of labor inputs by firms.

The method used in the past to normalize output per man-hour, and hence unit labor costs, was based on production functions estimated from historical data for each of the countries involved.2 In recent years, however, the application of this methodology was found to introduce a serious problem: for a number of countries there was a sustained drift of estimated normalized unit labor costs from current unit labor costs over periods far longer than what would generally be considered to be the duration of half a cycle. This feature of the estimates was clearly undesirable: normalized unit labor costs should in principle differ from actual unit labor costs only on account of transitory cyclical developments. These differences indicated that the method of normalization generated estimates of trend productivity growth for some countries that differed substantially from actual average productivity growth over full cycles. The result was a sustained drift of the real exchange rate indices based on RNULC from those based on RULC that in some cases was quite substantial.

The problem is illustrated in Chart 5, based on calculations of alternative measures of REER for the United States. The REER based on RULC indicates that the international competitiveness of the U.S. manufacturing sector improved by roughly 10 percent between early 1980 and late 1989, whereas the REER based on RNULC suggests that there was virtually no change in competitiveness. The difference reflects mainly the fact that the average growth rate of labor productivity in U.S. manufacturing over the decade exceeded the trend growth rate implied by the normalization procedure. The secular rise in RNULC compared to RULC over a period as long as a decade is clearly difficult to justify as a cyclical phenomenon.

The problem of RNULC drifting away from RULC for some countries may be attributed to a number of factors. First, the irregularity of economic cycles makes it difficult for any methodology to distinguish cyclical changes in the pace of productivity growth from changes in trend. This certainly applies to the past two decades, when cycles have been far from regular in both amplitude and duration. Second, application of the production function methodology is problematic, because of shortcomings of the available data (for example, for the capital stock), and requires the adoption of a number of arbitrary assumptions in the process of estimation. Third, some data are only available on an annual basis and the relatively long lags with which they become available implies that the production functions have to be estimated over relatively long periods, thus giving little weight to the most recent years. As a result, there is a danger that even the latest available econometric estimates are somewhat out of date and may fail to take proper account of recent structural changes.

To overcome these difficulties, a new method of normalization has been introduced. Normalized output per man-hour is now defined simply as the centered moving average of output per man-hour over a period of roughly five years (19 quarters), a period sufficiently long to span the average duration of business cycles in the postwar period. For the most recent nine quarters, this centered moving average can be calculated only if there are projections for output per man-hour; this is done by extrapolating the moving average using its growth rate in the last quarter for which data are available. This new definition is intended to eliminate the problem of long-term drift described above, while avoiding the technical complexity of the previous methodology. It is also intended to satisfy the original objective of correcting for cyclical movements in labor productivity, although the correction is, to some extent, arbitrary. The REER calculated on the basis of the newly defined RNULC for the United States is shown by the solid line in Chart 5. Corresponding indices are shown for all the major industrial countries in Chart 6. The new estimates will be published in International Financial Statistics beginning with the September 1990 issue.

Chart 5.United States: Alternative Real Effective Exchange Rate Indices

(1980 = 100)
1The choice among measures of international competitiveness for the industrial countries is discussed in Issues in the Assessment of the Exchange Rates of the Industrial Countries. Occasional Paper No, 29 (Washington: International Monetary Fund, 1984).2The basic methodology used for the ten largest industrial countries (together with early estimates) is described in Jacques R. Artus, “Measures of Potential Output in Manufacturing for Eight Industrial Countries.” Staff Papers, international Monetary Fund (Washington). Vol. 24 (March 1977), and Jacques R. Artus and Anthony G. Turner. “Measures of Potential Output in Manufacturing for Ten Industrial Countries, 1955–80,” unpublished manuscript. International Monetary Fund. 1978, The most recent estimates for the ten largest industrial countries are described in Anthony G. Turner, “Potential Output in Manufacturing for Ten Industrial Countries: Revised Estimates, 1965–86,” IMF Working Paper WP/87/2 (Washington: International Monetary Fund. 1987).

Long-term interest rates declined in the other major economies in the second quarter of 1990, and then increased in August to levels similar to their March peaks. In France and Italy, the declines in the second quarter reflected the easing of monetary policies noted above and, in the case of Italy, a reduction in inflation expectations following the budget agreement in May. In a number of other countries, price pressures and the associated tight monetary policies have kept interest rates high. In the United Kingdom, representative short-term rates in the first half of 1990 averaged 15¼ percent and long-term rates rose to 12½ percent, reflecting the continuation of restrictive policies aimed at containing high and rising inflation. Interest rates also remained high in Canada and Australia, although monetary policy was recently eased in both countries.

Equity prices rose in a number of countries in the first half of the year, partly reflecting the declines in bond yields (Chart 4). In the United States, equity markets reached record levels in mid-1990 despite a decrease in corporate earnings and prospects of a weaker economy. Equity prices in Japan recovered in the spring following the sharp fall that began in early 1990. In the Federal Republic of Germany, stock prices were relatively stable after March 1990 following large increases in the preceding six months, reflecting favorable business expectations associated, in part, with the prospect of unification. Equity prices fell sharply in all of the major markets following the developments in the Middle East. Differences in the extent of the decline in each market appeared to reflect movements in domestic interest rates and differences in the degree of dependence on imported oil. Through early September, the largest declines (of 16 to 22 percent) occurred in Japan and the major continental European countries that are most dependent on imported oil. In the United Kingdom and the United States, the decline in equity markets over this period was more moderate, in the neighborhood of 10 percent. The Canadian equity market was the most resilient, declining by 6 percent, not only because Canada is a small net exporter of energy (as is the United Kingdom), but also because short-term interest rates declined.

Compared to developments on world equity markets, the reaction of exchange markets to developments in the Middle East in early August was relatively muted. The decline in the U.S. dollar, which had been proceeding over much of the past year, was interrupted only briefly when the crisis in the Middle East broke. Over the month of August, the U.S. dollar depreciated further against each of the major currencies and in real effective terms it fell by 2½ percent to its lowest level in at least 30 years (Charts 5 and 6). With this latest fall, the dollar now stands at its lowest level in the postwar period against the deutsche mark. The decline in the dollar over the past year has reflected, at least in part, the significant narrowing of interest rate differentials and the relative cyclical positions of the major economies.

Chart 6.Major Industrial Countries: U.S. Dollar and Real Effective Exchange Rates1

(1980 = 100)

1 Real effective rates are calculated on the basis of relative normalized unit labor costs in manufacturing (see Box).

The Japanese yen depreciated in real effective terms by 14 percent during 1989 and by an additional 10 percent in the first four months of 1990. The decline in the effective value of the yen over this period can be attributed, in part, to some unwinding of the large appreciation against the deutsche mark that took place during 1988, even though interest differentials were moving in favor of assets denominated in deutsche mark. In addition, the depreciation of the yen in 1989 and early 1990 may have reflected a revision in market expectations concerning the need for future yen appreciation following the rapid decline in Japan’s current account surplus since the second quarter of 1989, as well as a decline in early 1990 in investor demand for Japanese equities that were offering relatively low yields. From April to July, however, the yen appreciated by 3¼ percent in real effective terms following the successful conclusion of bilateral negotiations between Japan and the United States that alleviated trade tensions, and following movements in interest rate differentials in favor of yen-denominated assets. By early September, the yen had recovered in effective terms from the declines during August associated with developments in the Middle East.

Over the course of 1989, the real effective value of the deutsche mark appreciated by 3 percent, but it remained stable during the first half of 1990 in the face of rising interest rates early in the year and uncertainty over the Government’s borrowing needs associated with unification. A noteworthy development in exchange markets has been the pattern of pressures on currencies in the exchange rate mechanism (ERM) of the European Monetary System. Over the first half of 1990, the Italian lira and the French franc displayed unusual strength and traded near their upper limits. During this period, offsetting actions were taken by the authorities of these countries, including reported official intervention on the part of the Bank of France and the Bank of Italy and reductions in official interest rates in both countries. More recently, the franc has been near the bottom of the narrow band and the lira has declined from its upper limit.

Progress on reducing inflation in France to a level that is now one of the lowest among the members of the EMS, as well as the associated gain in the credibility of French anti-inflation policy, may have contributed to the strength of the franc following the elimination of remaining capital controls in early 1990.3 The upward pressure on the lira also coincided with the elimination of remaining capital controls but, in contrast with the situation in France, inflation and interest rates are considerably higher in Italy than in the other ERM countries. The strength of the lira reflected large interest rate differentials—yields on Italian government bonds in early September, for example, were about 4½ percentage points above those on similar instruments in the Federal Republic of Germany—and perhaps also a decline in the currency risks of lira-denominated assets following the movement of the lira into the narrow band of the ERM in January 1990. There has also been upward pressure on the peseta reflecting a similar situation in Spain, including high rates of return on peseta-denominated assets. Expectations that the United Kingdom would join the ERM in the near future may have reduced the perceived currency risks of sterling-denominated assets and appear to have contributed to the strength of the pound sterling in the second quarter of 1990—although there remains considerable uncertainty concerning both the timing of the United Kingdom’s entry into the ERM and the limits of the band on entry. After the invasion of Kuwait by Iraq, sterling may have benefited to some extent from the position of the United Kingdom as a small net exporter of oil.

Economic Activity and Employment

Output growth in North America has been weak in the three quarters to mid-1990, averaging only about 1 percent at an annual rate. Real domestic demand is expected to increase by less than 1 percent in 1990, largely because of a slowdown in the pace of business investment and consumer spending, and by 1½ percent in 1991 (Chart 7 and Table 2). The external sector is projected to contribute ½ of 1 percentage point to GNP growth in 1990—slightly more than in 1989—but it would have virtually no impact on GNP growth in 1991 as export growth is projected to slow from an average of 13¾ percent in the past three years to about 6½ percent in 1990–91. In Canada, restrictive monetary and fiscal policies over the past few years are expected to slow domestic demand growth from 3 percent in 1989 to an annual average of about 1 percent in 1990–91. In contrast to developments in 1985–89, when the expansion of domestic demand outstripped the growth of output, the external sector is expected to contribute modestly to output growth in Canada in 1990.

In Japan, GNP is projected to continue to expand by 5 percent this year and by 3¼ percent in 1991. Although this is a downward revision from the May 1990 projections, reflecting the recent tightening of monetary policy and, to some extent, higher oil prices, growth in Japan remains robust. According to preliminary data, output rose at an annual rate of 10½ percent in the first quarter of 1990, owing in large part to a rebound of exports from an unusually low level in the last half of 1989, as well as to a surge in investment income from abroad. The projected growth of demand could exert further pressure on Japanese factor markets, although the large increases in fixed investment (at an average rate of 13¾ percent over the past three years) should expand capacity and help to maintain productivity and potential output growth at high levels in the near term.

Chart 7.Industrial Countries: Real Output and Total Domestic Demand1

(Percent change)

1 The shaded area indicates staff projections.

Table 2.Industrial Countries: Output and Demand in Real Terms(Annual percent change, in constant prices)
Staff Projections
19871988198919901991
Consumer expenditure3.43.92.72.32.2
Public consumption1.91.41.82.01.4
Gross fixed investment4.78.05.53.32.7
Final domestic demand3.64.43.42.72.2
Stock building10.20.2–0.20.1
Total domestic demand3.74.63.42.42.3
Exports of goods and services3.65.710.97.05.9
Imports of goods and services10.19.211.46.45.4
Foreign balance1–0.4–0.2–0.10.20.1
Real GNP3.44.43.42.62.4
Memorandum
Business investment25.911.48.24.93.2
Canada9.315.25.0–1.4–0.1
United States2.68.33.91.02.4
Japan8.215.517.811.14.8
France5.410.86.97.06.0
Germany, Fed, Rep. of4.16.88.510.56.3
Italy9.411.65.64.84,4
United Kingdom14.419.76.10.1–5.2

Changes expressed as a percent of GNP in the preceding year.

1988 GNP weights.

Changes expressed as a percent of GNP in the preceding year.

1988 GNP weights.

The revised projections for the Federal Republic of Germany include the anticipated effects of economic unification.4 The growth of GNP for 1990 is expected to be 4 percent, the same as in 1989 but ½ of 1 percentage point higher than in the May 1990 projection, which did not take into account the estimated effects of unification. The continuation of high growth in 1990 in spite of a 1¾ percentage point reduction in the contribution of the external sector would reflect a large rise in consumer spending related to the tax cut and, in part, to increased spending by residents of—or immigrants from—the German Democratic Republic.5 In 1991, the growth of consumption is expected to moderate to a more sustainable pace, and GNP in the Federal Republic would grow by 3¼ percent, ½ of 1 percentage point higher than projected in the May 1990 World Economic Outlook.

Growth over the next two years in France, Italy, and many of the smaller European Community countries is projected to slow somewhat, to an average of about 3 percent—broadly in line with estimates of potential output growth. In the United Kingdom, high interest rates are expected to contribute to a decline of ¼ of 1 percent during 1990 in domestic demand (fourth quarter to fourth quarter basis), reflecting a drop in fixed investment and a large fall in stockbuilding; exports would rise by 8½ percent in 1990, as producers have reportedly redirected output to export markets. GDP growth in 1990–91 is projected to slow in most of the other industrial countries reflecting slower growth in the larger industrial countries and the impact of higher oil prices.

Chart 8.Industrial Countries: Employment and Labor Force Growth and Unemployment Rates1

(In percent)

1 The shaded area indicates staff projections.

2Industrial countries except for the United States, Japan, Canada, and members of the European Community.

Chart 9.Major Industrial Countries: Capacity Utilization in Manufacturing1

(1980 = 100)

1 These indices provide an indication of the evolution over time of capacity utilization within individual countries. Because of differences in concepts and coverage, however, these indices may not be reliable indicators of differences in capacity utilization among countries.

2 Percent of firms operating at full capacity.

Employment growth in 1990 in the industrial countries is projected to slow by ½ of 1 percentage point to 1¼ percent, the smallest increase since 1983, largely because of the anticipated slowdown in North America and the United Kingdom (Chart 8). As a result, the unemployment rate is expected to rise in Canada and the United Kingdom by ¾ and 1 percentage point, respectively, from 1990 to 1991; in the United States the growth of the labor force is projected to slow, with the unemployment rate remaining broadly stable. In contrast, employment growth in the Federal Republic of Germany is expected to remain high relative to the growth of the labor force, and the unemployment rate in the Federal Republic is projected to fall by ¾ of I percentage point from 1989 to 6 percent by 1991. In Japan, gains in employment are expected to outpace increases in the labor force in 1990 allowing the unemployment rate to edge down further to 2 percent, and then remain broadly unchanged in 1991. The increase in employment in France and Italy is expected to remain unchanged at 1 and ½ of 1 percent, respectively, over the next two years. In France, the unemployment rate would fall to 8¾ percent by 1991, from 9½ percent in 1989. Unemployment rates declined in 1989 in a number of the smaller industrial countries, including Australia, Belgium, Finland, the Netherlands, Portugal, and Spain, although remaining relatively high in several of these countries. The average unemployment rate in the smaller industrial countries is expected to decline by ½ of 1 percentage point to 8½ percent in 1991; it would decline by 1 percentage point or more in Belgium, Ireland, the Netherlands, and Spain.

Robust growth in the three major continental European countries has raised rates of capacity utilization in manufacturing to their highest levels since the 1980–81 cyclical peak (Chart 9). In Japan, capacity utilization declined in the later part of 1989, reflecting some softening in manufacturing output owing in part to weakness in the U.S. automobile market. Since March 1990, however, manufacturing output has recovered, and capacity utilization in manufacturing rose to high levels in May-June. By contrast, in North America and the United Kingdom where output growth has slowed, capacity utilization rates have declined since 1988.

Price and Wage Developments

Consumer price inflation in the industrial countries is projected to increase by nearly ½ of 1 percentage point in 1990 to 4¾ percent (Charts 10 and 11). Average consumer price inflation in the industrial countries has increased steadily since 1986, with the increase in 1990 reflecting higher oil prices and tight factor markets in a number of countries. The expected slowdown of inflation in the industrial countries to 4¼ percent in 1991 reflects tightened monetary policies and the associated moderation of demand growth and wage pressures, the lagged effects of lower non-oil commodity prices, and in most European countries, the effects of currency appreciation.6

In the United States, consumer price inflation is expected to edge up to 5 percent in 1990 before declining to 4½ percent in 1991. The introduction of the goods and services tax in Canada in 1991 is expected to raise consumer prices by about 1 percentage point, but the underlying rate of inflation is expected to remain broadly in line with the U.S. rate. In Japan, consumer price inflation is projected to increase in 1990 to 2¾ percent, reflecting cost pressures from factor markets, before moderating to 2¼ percent in 1991 as the effects of the depreciation of the yen dissipate.

Chart 10.Industrial Countries: Consumer Prices, Unit Labor Costs in Manufacturing, and Commodity Prices

(In percent)

1 See Statistical Appendix Table A9, note 1, for the definition of the aggregate consumer price index.

2 The commodity price index is a global export-weighted basket of 35 commodities including oil.

There has been a substantial convergence of consumer price inflation in the larger European economies. In 1990 the average inflation rate in France is expected to be slightly higher than that in the Federal Republic of Germany, whereas in 1991 a further reduction in inflation in France and a rise in the Federal Republic are expected to result in a lower annual rate of inflation in France compared with Germany. Inflation in Italy is projected to decline by ¾ of 1 percentage point from 1989 to 1991, and reach 5½ percent by 1991. In the United Kingdom, inflation would decline by almost 1¼ percentage points by 1991.7 In many smaller industrial countries, inflation projections have also been revised upward reflecting, in part, higher oil prices. Inflation is expected to fall in 1990–91 in a number of countries that have adopted restrictive policies, notably Australia and New Zealand.

Chart 11.Major Industrial Countries: Consumer Price Indices

(Percent change from four quarters earlier)

1 Increases in indirect taxes raised consumer prices in 1989 in Canada, the Federal Republic of Germany, Japan, and Italy, and are expected to do so again in 1991 in Canada.

Unit labor cost increases in the manufacturing sector are projected to increase more rapidly over the next two years than in the recent past owing to more modest gains in productivity and higher wage gains (Chart 12 and Appendix Table A10). For the industrial countries as a group, the projected increase in labor costs would be less than those following the oil price increases in the 1970s, owing to the smaller percentage increase in world oil prices and the tight monetary policies now in place which would tend to dampen second round price effects. The continued above-average productivity performance projected for Japan may cushion the impact on price inflation of the 6 percent wage agreement in the spring of 1990. The effect on aggregate wage costs of recent wage settlements in the Federal Republic of Germany—also about 6 percent—is moderated by existing multiyear wage contracts that cover a substantial number of workers. Among the major industrial countries, increases in unit labor costs are expected to be highest in Italy and the United Kingdom, reflecting cyclical slowdowns in productivity growth and wage increases above the average for industrial countries. Among the smaller industrial countries, the rise in unit labor costs would slow somewhat over the next two years, particularly in Australia, New Zealand, and Spain, but it would remain high in Finland, Greece, Portugal, and Sweden.

Chart 12.Industrial Countries: Average Earnings and Unit Labor Costs12

(Percent change)

1 Average earnings are defined as total compensation per employed person. Unit labor costs are defined as compensation of employees per unit of output.

2 The shaded area indicates staff projections.

Developing Countries8

Stance of Policies

Macroeconomic imbalances, reflected in high and accelerating inflation and unsustainable balance of payments positions, have been an important factor in the poor growth performance of many developing countries in recent years. These imbalances have discouraged investment and have complicated the implementation of the structural reforms that are needed to improve the efficiency of resource allocation. Imprudent financial policies have played a key role in the development of these imbalances, even though external factors such as high debt-service obligations and revenue losses resulting from unfavorable terms-of-trade developments have also been important.

A number of developing countries—such as Bolivia, Chile, Ghana, Indonesia, Madagascar, Mexico, and Tunisia—have implemented comprehensive adjustment programs in recent years, combining macroeconomic stabilization and far-reaching structural reforms. Other countries, such as Argentina, Brazil, Cote d’lvoire, and Zambia, have tightened policies more recently in response to rapidly deteriorating macroeconomic conditions. A less favorable external economic environment, particularly the rise in oil prices and other economic repercussions of recent events in the Middle East, has complicated the task of macroeconomic adjustment in many oil importing countries, notably the indebted and low-income countries. More important, however, delays and slippages in the implementation of adjustment measures continue to pose serious problems in a significant number of developing countries.

Inflation remains a major concern of policymakers in many developing countries of the Western Hemisphere. Faced with hyperinflation, Argentina and Brazil severely tightened monetary conditions earlier this year and initiated measures to reduce fiscal deficits and improve efficiency, including tax reforms and the privatization of public sector enterprises. While monetary restraint has reduced inflation, the ultimate success of these stabilization efforts will depend critically on a lasting improvement in public finances. Rising inflation, albeit from much lower levels, has required a tightening of monetary policy in several other countries in the region such as Chile, Colombia, and Uruguay. Mexico and Bolivia have sustained policies of fiscal consolidation and moderate monetary expansion in order to avoid a resurgence of inflation after the successful implementation of stabilization programs in earlier years.

The decline in prices for a number of non-fuel primary commodities over the past year, notably tropical beverages, has affected financial conditions in many developing countries in sub-Saharan Africa. In these countries, primary commodities continue to account for a large share of output and exports, and trade taxes remain a major source of government revenue. The impact of adverse external developments, however, has varied considerably among countries, largely because of different economic policies pursued in recent years. Countries such as Ghana, Kenya, Madagascar, Nigeria, and Uganda, which have pursued policies of macroeconomic stabilization and structural adjustment, have avoided major disruptions and continue to consolidate the financial position of the public sector. By contrast, countries such as Cameroon, Cote d’lvoire, Ethiopia, Zaïre, and Zambia have delayed the implementation of restrictive monetary and fiscal policies and have experienced a marked deterioration in financial conditions. More recently, Côte d’lvoire and Zambia have begun to strengthen adjustment efforts, but delays and slippages in the adoption of stabilization programs remain a serious problem and financial conditions remain fragile in these and many other countries in sub-Saharan Africa. Elsewhere in Africa, stabilization and structural adjustment efforts continue in Algeria, Morocco, and Tunisia.

Following a sharp deterioration of the fiscal situation after the decline in oil prices in 1986, most fuel exporting countries in the Middle East, notably Saudi Arabia and the United Arab Emirates, have significantly strengthened public finances in recent years. In these countries, the stance of policy is expected to continue to be determined by the objective of fiscal consolidation, which will be facilitated by the recent increase in oil prices. Among the countries in the region that are not classified as fuel exporters, Jordan has tightened financial policies while Israel has allowed an increase in the fiscal deficit and somewhat faster monetary growth. In Egypt, fiscal imbalances have been reduced in recent years but they remain substantial. Fiscal conditions have deteriorated and monetary expansion has been high but declining in Turkey, one of the developing countries in Europe.

After several years of rapid economic expansion, inflation pressures have intensified in a number of developing economies in East and Southeast Asia. Responding to the prospect of higher inflation, monetary policy has been tightened in Singapore, Taiwan Province of China, and, more recently, in Indonesia and Thailand. In Korea, however, the moderation of economic activity from an extraordinarily rapid pace in recent years has raised concerns about the outlook for growth, and financial policies have not been tightened even though inflation has increased. In China, credit conditions have been eased substantially in response to the sharp decline in domestic demand that followed the stabilization measures implemented in 1989. While fiscal imbalances have been small in recent years in most developing economies in East and Southeast Asia, they have been quite large in a number of countries in South Asia such as India, Pakistan, and Sri Lanka. Pakistan and Sri Lanka have cut their fiscal deficits in the past two years, but the process of fiscal consolidation appears to have slowed recently even though fiscal imbalances remain substantial.

Economic Activity and Employment

For many developing countries, the recent increase in oil prices and other economic repercussions stemming from the invasion of Kuwait by Iraq have aggravated an already less favorable external economic environment. Slower growth of export markets, declining prices for non-fuel primary commodities, and higher interest rates in international financial markets have contributed to a slowdown of economic activity in many developing countries. In addition, in a significant number of countries the recent tightening of financial policies has dampened economic activity. However, the disruptions associated with large macroeconomic imbalances have also weakened growth in the countries that have tried to avoid or postpone adjustment. In view of these developments, the staff’s revised projections envisage a further decline in the growth of real GDP in the developing countries as a group from 3 percent in 1989 to 2¼ percent in 1990. The slower pace of economic activity is expected to result in declining or stagnating per capita GDP in 1990 in all developing regions with the exception of Asia (Chart 13). GDP growth in the developing countries is forecast to rebound to 4¼ percent in 1991, assuming that current stabilization efforts are sustained.

In the developing countries in the Western Hemisphere, economic activity in 1989 appears to have been somewhat stronger than previously estimated, but output is expected to contract in 1990. In Argentina and Brazil, the disruptions associated with hyperinflation and the sharp tightening of financial policies earlier this year have led to a marked downturn in economic activity. Output is also expected to contract in Peru. In both Argentina and Peru, 1990 is likely to mark the third consecutive year of negative growth. In Chile, monetary restraint has dampened buoyant investment demand and growth is expected to slow significantly in 1990. Economic activity continues to strengthen gradually in Mexico and Bolivia following the implementation of comprehensive stabilization and structural adjustment programs in earlier years. In Venezuela, however, output is recovering only slowly after the 1989 recession. The outlook for 1991 for the developing countries in the Western Hemisphere depends critically on the success of recent stabilization efforts. In the absence of policy slippages, economic activity is expected to revive in Argentina, Brazil, and Venezuela, while growth is expected to strengthen further in Mexico and to be relatively well sustained in a number of smaller countries in the region. The average growth of GDP in the Western Hemisphere is projected to rise to 3 ½ percent in 1991.

Chart 13.Developing Countries: Real GDP per Capita by Region1,2

(1970 = 100)

1 Composites are averages of percent changes for individual countries weighted by the average U.S. dollar value of their respective GDPs in 1988.

2 The shaded area indicates staff projections.

In Africa, GDP growth is projected to slow from 3¼ percent in 1989 to 2¾ percent this year, and to recover again to 3¼ percent in 1991. However, these aggregate growth rates mask considerable differences among the countries in the region. Although the recent decline in prices for non-fuel primary commodities has adversely affected many countries in sub-Saharan Africa, a number of countries such as Ghana, Kenya, Madagascar, and Uganda are expected to sustain growth rates in the range of 4¼ to 5½ percent in 1990 as continued stabilization and structural reform efforts in recent years have stimulated investment and exports. In response to significant adjustment efforts, growth has also strengthened in Algeria and Nigeria, although in Nigeria activity is expected to slow this year after a relatively strong expansion in 1989. Economic activity in these countries and in some smaller fuel exporting countries in the region is likely to be stimulated by the recent rise in oil prices. Output has started to decline, or has continued to contract, in countries that have delayed adjustment programs or have experienced repeated slippages in implementation, such as Cameroon, Côte d’lvoire, Sudan, and Zambia. As noted above, some of these countries (Cote d’lvoire and Zambia) have recently strengthened adjustment efforts. The projected recovery of growth in Africa in 1991 assumes that these adjustment efforts will be sustained. Growth in 1991 is expected to be relatively well maintained in most countries that have succeeded in reviving economic activity in recent years.

In the Middle East, real GDP growth is projected to slow to 2½ percent in 1990, reflecting in large part a substantial contraction of output in Iraq and Kuwait as a result of the trade embargo. In the other fuel exporting countries in the region, economic activity is likely to be stimulated by the recent increase in oil prices. Growth in these countries is expected to be sustained by relatively strong activity in the non-oil sector, and, in some cases, significant increases in oil sector output. The pace of economic activity is projected to strengthen in 1990 in several countries in the region that are not classified as fuel exporters, although some of these countries are likely to be adversely affected by shortfalls in workers’ remittances and the impact of the trade embargo of Iraq. After two years of recession, output growth has begun to recover in Jordan, while in Israel, recent increases in the labor force are likely to stimulate growth. In Egypt, however, activity is expected to remain weak. Real GDP growth in the Middle East is projected to strengthen in 1991 but the outlook for this region has become particularly uncertain since the invasion of Kuwait by Iraq. Output growth is expected to strengthen in Turkey, reflecting a strong expansion of domestic demand.

In the developing countries in Asia, output growth is projected to remain stable at 5 percent in 1990, slower than in 1987–88 when GDP in the region expanded at an average rate of 8½ percent, but considerably faster than in other developing regions. In China, the recent easing of monetary policy is likely to limit the further decline in GDP growth resulting from stabilization measures undertaken in 1989 and heightened uncertainty about the future of structural reforms. In Indonesia, Korea, and Thailand, growth in 1990 is expected to be stronger than anticipated earlier in the year. Domestic demand, particularly private investment, is a key factor in the current economic expansion in most developing countries in East and Southeast Asia. Export growth has slowed in several newly industrializing economies in the region, but continues to provide a strong stimulus in Indonesia, the Philippines, Thailand, and, more recently, Viet Nam. Export activity is also expected to support growth this year in India and Pakistan. Real GDP growth in the developing countries in Asia is projected to rise to 5½ percent in 1991. Output growth is expected to recover partially in China with the recent relaxation of financial policies, although it would remain below the rates achieved in the 1980s. GDP growth would be sustained or even strengthened in most countries in East and Southeast Asia, in spite of the recent monetary tightening in several countries. In Bangladesh, India, and Pakistan, GDP growth is expected to be sustained or increase slightly, but average growth rates in South Asia are likely to remain below those in East and Southeast Asia.

In most of the newly industrializing economies in Asia, such as Korea and Taiwan Province of China, employment growth has been comparatively strong, and unemployment rates—after declining steadily during the 1980s—have been in the 2 to 4 percent range. Unemployment also has declined in several other developing countries where economic activity has been relatively robust in recent years, notably Chile and more recently the Philippines.9 By contrast, unemployment has risen in a significant number of countries where widening macroeconomic imbalances necessitated a tightening of financial policies, such as Algeria, Argentina, and Venezuela. Unemployment appears to be particularly high in the developing countries in Africa, where jobless rates of between 20 and 30 percent appear to be quite common in urban areas.

Inflation

Following the introduction of stabilization programs earlier this year, price pressures have abated sharply in several high-inflation countries in Europe and the Western Hemisphere (Chart 14). Between January and June 1990, monthly rates of consumer price increases fell from 79 percent to less than 14 percent in Argentina, and from 72 percent to 1½ percent in Brazil. (These large declines are not fully reflected in the annual data presented in Chart 14.) Assuming that current stabilization efforts will be sustained, average annual rates of consumer price increases for these countries, as well as for the developing countries as a group, are projected to decline significantly in 1991.

Inflation is expected to be contained or to decline further in 1990–91 in most countries that have successfully reduced inflation from very high levels in the recent past, such as Bolivia, Mexico, Uganda, and Viet Nam. While price increases have begun to edge up in Chile, monetary restraint is expected to prevent a resurgence of high inflation. Inflation is projected to remain high in 1990 in several countries such as Sudan and Zambia that have experienced chronic inflation in recent years; but it would slow in 1990–91 in most developing countries where inflation pressures traditionally have been more moderate, including most developing countries in Africa, Asia, and the Middle East, as well as a number of developing countries in Europe and the Western Hemisphere. Financial restraint has substantially reduced inflation in 1990 in a number of these countries, including China, Madagascar, and Nigeria, although inflation is likely to increase significantly this year in Algeria. Price pressures also have intensified in 1990 in a number of rapidly expanding economies in East and Southeast Asia (including Korea and Thailand), where inflation had been kept in single digits. However, recent moves toward monetary restraint in several of these countries suggest that, in most cases, these pressures are likely to be contained.

Real Effective Exchange Rates

The depreciation of real effective exchange rates that began in 1989 in the developing countries in Asia, Europe, and the Middle East continued in the first quarter of 1990 but slowed or was reversed in the second quarter (Chart 15). In Asia the recent average depreciation reflects mainly a substantial decline in the real value of the Chinese yuan. Real effective exchange rates also depreciated, albeit at moderate rates, in late 1989 and early 1990 in a number of other economies in the region, including India. Korea, the Philippines, and Taiwan Province of China. In Korea and Taiwan Province of China, however, real effective exchange rates remain considerably above their troughs in 1987, with the depreciation during 1985–86 almost fully reversed. In nominal effective terms, the values of most currencies in the Middle East remained broadly unchanged in early 1990, but they fell in real effective terms mainly because of significant inflation differentials between the countries in the region and some major trading partners among the other developing regions.

Chart 14.Developing Countries: Inflation by Region12

(Percent change)

1 Regional composites are geometric averages of consumer price indices measured in local currencies for individual countries weighted by the average U.S. dollar value of their respective GDPs over the preceding three years. The large increases in inflation in Europe and the Western Hemisphere reflect the high inflation rates in a few developing countries in these areas.

2 The shaded area indicates staff projections.

In contrast to other developing country regions, real effective exchange rates in the Western Hemisphere continued to appreciate in the first half of 1990 as rapidly rising prices outstripped nominal devaluations in countries such as Argentina, Brazil, and Peru. In most other countries of the region, including Bolivia, Chile, and Mexico, real effective exchange rates changed little. In Africa, the improvements in competitiveness between 1985 and 1989 have generally been maintained as more countries, including Algeria, The Gambia, Ghana. Nigeria, and Uganda, have liberalized their exchange arrangements and adopted more flexible exchange rate policies. Nonetheless, a few countries in the region, such as Liberia and Sudan, have recently allowed substantial real appreciations of their currencies.

Chart 15.Developing Countries: Real Effective Exchange Rates1

(1980 = 100)

1 Composites for regional groups are weighted averages, where countries weights are dollar values of their respective GDPs during 1982–87. Because of the lack of appropriate domestic price data, the countries included for the Middle East and African regions cover only about 50 percent and 85 percent, respectively, of their regional GDPs. Coverage for the Western Hemisphere, Europe, and Asia is complete.

Eastern Europe and the Union of Soviet Socialist Republics10

In the past year, a broad consensus has emerged in most of the countries of Eastern Europe in favor of a market-oriented economic system. However, considerable disagreement remains about the desirable pace of reforms and the sequencing of reform measures, a disagreement that is particularly evident in the U.S.S.R. The following discussion focuses on recent economic developments and stabilization policies in the region, while issues of systemic reform are discussed in Supplementary Note 1.

Stance of Policies

The experience in many developing and industrial countries indicates that the establishment of conditions for relatively low and stable inflation is of central importance for the successful implementation of structural reforms. Under the previous system of central planning and microeconomic controls, stabilization policies were mostly confined to adjustments of physical output plans, with fiscal as well as monetary policies playing only a secondary role. As the countries of Eastern Europe abandon central planning or reduce its role, a fundamental task for economic management is to establish instruments of indirect macroeconomic control.11

The lack of necessary instruments and institutions and, in some cases, slippages in policies contributed to growing macroeconomic imbalances in the region in 1989. To reduce these imbalances and to provide a more stable framework for structural reforms, several countries undertook adjustment efforts in 1990. In Czechoslovakia, Hungary, Poland, and Yugoslavia, the fiscal policy adjustments that began in the first half of this year are expected to continue and, in some cases, to be strengthened so that all four countries would report a fiscal surplus for 1990. In 1991, the fiscal balance of some countries in Eastern Europe could deteriorate if trade among the members of the Council for Mutual Economic Assistance (CMEA) is shifted to world prices and payments in convertible currencies. For example, the staff estimates that the net fiscal benefits to Hungary from CMEA trade in 1990 are equivalent to about 2½ percent of GDP, largely reflecting taxes on cheap Soviet petroleum products. If the CMEA trade regime is abandoned, renewed efforts would be required to avoid a significant deterioration in fiscal positions that could jeopardize macroeconomic stability and adversely affect growth prospects.

In the U.S.S.R. the fiscal target for 1990 envisaged a sharp decline in the budget deficit, following an estimated deficit of about 10 percent of GDP in 1989.12 In June 1990, the Parliament attempted to address budgetary developments and the Prime Minister of the U.S.S.R. presented a proposal that called for a substantial increase in July in some food prices, most notably bread, with additional price increases planned for the beginning of 1991. However, the Parliament rejected the price increases, partly because the adjustments would have been implemented without parallel structural reforms of the economy. Budgetary problems in several countries in Eastern Europe were aggravated by weaker-than-expected levels of economic activity in the first half of 1990 that contributed to reduced fiscal revenues. In Yugoslavia, the management of fiscal policy was complicated by an erosion of the central government’s ability to control the unexpectedly high expenditures of the Republics.

The main goal of monetary policy in Yugoslavia since mid-December 1989, and in Poland since January 1990, has been to reduce the rate of price increases from hyperinflation levels. Tight monetary policies supported by fiscal and, especially in Poland, by incomes policies have successfully eliminated hyperinflation in these countries. In both countries and also in Hungary, where inflation pressures were substantially lower than in Poland and Yugoslavia, upward adjustments in interest rates and tighter control over credit expansion were the key monetary instruments. In Bulgaria, Romania, and the U.S.S.R., on the other hand, the government continued to have essentially automatic access to credit from the banking sector. In the absence of an independent monetary policy, suppressed, and sometimes open, inflation pressures remain a central problem in these countries. Monetary policy developments were radically different in the German Democratic Republic: the Deutsche Bundesbank became the monetary authority and the deutsche mark became the sole legal tender after the country formed a currency and economic union with the Federal Republic of Germany on July 1, 1990.

Economic Activity and Employment

In the first half of 1990, economic activity in Eastern Europe has been weak and for the year as a whole output is projected to decline by about 5¼ percent; a decline also is expected in the U.S.S.R.13 In 1991, output growth is likely to be slightly negative in the Eastern European countries as a group—partly as a result of the assumed increase in oil prices, which is compounded by the high energy intensity of these economies—and stagnation is projected for the U.S.S.R. Given the uncertainties with regard to both the course of current and future policies and the effects of changes in policies on economies undergoing radical transformations, these projections are highly tentative.

The decline in output in 1990 is projected to be most severe in the German Democratic Republic and Poland, the countries that have implemented the most far-reaching reforms.14 There has been a substantial increase in activity in the nonsocialized sector in both countries, but this sector is currently relatively small in all countries in the region and a temporary fall in total output appears to be inevitable as these economies restructure from inefficient production and distribution systems based on central planning toward a market-oriented system. The German Democratic Republic and Poland are projected to be the first countries to reap the efficiency gains of the market system, and this is reflected in relatively favorable medium-term growth projections. The German Democratic Republic, of course, would also benefit from integration with the Federal Republic of Germany.

In the U.S.S.R., the projected decline in output in 1990 is, in part, a reflection of a breakdown in labor discipline and a result of ethnic and regional conflicts. The policy shift in late 1989, which placed greater emphasis on the production of consumer goods, was largely ineffective in alleviating the excess demand for these goods. From the demand side, sizable increases in wages and the large fiscal deficit contributed importantly to the continuation of market imbalances. On the supply side, there have been many indications in the U.S.S.R. and several countries of Eastern Europe of a widespread failure of coordination between different enterprises, as the role of the central plan was weakened without the simultaneous introduction of a market-based coordination mechanism based on freely determined prices. By mid-1990, this coordination failure had resulted in supply shortages and threatened production stoppages; it had also led to underfulfillment of bilateral trade agreements, especially as regards exports of the U.S.S.R., and hence had spillover effects on other countries in the region. As a net exporter of oil, the U.S.S.R. will benefit somewhat from the recent increase in oil prices. However, the potential benefits will be limited by lower levels of” oil production resulting from the deteriorating capital stock in this sector.

In the German Democratic Republic. Hungary. Poland, and Yugoslavia, the slowdown in economic activity and the restructuring of the economy were accompanied by a rise in unemployment. By the end of August 1990, unemployment in Poland is estimated to have increased to 4 ½ to 5 percent of the labor force and in the German Democratic Republic to 4 to 4½ percent, with some further increases likely over the remainder of the year.15 At the same time, unemployment in Hungary remained low at about 1 percent. The unemployed in these countries are eligible for benefits and. in some cases, retraining: the Government of the U.S.S.R. is planning to introduce a similar unemployment insurance system in the second half of 1990. Although unemployment in these countries is large by the standards of the past—open unemployment had been virtually nonexistent under the old system—it is still relatively low in comparison with many industrial countries.

Inflation and Exchange Rates

Inflation in most countries of Eastern Europe and the U.S.S.R. had been suppressed prior to 1989. The continued underlying inflation pressures in the U.S.S.R. in 1990 were manifested in widespread shortages, queuing, and possibly a sizable monetary overhang.16 Given this legacy, substantial upward movements in average price levels may be unavoidable with large-scale price liberalization, particularly if subsidies are reduced or eliminated at the same time and alternative outlets for purchasing power, such as the sale of state assets to the private sector are slow to develop. In these circumstances, it is important that financial policies prevent the initial jump in prices from evolving into a lasting inflationary process.

During the first half of 1990, inflation rates differed significantly across countries. The highest rates were reported in countries that had either undertaken price reforms, or where inflation had already been high in 1989, such as Poland, Yugoslavia, and, to a much lesser extent, Hungary. Faced with hyperinflation at the end of 1989, Poland and Yugoslavia adopted programs designed to reduce inflation significantly. After a sharp devaluation of their currencies, Yugoslavia in mid-December 1989 and Poland on January 1, 1990 introduced a fixed exchange rate regime with full convertibility for most current account transactions by pegging their currencies against the deutsche mark and the U.S. dollar, respectively. Consumer price inflation in Poland declined quickly and markedly, and by July 1990 it had fallen to about 3½ percent at a monthly rate. In Yugoslavia, monthly inflation was approximately zero in June 1990, although it increased again somewhat to about 2 percent in the subsequent two months following the upward adjustment in selected administered prices and additional price liberalizations. The move to a fixed exchange rate regime has been widely viewed as having fulfilled its objective, namely, to establish a credible domestic anti-inflation policy by pegging to a low-inflation currency. That the commitment to the fixed exchange rate regime was itself credible, stemmed to a large extent from tight domestic monetary and fiscal policies.17

In several countries, but particularly in Poland, incomes policies contributed importantly to the early success of anti-inflation programs. Wages served as a second nominal anchor (along with the exchange rate), and wage increases during the first half of 1990 were below the ceilings that would have triggered punitive taxation, and substantially below the actual rate of price inflation. Taxes on “excessive” wage increases were also introduced in Hungary and the U.S.S.R. In general, the experience of other countries indicates that incomes policies, including those based on wage taxes, have seldom been effective except for short periods. Moreover, continued access for state-owned enterprises to additional credits and subsidies has often undermined incomes policies; in some countries in the region, the effectiveness of supporting credit policies has been mitigated by the increasing importance of forced credit through interlocking enterprise arrears. This underscores the importance of introducing a competitive financial sector, combined with effective bankruptcy laws, to eliminate distortionary and inflationary consequences of the “soft” budget constraint for enterprises.18

Several countries in Eastern Europe implemented discrete adjustments in some prices and a limited liberalization of their pricing system. In Czechoslovakia, prices for transport and communication were based on a uniform markup at the beginning of 1990, following the earlier introduction of a similar pricing rule for industrial wholesale goods and agricultural inputs. While this resulted mostly in adjustments of relative wholesale prices, the overall retail price level increased significantly after food prices were raised by an average of about 25 percent in July. Inflation pressures increased further in some countries in Eastern Europe when the U.S.S.R. reduced its subsidized fuel shipments in the second half of 1990, and they were again increased when world oil prices rose sharply in August.

Recent changes in the average real effective exchange rate of Eastern Europe largely reflect developments in the countries that have had high rates of inflation. In Poland, the large nominal depreciations late in 1989 and at the beginning of 1990 resulted in sharply lower real effective exchange rates in the first quarter of 1990. During the second quarter, the real effective exchange rate remained broadly stable. In Yugoslavia the real effective exchange rate appreciated substantially, especially during the first quarter of 1990, when domestic price increases were still high.

World Commodity Markets

Oil Market Developments

World oil prices strengthened considerably in 1989 and remained volatile in the first half of 1990: the average petroleum spot price (APSP) fluctuated between $14.30 and $19.60 a barrel between April 1989 and June 1990, reflecting weather conditions and other temporary factors (Chart 16).19 Oil prices were weakest in mid-1990, owing primarily to the continued high level of total OPEC crude oil production in excess of the aggregate output quota. As a result, world oil inventories increased considerably in the second quarter of 1990, which exerted additional downward pressure on prices. Following an OPEC decision in early May 1990 to curtail output temporarily, total OPEC production was estimated to have declined somewhat in May—June 1990.

Chart 16.World Commodity Prices

(Percent change)

1 Average monthly spot market price of Brent, Dubai, and Alaskan North Slope, representing light, medium, and heavier crude oils in three different regions. The shaded area indicates staff assumptions.

2 Oil and commodity prices deflated by the export price of manufactures of industrial countries. The shaded area in the lower panel indicates staff assumptions.

3 The OPEC reference price of $18 a barrel was effective from February 1, 1987 to July 27, 1990 when it was raised to $21. The reference price refers to the unweighted average of the official export prices of seven crude oils.

The average petroleum spot price rose by 14 ¾ percent to $16.40 a barrel in July 1990, reflecting mainly market speculation regarding the outcome of the OPEC meeting and the threats of Iraq to “deal with force” with persistent quota violators.20 Oil prices surged on August 2, the day of the invasion of Kuwait by Iraq. The APSP immediately jumped to $22 a barrel from an average of $18 a barrel in the previous week. In the following six weeks the APSP fluctuated between $23 and $33 a barrel, reflecting market fears that the invasion could disrupt oil coming from Iraq and the countries around the Persian Gulf—which account for about 25 percent of world supplies—the possible effects on oil supplies of the sanctions imposed on Iraq by the Security Council of the United Nations, and the risk of further military operations in the area.

Future movements in oil prices will depend upon developments in the Middle East. Prices could rise further, perhaps substantially, in the event that military operations resulted in the destruction of oil producing facilities; or they could fall from present levels if the political problems were to be resolved, or even if the situation remained unchanged but other oil producing countries increased production. It is estimated that the excess idle capacity of OPEC members, excluding Iraq and Kuwait, amounts to about 4 million barrels a day, which is roughly equivalent to the combined pre-crisis level of exports from Iraq and Kuwait. A majority of OPEC members agreed on August 29 to suspend production ceilings and to allow members to increase production. A number of countries have stated that they would increase production, and Saudi Arabia has already done so. In addition, commercial oil inventories at the present time remain at relatively comfortable levels, reflecting high OPEC production in the first seven months of 1990, and the governments of major industrial countries hold strategic petroleum reserves of close to 1 billion barrels.

As noted in the Introduction, oil prices are assumed to average $26 a barrel in the fourth quarter of 1990 before coming down gradually to the new OPEC reference price of $21 per barrel by the fourth quarter of 1991. This reflects the assumption that most of the production shortfall corresponding to Iraq and Kuwait would be gradually offset by increased production by other members of OPEC. For the medium term, the projections are based on the usual technical assumption of constant real oil prices, implying increases of about 4 percent at an annual rate in the nominal U.S. dollar price from the first quarter of 1992 to 1995.

Non-Oil Commodity Prices

Non-oil commodity prices declined sharply during 1989, reflecting the reduced pace of world economic activity as well as improved supplies in some commodity markets (see Chart 16). In the first half of 1990, food prices declined a further 6 ½ percent, agricultural raw material prices were stable, whereas tropical beverage and mineral and metal prices increased by 7 ½ and 4 percent, respectively. Notwithstanding this recent firming, in June 1990 non-oil commodity prices were on average 7¼ percent below their levels in June of the previous year, with the most pronounced decline for tropical beverages (20 percent) and the smallest for agricultural raw materials (3¼ percent). Non-oil commodity prices appeared to be largely unaffected by the increase in oil prices in August, the notable exceptions being aluminium prices, which rose—reflecting concerns over the availability of supplies from smelters in some countries around the Persian Gulf—and tea prices, which weakened mainly because of the embargo of tea shipments to Iraq.

On a year-over-year basis, the Fund’s index of non-oil commodity prices (based on world export weights and expressed in U.S. dollars) is projected to decline by 8 percent in 1990, although the bulk of that decline occurred during the second half of 1989. In the ten years since 1980, non-oil commodity prices have dropped by some 40 percent relative to the export price of manufactures of industrial countries. With broadly stable growth in the industrial countries, average non-oil commodity prices are projected to decline by about ½ of 1 percent in 1991. Prices of tropical beverages are expected to recover from the sharp declines of the past few years and increase by 8¾ percent in 1991, reflecting some rundown in stocks and increased demand. Mineral and metal prices are projected to decline by 10¾ percent in 1991, with continued easing of supply constraints and reductions in demand.

Trade and Payments Balances and Debt

World Trade Developments

The volume of world trade is projected to increase by about 5½ percent in both 1990 and 1991. The slowdown from the rapid growth in 1988 and 1989 (9 percent and 7¼ percent, respectively) is in line with the anticipated moderation in the expansion of the world economy, particularly the weakening growth of investment which is relatively trade-intensive. Growth in the volume of trade is projected to fall from 7½ percent in 1989 to 5 percent in 1991 in the industrial countries; and from 7¾ percent to 5¾ percent in the developing countries.

The growth of industrial country import volumes is projected to decline by 3½ percentage points from 1989 to 1991, while the rate of expansion of exports would fall by 1 ¾ percentage points. Among the major industrial countries, steady declines in export growth are projected for the continental European countries, with the most pronounced decline in the Federal Republic of Germany largely reflecting the diversion of trade to the German Democratic Republic.21 World market shares of non-oil exports are projected to rise in 1990–91 for France, Italy, and the United Kingdom; the market share of the Federal Republic of Germany is projected to increase in 1990 and to fall in 1991 (Chart 17).

Chart 17.Market Shares of World Non-Oil Exports12

(In percent)

1 Shares are calculated in U.S. dollars at current prices.

2 The shaded area indicates staff projections.

In the developing countries, import growth is projected to fall faster than exports in volume terms in 1990, while the opposite pattern is expected in 1991. The decline in export growth among the developing countries reflects reductions in the volume of fuel exports; export growth of the non-fuel exporting countries is projected to decline only moderately in 1990–91. By contrast, the reduction in the growth of developing country imports would result from the performance of the non-fuel exporting countries largely on account of adjustments to higher oil prices; import growth in the fuel exporting countries is expected to increase rapidly in 1991. The growth of exports is projected to outpace the expansion of imports in the four newly industrializing Asian economies as a group in 1991—reverting to the pattern of higher export growth that existed before 1987—reflecting import volume adjustments to compensate for the deterioration in the terms of trade.

Current Account Developments: Industrial Countries

From 1986 to 1989 the current account surplus of Japan narrowed substantially by about 2½ percent of GNP; over this period the U.S. current account deficit fell by 1 ¼ percent of GNP (Chart 18, Table 3). Corresponding to these changes in the current account were changes in net private capital flows and the reserves of the monetary authorities. In each year from 1986 to 1988, the net asset position of the monetary authorities declined in the United States but rose in Japan; this pattern was reversed in 1989 (Table 4).22 Based on the usual assumptions of unchanged policies and real exchange rates, the external imbalances of these two countries are projected to narrow further in 1990 and remain broadly unchanged in 1991. After increasing somewhat from 1986 to 1989, the surplus of the Federal Republic of Germany is projected to fall by the equivalent of 2¼ percent of GNP from 1989 to 1991. as national savings are redirected toward increased investment associated with unification.

Chart 18.Three Major Industrial Countries: Current Account Imbalances1

(In percent of GNP)

1 The shaded area indicates staff projections.

Table 3.Alternative Measures of Current Account Imbalances in Selected Countries, 1980–91
Staff Projections
198019861988198919901991
United States
In billions of U.S. dollars1.1–145.4–128.9–110.0–97.0–99.7
In percent of GNP0.0–3.4–2.6–2.1- 1.8–1.7
Japan
In billions of U.S. dollars–10.785.879.657.247.555.8
In trillions of yen–2.414.510.27.97.18.2
In percent of GNP–1.04.42.82.01.71.8
Germany, Federal Republic of
In billions of U.S. dollars–13.839.750.455.448.938.4
In billions of DM–25.185.888.4104.180.060.5
In percent of GNP–1.74.44.24.63.32.3
United Kingdom
In billions of U.S. dollars6.60.1–26.0–31.3–26.6–21.6
In percent of GNP1.2–3.1–3.7–2.8–2.0
Canada
In billions of U.S. dollars–1.0–7.3–8.3–14.1–15.7–16.9
In percent of GNP–0.4–2.0–1.7–2.6–2.7–2.7
Memorandum
Four Asian NIEs1
In billions of U.S. dollars–9.123.227.821.313.111.8
In percent of GNP–6.39.87.44.82.72.2
European Community
In billions of U.S. dollars–47.751.217.26.2–3.7–16.6
In percent of GNP- 1.51.50.40.1–0.1–0.2

The four Asian newly industrializing economies comprise Hong Kong, Korea, Singapore, and Taiwan Province of China. The current account projections for this group, which in some cases are based on partial information, are subject to a larger margin of error than are those for the other countries listed in the table.

The four Asian newly industrializing economies comprise Hong Kong, Korea, Singapore, and Taiwan Province of China. The current account projections for this group, which in some cases are based on partial information, are subject to a larger margin of error than are those for the other countries listed in the table.

The current account deficit of the United Kingdom, which rose substantially during 1986–89, is projected to decline by PA percent of GNP during 1990–91, owing to the contraction of domestic demand in 1990. After widening to 2 ½ percent of GNP in 1989, the deficit of Canada is expected to increase somewhat further and to average 2¾ percent of GNP in 1990–91. In the same period, external deficits are expected to range from 3¾ percent to 5 ½ percent of GNP in Australia, Finland, Greece, New Zealand, Spain, and Sweden; Belgium, the Netherlands, and Switzerland would continue to register substantial surpluses.

The trade deficit of the industrial countries as a group is projected to fall by $12 billion in the two years after 1989 to $28¼ billion in 1991. The trade balance of the major industrial countries is expected to shift from a deficit of $5 billion in 1989 to a surplus of $22 billion in 1991, while the combined trade deficit of the other industrial countries would widen by $14 ½ billion over the same period, reflecting primarily developments in non-oil trade. In 1989, the rise in oil prices led to a $23 billion increase in the oil trade deficit for the industrial countries as a group, with most of the deterioration affecting the major industrial countries. On the basis of the new oil price assumption, the oil trade deficit for the industrial countries is expected to rise by over $25 billion in 1990 and by an additional $16 billion in 1991.

Current Account Developments: Developing Countries

The aggregate current account deficit of the developing countries is estimated to have increased by $2 billion in 1989 to $16 billion, or 1¾ percent of exports of goods and services. The increased deficit reflected the net effect of declines in non-oil commodity prices and prices of manufactures, a deterioration in net service payments, and also the impact of higher oil prices (which was largely responsible for the overall improvement in the developing countries’ terms of trade). The current account deficit of the developing countries is projected to fall sharply to $4¾ billion in 1990, and to widen further to $11 billion in 1991 (½ of 1 percent and I percent of exports of goods and services, respectively). This deterioration between 1989 and 1991 in the current account deficit for the developing countries as a group reflects very different developments in the fuel exporting and the non-fuel exporting countries: for the fuel exporters, the current account is projected to improve by $17 billion, swinging from a deficit in 1989 to an $11 billion surplus in 1991; for the non-fuel exporters, the current account deficit is expected to widen by $12 billion to nearly $22 billion in 1991.

Table 4.United States, Japan, and Federal Republic of Germany: Current Account Financing, 1986–90(In billions of U.S. dollars and percent)
19901

1st
1986198719881989half
United States
Current account2–145.4–162.3–128.9–110.0–87.0
Capital account, net3109.5108.093.3126.596.4
Of which:
Direct investment. net2415.415.942.240.5–3.6
Assets–18.7–31.0–16.2–31.7–24.8
Liabilities34.146.958.421.0
Net transactions of monetary authorities535.954.435.6–16.5–9.4
(As a percent of current account)(–24.7)(–33.5)(–27.6)(15.0)(10.8)
Japan
Current account85.887.079.657.247.2
Capital account, net3–72.1–44.8–64.1–81.9–78.0
Of which:
Long-term–131.5–136.5–130.989.2–69.6
Of which: direct investment, net4–14.3–18.4–34.7–45.2–51.2
Short-term56.995.764.029.43.6
Net transactions of monetary authorities5–13.7–42.3–15.524.7
(As a percent of current account)(–16.0)(–48.6)(–19.4)(43.2)
Germany, Federal Republic of
Current account39.745.850.455.555.4
Capital account, net3–36.9–22.8–70.2–65.6–50.6
Long-term15.5–12.9–49.6–12.1–58.5
Of which: direct investment, net4–8.5–7.2–9.9–7.5–14.9
Short-term3–52.4–9.9–20.653.5–9.7
Net transactions of monetary authorities5–2.8–23.019.810.1–5.6
(As a percent of current account)(–7.1)(–50.2)(39.3)(18.2)(–10.1)

At annual rates. Current account data have been seasonally adjusted.

Data have been revised to exclude unrealized capital gains and losses associated with exchange rate changes.

Includes errors and omissions.

A minus sign indicates a rise in net assets or an outflow of capital.

Excludes valuation adjustments; a minus sign indicates an increase in reserves.

At annual rates. Current account data have been seasonally adjusted.

Data have been revised to exclude unrealized capital gains and losses associated with exchange rate changes.

Includes errors and omissions.

A minus sign indicates a rise in net assets or an outflow of capital.

Excludes valuation adjustments; a minus sign indicates an increase in reserves.

The reduction in the current account surpluses of the four newly industrializing economies of Asia that began in 1987 is projected to continue in 1990–91. Most of this adjustment reflects large increases in merchandise imports, which rose from $150 billion in 1987 to $232 billion in 1989 and are projected to increase further to $287 billion in 1991. Net investment income receipts rose sharply from a deficit of $¾ billion in 1985 to a surplus of $4¾ billion in 1989, but they are expected to increase only marginally in 1990–91. Most of the increase in net investment income receipts during 1985–91 is accounted for by a large rise in net receipts in Taiwan Province of China and a decline in net payments in Korea. The projected decline in export growth and the rapid expansion of imports reflect the anticipated slowdown in external demand, the increase in oil prices, relatively robust domestic demand, and the increased openness of Korea and Taiwan Province of China to foreign products.

The external accounts of a number of Eastern European countries are projected to improve temporarily in 1990, the result of significant declines in imports and strong export growth related to weak domestic demand and better access to foreign markets. In 1991, a halt to the sharp declines in output in 1990, together with the increase in oil prices, is expected to lead to a deterioration in the current account position of the Eastern European countries as a group. The projections also reflect a combination of the anticipated terms-of-trade deterioration vis-a-vis the U.S.S.R., the short-term effects of trade liberalization, and increased demand for investment goods associated with the economic transformations under way in some countries. The switch to convertibility envisaged for trade with other CMEA partners, especially the U.S.S.R., is expected to have several important effects on trade relations in the region. First, the dramatic increase in commodity prices relative to the prices of manufactures in trade with the U.S.S.R. is expected to change both the geographic and the commodity composition of trade and to reduce purchasing power in Eastern Europe. Second, the move to world prices in trade between Eastern European countries and the realignment of exchange rates are likely to increase trade with industrial countries (and reduce trade with the U.S.S.R.) and reduce trade volumes until these countries are in a better position to compete on world markets.

The financing of the increased current account deficits of the developing countries is expected to be provided largely by official creditors. The total amount of net external borrowing is projected to rise from $32 billion in 1989 to $42 billion in 1991, nearly all of which represents financing from official sources, including use of Fund credit. Net Fund financing is projected to reach $2 billion in 1990 and nearly $5 billion in 1991, reversing the pattern of net repayments to the Fund during the four preceding years. The increased use of Fund credit is to support policy changes that are being adopted in a number of countries, including through the provision of financing for debt and debt-service reduction operations.23 The rise in net official financing has been accompanied by a decline of one third in the total amount of new commitments raised in international capital markets by developing countries in 1989 and early 1990. This decline mainly reflected the absence of concerted lending arrangements as spontaneous lending to countries with market access remained broadly unchanged. An encouraging development, however, has been that a few private borrowers from countries with recent debt-servicing difficulties were able to obtain limited amounts of foreign credits on a voluntary basis. Over the near term, it is likely that developing countries’ relations with commercial creditors will continue to be dominated by debt-reduction operations.

During 1990–91, the net cash flow position of the developing countries, measured by the net availability and use of foreign exchange, is projected to reflect the net effect of weaker trade performance, additional external borrowing, and a buildup of reserves (Chart 19). In countries with recent debt-servicing difficulties, the projected developments in net sources of foreign exchange stem from the substantial narrowing in the trade surplus—from $30 billion in 1989 to $22 billion in 1991—which is expected to be more than offset by a rise in non-debt-creating flows (from $14 billion to $20 billion) and external borrowing (from $20 billion to $28 billion). Given the projected decline in interest payments, the improved net cash flow position will allow countries with recent debt-servicing difficulties to add $33 billion to their foreign exchange reserves during 1990–91. Exceptional financing would decline in 1990–91, largely because of the anticipated reduction in payments arrears. Countries without debt-servicing problems are projected to nearly double their net borrowing in 1990 to over $30 billion, as non-debt-creating flows are expected to stabilize at around $20 billion; these resources are expected mainly to finance the increase in foreign exchange reserves and other foreign assets.

External Debt

Total external liabilities of developing countries (excluding Fund credit) are projected to increase by 9 percent in 1990–91 and to reach $1,354 billion by the end of 1991. As commercial bank debt is expected to fall by 1¾ percent to $518 billion, most of the increase in liabilities would be to official creditors. The Western Hemisphere is the only region where external debt is projected to remain broadly unchanged (at $415 billion); the debt of other regions is expected to rise by about 13 percent in 1990–91. The share of the total debt of developing countries owed to official creditors would rise from 42 percent in 1989 to 45 percent in 1991, with countries with recent debt-servicing difficulties accounting for nearly three fourths of the $100 billion increase in official debt. The increased importance of official creditors reflects their relatively large contribution to the new financing provided to heavily indebted countries as well as the debt-reduction operations concluded between developing countries and their commercial bank creditors, including market-based debt conversions such as debt-equity swaps, buy-backs, and private-sector discounted prepayments. In recent years, the share of official creditors in the total debt of countries with recent debt-servicing difficulties has continued to reach new peaks, while for the countries that avoided such difficulties this share declined to levels considerably below those of 20 years ago (Chart 20).

Since early 1989, there has been continued progress in implementing the strengthened debt strategy, Costa Rica, Mexico, and the Philippines have already concluded financing packages that include debt and debt-service reductions. Morocco has reached an agreement in principle and Venezuela has agreed on debt-restructuring terms with their commercial bank creditors: both agreements provide for debt and debt-service reductions. Uruguay has obtained waivers for comprehensive buy-back operations, while Jamaica has obtained waivers for limited buy-backs in the context of debt rescheduling. An encouraging development has been the ability to raise external funds on a limited basis by a number of heavily indebted countries—including Chile, Mexico, and Venezuela—that have been relatively successful in implementing sound economic policies while maintaining constructive relations with their external creditors. However, the number of debt-reduction agreements is still limited because of the prolonged and complex negotiation process, the divergence of interests among creditors, and uncertainties about the adjustment efforts on the part of some debtors. A number of other countries that have introduced stabilization programs and signaled their intention to reach agreement with their external creditors have encountered difficulties in the negotiations and have experienced a substantial accumulation of external payments arrears.

Chart 19.Developing Countries: Availability and Use of Foreign Exchange1

(In billions of U.S. dollars)

1 The shaded area indicates staff projections.

2Including direct foreign investment and official transfers.

3Excluding interest and official transfers.

Official creditors have continued to provide countries implementing adjustment programs with support in the form of debt forgiveness, rescheduling, and additional credit guarantees from export credit agencies. Since 1980, about $5 billion of concessional debt has been converted into grants by ten OECD donor countries. From October 1988 through July 1990, Paris Club creditors have applied the menu of concessional options (the “Toronto terms”) to the consolidation of over $5 billion in debt-service obligations of low-income countries. At present, 23 low-income African countries implementing strong adjustment programs are eligible for support under the World Bank’s Special Program of Assistance (SPA), launched in 1987. Additional concessional funding during 1988–90 of $4¼ billion from bilateral creditors (about 70 percent in grant form) and $1 billion from the International Development Association (IDA) of the World Bank has been provided to support adjustment programs in SPA countries. And additional IDA credits have been provided to facilitate interest payments to the World Bank from low-income countries.

Chart 20.External Debt: Official and Private Creditors1

(In billions of U.S. dollars and percent)

1 The shaded area indicates staff projections.

Canada. France, and the United States have recently announced initiatives that will help to alleviate the debt burden of the low- to middle-income countries in Africa and Latin America. The Fund has continued to provide financial assistance as part of its broader support to member countries. During fiscal 1989/90, 26 arrangements amounting to SDR 11 billion were approved; these include support under special concessional lending programs for low-income countries with severe balance of payments difficulties: the structural adjustment facility (SAF) and the enhanced structural adjustment facility (ESAF).

Chart 21.Developing Countries: Debt and Debt-Service Ratios

(In percent)

The impact of measures to reduce debt and debt-service payments on debt and debt-service ratios will become more transparent in the next few years when more countries conclude agreements with their external creditors and when repayments of arrears to normalize creditor-debtor relations no longer obscure the magnitude of savings gained by individual debtors (Chart 21). Debt-equity swaps and other conversion programs that will be instituted by developing countries in the near future should further contribute to reducing their commercial bank debts. Thus, for countries with recent debt-servicing difficulties, the ratio of total debt to exports of goods and services would continue to decline (from 252 percent in 1989 to 231 percent by 1991) as the growth of exports is expected to outpace increases in debt. For the countries without debt-servicing difficulties, debt ratios are projected to continue the steady decline that has occurred since 1986.

Appendix
The Possible Effects of a Rise in Oil Prices on the World Economy—An Illustrative Scenario

To illustrate the possible effects on the world economy of a rise in oil prices above the levels adopted for the projections discussed in Chapter 1, the scenario presented here assumes that the world price of oil, as represented by the average petroleum spot price, rises by 40 percent beginning in August 1990.24 It should be stressed that this assumption in no way constitutes a forecast of the likely evolution of oil prices and is adopted only to illustrate the possible effects of higher oil prices on the world economy.

Effects on the Industrial Countries

An important consideration in evaluating the current situation is that the magnitude of the recent price rise is small relative to the previous episodes of oil price increases in 1973–74 and 1979–80. The average petroleum spot price in August 1990 was about 50 percent above the average price in 1989. By comparison, oil prices had more than quadrupled from 1972 to 1974, and nearly trebled from 1978 to 1981. Moreover, as indicated in Table 5, oil consumption and oil imports have declined significantly in relation to GNP in most industrial countries during the 1970s and the 1980s, making the industrial economies less vulnerable to oil price increases. The substantial differences in the direct impact of the three oil price rises on the value of net oil imports, reflecting the interaction of these two factors, is illustrated in Table 6.

In general, the effect of higher oil prices on the industrial countries considered as a group is to raise domestic consumer and producer prices and to lower domestic demand and output. The negative effects on economic activity occur through three main channels: (i) the rise in oil prices involves a reduction in aggregate supply (similar to the effects of a tax on factor inputs) and therefore a lower level of output and employment, even if monetary policy works to keep interest rates unchanged; (ii) assuming no change in the supply of money in nominal terms, the reduction in aggregate supply would also involve a rise in interest rates in response to the decline in real money balances that would result from higher prices; and (iii) for the oil importing countries, real disposable income and consumption would fall owing to the deterioration of the terms of trade. The size of the “supply side” effect is influenced by the share of total oil consumption (and, more broadly, of total energy use) in GNP (see Table 5); the size of the interest rate effect reflects the interest-elasticity of the demand for money and the interest-sensitivity of investment and other components of aggregate demand; and the magnitude of the terms-of-trade effect is determined by the share of imported oil in GNP, as illustrated in the bottom panel of Table 5.

The simulation results for the industrial countries are summarized in Table 7. Relative to the baseline, the higher oil prices would raise the level of consumer prices in the industrial countries by just over ¼ of 1 percent in 1990 and by ¾ of 1 percent in 1991. (Thus, the rate of consumer price inflation would increase by approximately ¼ of 1 percentage point in 1990 and by ½ of 1 percentage point in 1991.) In Japan and Germany, this rise would result mainly from an increase in the price of imported oil, while in the United States it would reflect higher prices for both imported and domestically produced oil. The rise in the GNP deflator—which does not include import prices—would be only 1/10 of 1 percent in 1990 and less than ½ of 1 percent in 1991 for the industrial countries as a group.

Table 5.Seven Major Industrial Countries: Oil and Energy Consumption and Oil Imports, Selected Years1(Percent of GNP)
19691972197519781981198419851986198719881989
(Volume)2
Total Energy Consumption
Canada7.57.77.27.06.56.05.95.85.85.85.6
United States6.76.76.36.05.55.14.94.84.84.84.8
Japan2.82.82.72.52.22.12.01.91.91.91.8
France3.43.53.23.22.92.82.82.82.82.72.6
Germany, Fed. Rep. of3.83.81.63.53.23.13.13.13.02.92.7
Italy3.03.33.02.92.62.42.32.32.32.32.3
United Kingdom5.04.84.34.13.83.53.53.53.33.23.1
Oil Consumption
Canada3.43.43.12.82.41.81.81.71.71.71.8
United States2.73.02.82.82.32.12.02.02.02.01.9
Japan1.92.12.01.81.41.21.11.11.01.01.0
France1.92.32.12.01.61.31.31.21.21.21.2
Germany, Fed. Rep. of2.02.11.91.91.51.31.31.41.31.31.1
Italy2.12.42.12.01.71.41.41.41.41.41.4
United Kingdom2.32.41.91.81.51.61.41.31.21.21.2
(Value)3
Total Energy Consumption
Canada2.42.89.59.918.713.212.66.37.35.25.6
United States2.02.58.88.114.89.98.84.35.44.14.8
Japan1.71.85.53.57.66.15.61.92.11.51.8
France1.31.54.13.88.07.77.12.72.92.12.6
Germany, Fed. Rep. of1.81.64.84.09.58.68.43.03.12.32.7
Italy1.41.75.24.79.07.06.52.42.61.92.3
United Kingdom2.22.37.26.39.69.28.73.83.92.63.1
Oil Consumption
Canada1.11.24.13.96.94.03.91.92.21.61.8
United States0.81.13.91.86.24.03.61.82.21.71.9
Japan1.21.34.02.64.83.63.11.11.10.81.0
France0.71.02.72.44.33.63.21.21.30.91.2
Germany, Fed. Rep. of0.90.92.52.14.33.73.51.31.31.01.1
Italy1.01.23.73.26.04.33.91.51.61.11.4
United Kingdom1.01.23.22.81.74.33.31.41.41.01.2
(Value)3
Net Oil Imports
Canada-0.0-0.3-0.l0.51.0-0.6-0.8-0.3-0.3-0.3-0.2
United States0.20.31.61.82.41.41.10.70.80.70.9
Japan1.41.54.32.75.33.83.21.31.21.01.1
France0.60.72.32.34.33.53.11.31.31.01.2
Germany, Fed. Rep. of1.21.12.62.34.23.53.51.61.31.11.2
Italy1.11.41.42.95.63.83.71.51.41.01.2
United Kingdom1.01.02.91.2-1.2-2.1-2.3-1.1-1.0-0.6-0.3
Sources: Energy and oil data are from BP Statistical Review of World Energy, various issues. GNP and import data are from the World Economic Outlook data base.

Energy is measured in oil equivalent terms.

Energy and oil are measured in 1989 prices. Real GNP is measured in 1989 prices and converted into U.S. dollars using exchange rates in 1989.

Energy and oil are valued at current period U.S. dollar world oil prices. Nominal GNP is converted into U.S. dollars using current period exchange rates.

Sources: Energy and oil data are from BP Statistical Review of World Energy, various issues. GNP and import data are from the World Economic Outlook data base.

Energy is measured in oil equivalent terms.

Energy and oil are measured in 1989 prices. Real GNP is measured in 1989 prices and converted into U.S. dollars using exchange rates in 1989.

Energy and oil are valued at current period U.S. dollar world oil prices. Nominal GNP is converted into U.S. dollars using current period exchange rates.

On the assumption of unchanged monetary and fiscal policies, short-term interest rates would increase by about ¾ of 1 percentage point in 1991. The rise in long-term interest rates would be smaller, on the assumption that financial markets would anticipate an abatement of the pressure on short-term rates over the medium term as the rate of inflation returns to its baseline level.

The deterioration in the terms of trade resulting from the rise in the cost of imported oil leads to a decline in real disposable income for the industrial countries as a whole. This decline, together with the rise in interest rates, lowers private consumption and investment, with the result that the level of real GNP in the industrial countries falls below the baseline by ¼ of 1 percent in 1990 and by ½ of 1 percent in 1991. (Correspondingly, the rate of growth of output is reduced by roughly ¼ of 1 percentage point in both 1990 and 1991.) The output effects for individual countries reflect the combination of two factors: the dependence on imported oil, which influences the size of the negative terms-of-trade effect, and the country’s total use of oil. On the first count, real disposable income (and therefore consumption) would tend to decline somewhat less in the United States than in Germany and Japan, which import most of their oil and much of their energy.25 However, the output effects stemming from the supply shock would be larger in the United States than in Japan and Germany, reflecting the relatively high share of oil consumption in U.S. GNP (see Table 5). In every industrial country the adverse effects of the oil shock on economic activity would be accentuated by lower exports to other industrial countries and t. oil importing developing countries, although this would be offset in part by a rise in exports to the oil exporting countries.26

Table 6.Industrial Countries: Direct Impact of Oil Price Increases on National Income1(Percent of GNP)
1972–741978–811989–90
Canada1.2-0.80.1
United States-1.2-2.9-0.5
Japan-5.4-4.4-0.6
France-2.6-3.7-0.6
Germany, Federal Republic of-4.1-3.7-0.6
Italy-4.8-4.7-0.7
United Kingdom-3.7-1.90.1
Three major industrial countries2-2.4-3.4-0.5
Seven major industrial countries3-2.4-3.3-0.5
All industrial countries-2.2-3.4-0.5

Calculated as the increase in the value of net oil importsfrom the first to the last year of the period (assuming no changein the volume of imports), as a percent of nominal GNP in thefirst year of the period. The price of oil isassumed toincreaseby about 50 percent from 1989 to 1990, corresponding to theaverage petroleum spot price in August 1990. A positive figureindicates that the country is a net exporter of oil.

The United States, Japan, and the Federal Republic of Germany.

The countries specified in the table.

Calculated as the increase in the value of net oil importsfrom the first to the last year of the period (assuming no changein the volume of imports), as a percent of nominal GNP in thefirst year of the period. The price of oil isassumed toincreaseby about 50 percent from 1989 to 1990, corresponding to theaverage petroleum spot price in August 1990. A positive figureindicates that the country is a net exporter of oil.

The United States, Japan, and the Federal Republic of Germany.

The countries specified in the table.

The external current account balance of the industrial countries taken as a group would deteriorate somewhat as a result of the higher oil import bill (by less than ¼ of 1 percent of GNP in 1991). The deterioration would be a little more pronounced in Japan and Germany than in the United States, reflecting in part differences in the share of oil imports in GNP. The worsening of the combined current account of the other industrial countries would be very small, as the deterioration in the positions of France and Italy and most of the smaller countries would be partly offset by improvements in the external positions of Canada, the United Kingdom, and Norway.

Table 7.Industrial Countries: Effects of a 40 Percent Rise in the World Price of Oil1(Deviations from baseline, in percent, unless otherwise noted)
Industrial

Countries
United

States
JapanFederal

Republic

of Germany
Other

Industrial

Coutries
1990199119901991199019911990199119901991
Real GDP (level)-0.2-0.5-0.2-0.5-0.2-0.6-0.3-0.7-0.2-0.4
Real GDP (growth rate)2-0.2-0.3-0.2-0.3-0.2-0.3-0.3-0.3-0.2-0.3
Real disposable income-0.4-1.1-0.4-1.1-0.6-1.5-0.7-1.6-0.4-0.9
Exports of goods and services3-0.2-0.5-0.0-0.1-0.1-0.3-0.3-0.7-0.2-0.5
Imports of goods and services3-0.5-1.4-0.6-1.6-0.4-1.1-0.5-1.3-0.6-1.4
Capacity utilization rate-0.2-0.5-0.2-0.5-0.2-0.5-0.3-0.6-0.2-0.4
Short-term interest rate20.50.80.61.00.50.90.50.90.30.6
Long-term interest rate20.20.40.20.40.20.40.20.50.20.4
Inflation (consumer prices)20.30.50.30.50.30.50.30.50.40.6
Consumer prices0.30.80.30.90.30.80.30.90.40.9
GNP deflator0.10.40.20.50.10.30.10.30.20.6
Import price deflator1.02.61.23.01.64.00.92.21.12.5
Export price deflator0.30.80.30.50.10.40.10.40.61.3
Current account balance4-0.l-0.2-0.1-0.2-0.1-0.3-0.1-0.3-0.0-0.1

The rise in the price of oil is assumed to be effective beginning in August 1990.

Deviations expressed in percentage points.

In real terms.

In percent of GNP.

The rise in the price of oil is assumed to be effective beginning in August 1990.

Deviations expressed in percentage points.

In real terms.

In percent of GNP.

Table 8.Developing Countries: Effects of a 40 Percent Rise in the World Price of Oil1(Deviations from baseline, in percent, unless otherwise noted)
1990199119901991
Net Debtor CountriesBy region:
Real GDP0.20.4Africa
Export volume-0.1-0.5Real GDP0.51.0
Import volume-0.9-1.6Export volume-0.2-0.6
Terms of trade0.40.9Import volume1.73.6
Current account balance20.10.2Terms of trade3.06.5
Current account balance20.7
By predominant export:
Asia
Exporters of primary productsReal GDP0.20.3
Real GDP-0.4-0.9Export volume0.0-0.3
Export volume-0.4-1.0Import volume-1.0-2.5
Import volume-2.1-4.3Terms of trade-0.2-0.4
Terms of trade-1.7-3.6Current account balance2-0.10.1
Current account balance2-0.3-0.4
Europe
Exporters of manufacturesReal GDP-0.4-0.9
Real GDP-0.2-0.4Export volume-0.3-0.7
Export volume-0.1-0.7Import volume-2.3-4.5
Import volume-1.5-3.3Terms of trade-2.0-4.6
Terms of trade-1.3-3.0Current account balance2-0.1-0.1
Current account balance2-0.2-0.3
Western Hemisphere
Fuel exportersReal GDP0.10.4
Real GDP2.04.5Export volume-0.3-0.7
Export volume-0.1-0.3Import volume-1.40.2
Import volume4.112.9Terms of trade1.74.8
Terms of trade11.326.6Current account balance20.80.9
Current account balance22.33.5
Memorandum items
Small low-income countriesNet Creditor Countries
Real GDP-0.3-0.6
Export volume-0.2-0.5Export volume-0.9-2.9
Import volume-2.4-5.0Import volume0.31.2
Terms of trade-1.9-4.4Terms of trade8.420.3
Current account balance20.1Current account balance310.838.6

See text and footnote 1 in Table 7.

Ratio to exports of goods and services. Deviations from the baseline are expressed in percentage points.

In billions of U.S. dollars.

See text and footnote 1 in Table 7.

Ratio to exports of goods and services. Deviations from the baseline are expressed in percentage points.

In billions of U.S. dollars.

Effects on the Developing Countries

For the net debtor developing countries taken as a group, the higher oil prices are estimated to have a small, net positive impact reflecting the fact that a number of countries in this group are substantial net exporters of oil (Table 8).27 In the net debtor countries that export fuel, the improvement in the terms of trade would more than offset the damaging influence of higher world interest rates and lower demand abroad, and on balance real GDP would rise. Import volumes also would rise in response to higher export earnings and there would be an improvement in the current account of the balance of payments and in the debt indicators.

In contrast, the majority of net debtor developing countries that import oil on a net basis would face a deterioration in their terms of trade, which would lower income and contribute to a decline in output. Moreover, the reduction in GDP and the resulting decline in the demand for imports in the industrial countries would adversely affect the exports of this group of developing countries,28 and the higher level of world interest rates would contribute to higher debt-service obligations. Debt and debt-service ratios also would rise reflecting both lower export earnings and, in some cases, higher levels of debt. These adverse effects are reflected in the simulation results for the exporters of manufactures and for the exporters of non-oil primary products.

The results for specific geographic regions shown in Table 8 reflect largely the relative importance of oil importers and exporters within each subgroup of net debtor countries. The substantial positive effects on the terms of trade and GDP in Africa, for example, reflect mostly the large weight of Nigeria in that region. Similarly, the favorable impact for the Western Hemisphere countries taken as a group reflects substantial gains for Ecuador, Mexico, and Venezuela; for Asia the net favorable effect reflects the large weight of China and Indonesia. By contrast, higher oil prices would have a strong negative impact on the group of small low-income countries, many of which are in Africa, and on the developing countries of Europe.

In the simulations the effect on the current account of the oil importing, net debtor countries is relatively small because the volume of imports (of both oil and non-oil products) falls appreciably, thus offsetting much of the direct impact of higher oil prices. This result reflects the assumption—incorporated into the structure of the models used for the simulation—that most net debtor countries have limited access to external financing. In practice, however, the required import adjustment may, in some cases, be difficult to achieve in the short run without resulting in major dislocations. An indication of the “impact effect” of the oil price increase on the current account of these countries is provided in Table 9. The absolute magnitude of these effects, which are calculated on the assumption that the volume of imports remains unchanged, are particularly large for the exporters of manufactures, predominantly in Asia. In relation to exports of goods and services, however, the effects are especially large for the small, low-income countries and, by region, for the oil importing countries of Africa and the Western Hemisphere. It should be noted that these aggregate results mask a potentially severe deterioration in the external position of some individual countries.

Table 9.Net Debtor Developing Countries Excluding Fuel Exporters: Impact Effect of a 40 Percent Rise in the World Price of Oil on the External Current Account1(Deviations from baseline)
In Billions of

Dollars
In Percent of

Exports
1990199119901991
Net debtor countries-8.8-21.9-1.7-4.0
By predominant export:
Exporters of primary products-1.1-2.6-1.8-4.0
Exporters of manufactures-6.0-15.4-1.6-3.8
Small low-income countries-0.6-1.5-2.0-5.0
By region:
Africa-1.3-3.1-2.2-4.8
Asia-3.7-10.2-1.5-3.6
Europe-1.4-3.6-1.6-3.8
Western Hemisphere-1.9-4.2-2.3-4.7

See text and footnote 1 in Table 7.

See text and footnote 1 in Table 7.

In the group of net creditor countries, which consists predominantly of oil exporting countries, the volume of exports drops reflecting the interruption of oil shipments from Iraq and Kuwait. However, the terms of trade improve sharply as a direct result of the rise in oil prices, and the current account balance improves by $11 billion in 1990 and by $39 billion in 1991. The rise in import volume is considerably smaller than in the subgroup of fuel exporting indebted countries because the propensity to save among the oil exporting creditor countries is historically much higher.

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