I Current Developments and Short-Term Prospects
- International Monetary Fund. Research Dept.
- Published Date:
- January 1991
Financial Markets and Policies
Monetary and interest rate developments in the major industrial countries have continued to be strongly influenced by cyclical conditions. Those countries that had experienced significant excess demand pressures in the late 1980s—the United States, the United Kingdom, and Canada—entered into recession in 1990 (Chart 1).1 In France and Italy, output remained near potential in the late 1980s, but the slowing of growth in 1990 took output below potential by the end of the year. By contrast, the economies of Germany and Japan, which operated below potential in the late 1980s, continued to expand strongly in 1990 and the first quarter of this year, giving rise to excess demand pressures.
Chart 1.Major Industrial Countries: Output Gaps1
1 The output gap is calculated as the percentage deviation between actual or projected GDP/GNP and staff estimates of potential output; composites are based on 1988-90 GDP/GNP weights. The shaded area indicates staff projections.
These cyclical developments in the industrial countries have shown up in different movements in interest rates. More generally, however, interest rates have been influenced by the more favorable performance and near-term outlook for inflation that followed the sharp decline in oil prices in late 1990 and early 1991, and which has accompanied the weakening of global economic conditions. As a result, interest rates have generally tended to fall so far in 1991.
The largest declines in short-term interest rates have occurred in those countries experiencing recession. In the United States, the easing of monetary conditions by the Federal Reserve intensified in late 1990 and continued through the first four months of 1991, with the federal funds rate declining from about 7 percent to about 5¾ percent (Chart 2). The discount rate of the Federal Reserve, which had already been lowered from 7 to 6½ percent in December 1990, was further reduced by of 1 percentage point at the beginning of February and again at the end of April. The Federal Reserve took no further action to change short-term rates between May and July, as growing evidence suggested that the decline in U.S. economic activity had ended. Subsequently, however, following indications that the recovery might be weaker than expected, the federal funds rate was allowed to fall to 5½ percent in early August and to 5¼ percent in mid-September, and on the latter occasion the discount rate was lowered again, to 5 percent, its lowest level since 1973. Reflecting these monetary actions, as well as the weakness in economic activity, most short-term market rates in the United States declined by about 1¾ percentage points between January and late September, with the greater part of the decline occurring in the first four months of the year (Chart 3).
Chart 2.Three Major Industrial Countries: Policy-Related Interest Rates1
1 End of month except for the federal funds rate, which is the average of daily observations; and the repurchase rate, which is the average of weekly data.
Chart 3.Major Industrial Countries: Short-Term Interest Rates1
1 Three-month certificate of deposit rate for the United Slates and Japan; three-month Treasury bill rate for Italy; rate on three-month prime corporate paper for Canada; three-month interbank deposit rates for other countries. Monthly averages are plotted for all countries.
2 Average of seven countries based on 1987 GNP weights.
In Canada, short-term interest rates fell by about 2¾ percentage points between January and late September 1991, with most of the decline, as in the United States, occurring in the first four months of the year. In the United Kingdom, where signs of economic recovery appeared later than in North America, monetary easing continued in early September, with the seventh ½ percentage point reduction in the Bank of England’s money market dealing rate, to 10½ percent, since the beginning of the year.
In Japan and Germany, movements in short-term interest rates between January and late September 1991 reflected differences in the strength of economic activity and prospects for inflation. In Japan, short-term market rates eased gradually through the first half of the year, by about ½ of 1 percentage point, owing to perceptions that the economy was slowing. At the beginning of July, the official discount rate was cut from 6 to 5½ percent; in explaining this cut, the Japanese authorities referred to the recent marked deceleration of the monetary aggregates and to other indications of moderating inflationary pressures. Subsequently, market rates declined more rapidly, and in September they were 1½ percentage points lower than in January. In Germany, official interest rates were raised on two occasions: at the beginning of February, the discount rate was raised from 6 to 6½ percent and the Lombard rate from 8½ to 9 percent; in mid-August, the discount rate was increased from 6½ to 7½ percent and the Lombard rate from 9 to 9¼ percent. Short-term market rates in Germany, however, rose by less than these administered official rates: peaks reached in mid-January were only exceeded in mid-August, and in late September rates were slightly lower than in January.
In France, official interest rates were lowered by ¼ of 1 percentage point in mid-March. Subsequently, the general weakness of the franc in the exchange rate mechanism (ERM) of the European Monetary System (EMS) appears to have been a factor inhibiting further reductions in official rates. Short-term market rates in France in late September were nevertheless about ½ of 1 percentage point lower than in January. In contrast, the position of the Italian lira at the top of the narrow band through most of the period between March and September 1991 contributed to an easing of short-term rates in Italy. The discount rate was lowered by 1 percentage point in May, and short-term market rates declined by roughly similar amounts between early 1991 and late September.
The relative levels of short-term interest rates among the largest industrial countries, as well as their recent movements, have partly mirrored divergent cyclical positions. Short-term rates in the United States have been below the average of the major industrial countries since mid-1989 and below comparable rates in Germany and Japan since mid-1990. In late September 1991, the spread in favor of mark-denominated assets, compared with U.S. dollar instruments, was about 3¾ percentage points, while that in favor of yen-denominated assets was about 1 percentage point.
Movements in long-term interest rates in the first nine months of 1991 reflected not only macroeconomic developments and the actual and expected policy actions of monetary authorities, but also the evolution of the crisis in the Middle East (Chart 4). In January and most of February, government bond yields continued to decline in most countries as oil prices fell and concerns about the potential effects of the crisis receded. With the cessation of hostilities in late February, yields stabilized or rose somewhat, reflecting market expectations that the end of the conflict would have a positive impact on confidence and economic activity. Long-term rates generally rose further during the early summer as expectations of economic recovery in the United States firmed, but they subsequently eased as these expectations became less sanguine. In some countries, bond yields rose temporarily in August, at the time of the attempted coup in the U.S.S.R. From the beginning of the year to late September, long-term yields declined by about ½ of 1 percentage point in the United States, Japan, and Germany, and by almost twice as much in other major industrial countries.
Chart 4.Major Industrial Countries: Long-Term Interest Rates1
1 Yields on government bonds with residual maturities of 10 years (the United States and the United Kingdom); 9-10 years (Germany): over 10 years (Canada); and 2-4 years (Italy). For Japan, the yield on 10-year government bonds with the longest residual maturity is shown. Monthly averages are plotted for all countries.
2 Average of seven countries based on 1987 GNP weights.
In all major industrial countries except Germany and France, short-term interest rates declined in relation to long-term rates through the first nine months of 1991. As a result, the upward-sloping yield curve in the United States steepened further; upward-sloping yield curves re-emerged in Italy and Canada; and inverted yield curves became markedly flatter in the United Kingdom and Japan. These developments conform with the historical tendency for yield curves to become more upward-sloping at the stage of the cycle when the authorities ease monetary conditions and financial markets become more confident about prospects for recovery.
Between January 1991 and late September, indices of equity market prices rose in each of the major industrial countries, but by widely varying amounts—2 percent in Japan, 6-8 percent in Italy and Canada, 12 percent in Germany, 18 percent in the United States, and 21-23 percent in France and the United Kingdom. The main influences on stock markets during the period included the resolution of the Middle East conflict, the general easing of short-term interest rates, and cyclical developments, most notably the expected recovery of the U.S. economy. The Tokyo stock market was adversely affected in June and July by news regarding certain business dealings of Japanese security firms. Stock prices generally fell sharply on August 19 following the attempted coup in the U.S.S.R., but recovered over the following few days as the coup’s failure became apparent.
The principal developments in foreign exchange markets in the first nine months of 1991 were the recovery of the U.S. dollar, mainly against the European currencies, between mid-February and early July, and its subsequent partial reversal. In the early weeks of the year, the dollar continued the decline begun in mid-1989, falling to historic lows in mid-February, both in nominal effective terms and against the deutsche mark. During the following six weeks, however, the dollar rose by about 11 percent in effective terms, reversing roughly half its decline over the preceding 1½ years. The pace of the dollar’s rise in this period has no precedent in the period of generalized floating since 1973. From late March, the recovery of the dollar lost much of its momentum: it rose sharply in mid-April and early June, but did not sustain a consistent upward trend, and from peaks reached in early July it fell through the remainder of the period. In late September, the nominal effective value of the dollar was 8 percent above its mid-February trough and 5 percent above its level in January. From January to late September, the dollar appreciated by about 11 percent in terms of the major currencies participating in the ERM of the EMS, but depreciated by 2 percent in terms of the Canadian dollar; in terms of the yen, the value of the U.S. dollar had by late September returned to its January level.
These exchange rate developments appear to have reflected a number of influences. First, the strong rise of the U.S. dollar during February and March appeared to be associated with a strengthening of expectations that the U.S. economy would soon turn upward and that any further easing of monetary conditions by the Federal Reserve would consequently be more limited. Such a shift in expectations is suggested by the firming of long-term interest rates in the United States and by the movement in long-term interest differentials in favor of dollar-denominated assets (Chart 5). Conversely, the dollar’s subsequent reversal (after June) was associated with less optimistic expectations about the U.S. economic recovery, with renewed easing by the Federal Reserve, and with movements in interest differentials that were predominantly unfavorable to U.S. dollar-denominated assets. Second, the dollar’s recovery in February—March may have owed something to perceptions that the currency was “undervalued” and close to a trough—perceptions based partly on real exchange rate calculations and purchasing power parity comparisons, but also on the narrowing of the U.S. external deficit described below. Third, the dollar’s movements may have been partly due to perceptions of official attitudes toward exchange market developments and reported official intervention in foreign exchange markets, particularly coordinated intervention by the major industrial countries, first in support of the dollar just before it reached its trough in mid-February and then in support of non-dollar currencies in mid-July.
Chart 5.United States, Japan, and Germany: Exchange Rates and Interest Rate Differentials1
1 The real effective exchange rate index shown is defined in terms of relative normalized unit labor costs in manufacturing and constructed using trade weights based on 1980 data. The same weights are used in constructing the nominal effective exchange rate index shown, Interest differentials are United Slates minus Japanese or German interest rates, in percent a year. The interest rates used are those defined in Charts 3 and 4, Exchange rates are drawn on logarithmic scales. Data are monthly averages.
With respect to other currencies, the strength of the yen relative to the European currencies may have been influenced by developments in external imbalances, and particularly the contrast between the widening of the current account surplus of Japan and the marked narrowing of the German surplus. The weakness of the deutsche mark also appears to have reflected in part concerns about the possible adverse consequences of German unification on the fiscal position and inflation, and perhaps also concerns about developments in Eastern Europe and the U.S.S.R. The latter influence was particularly apparent in August, when the dollar appreciated temporarily against all the major currencies, but most sharply against the mark, at the time of the attempted coup in the U.S.S.R.
The fiscal position of the general government in most of the large industrial countries is expected to remain unchanged or to deteriorate in 1991, with the major exception of Italy, owing in large measure to the effects of the slowdown in economic activity on both government receipts and expenditures (Chart 6 and Statistical Appendix Table A17). The staff’s projections imply that, adjusted for cyclical developments, the stance of fiscal policy in 1991 will be restrictive in all major industrial countries except Germany.2 Largely because of increased expenditures associated with unification, the borrowing requirement of the German territorial authorities (including the Unity Fund) is projected to rise from 3½ percent of GNP in 1990 to 5½ percent in 1991. There is likely to be little change in the overall thrust of fiscal policy in the major industrial countries in 1992, as a somewhat less restrictive stance in the majority of these countries would be offset by a decline in Germany’s deficit and a strongly restrictive budgetary position in Canada.
Chart 6.Three Major Industrial Countries: General Government Fiscal Indicators1
1 Calendar years. A positive fiscal impulse indicates an expansionary policy. Shaded areas indicate staff projections.
2 Data are for west Germany fur 1980-90 and for the united Germany thereafter. Because of data problems associated with unification, the fiscal impulse has not been calculated for 1090-92.
Economic Activity, Employment, and Inflation
Economic growth in the industrial countries slowed from 3¼ percent in 1989 to 2½ percent in 1990. Economic activity strengthened in Japan and west Germany last year, but the economies of the United States, the United Kingdom, and Canada and several smaller countries (Australia, Finland, New Zealand, Sweden, and Switzerland) entered into recession. As a result of the continued weakness of these economies in the first half of 1991 and the projected slowdown in Japan and Germany, output growth in the industrial countries is projected to slow further this year (Chart 7).
Chart 7.Industrial Countries: GDP/GNP Growth
1 Annual observations, as quarterly data are not available for some countries.
A number of factors suggest that recovery will take place during the course of this year in the countries that have experienced recession: the sharp fall in oil prices from almost $30 a barrel in the fourth quarter of 1990 to about $17 a barrel in the second quarter of 1991; the large decline in interest rates; and some recovery in consumer and business confidence following the swift resolution of the military confrontation in the Middle East (Chart 8). Together, these factors provide the conditions for a cyclical rebound that is expected to take place in consumer spending, stockbuilding, and business investment in several countries in 1991-92 (Table 2). Therefore in 1992 the divergence of cyclical positions in industrial countries that characterized 1990 and the first part of 1991 is projected to come to an end.
Chart 8.Major Industrial Countries: Indicators of Consumer Confidence
Sources: United States, the Conference Board; Canada, the Conference Board of Canada; lower panel, the European Economic Community.
1 Quarterly observations
2 The percentage of respondents expecting an improvement in their situation minus the percentage expecting a deterioration.
|Gross fixed investment||7.8||5.4||3.3||-1.2||3.3|
|Final domestic demand||4.4||3.3||2.8||1.0||2.6|
|Total domestic demand||4.6||3.4||2.4||0.9||3.0|
|Exports of goods and services||6.8||10.7||7.9||3.4||5.1|
|Imports of goods and services||9.4||11.1||7.4||3.0||6.3|
|Business fixed investment|
|Total of seven2||11.1||7.7||5.9||1.0||3.8|
Real GNP in the United States fell in the last quarter of 1990 and the first quarter of 1991, but declined only slightly in the second quarter as consumer spending rebounded from a steep decline in the previous two quarters. A recovery is already evident in industrial production (Table 3) and in residential construction where in August 1991 housing starts rose by 26 percent from the trough reached in January 1991. For the remainder of 1991 and for 1992, consumer spending is expected to be a major source of strength, along with a rebound in housing spurred in part by low interest rates, and a turnaround in inventory investment that generally occurs in the early phase of a recovery. With vacancy rates staying at high levels, however, investment in office structures is expected to remain sluggish. While U.S. exports are projected to expand in line with the growth in foreign markets, U.S. imports are expected to grow even faster than exports, and the foreign sector would make a negative contribution to growth in 1992, following a significant positive impact this year. Growth during the year following the second quarter of 1991 is expected to be about 3 percent, well below the 5-6 percent rate typically occurring in the four quarters following a trough, largely because the latest U.S. recession appears to have been relatively mild.
|(Percent change from previous period)|
|(Percent of labor force)|
The recession is estimated to have been much more severe in Canada and the United Kingdom than in the United States.3 During 1987-89, demand pressures on productive capacity were more intense in these countries than in the United States, and a longer period of monetary restraint was required to bring aggregate demand into better balance with capacity output. A turnaround in economic activity already began in Canada in the second quarter of 1991, while a recovery is expected to begin in the second half of the year in the United Kingdom. Economic growth in 1992 is projected to be considerably more robust in Canada, owing to the anticipated strength of gross fixed investment, which reflects both the recent drop in interest rates and relatively strong exports. In the United Kingdom, in contrast, fixed investment is expected to be broadly unchanged from 1991.
Growth in both west Germany and Japan is expected to slow in 1991-92 from an unsustainable pace in 1990 that was well in excess of the growth in potential output. The slowdown is expected to be particularly pronounced in west Germany, where output growth is projected to fall from about 3 percent in 1991 to 2 percent in 1992. A number of factors would contribute to this slowdown: large tax increases announced early in 1991; a declining stimulus from east Germany in 1992; the dampening effect of high real interest rates; and capacity constraints in certain sectors. In east Germany, output is expected to fall substantially again in 1991, bringing about a further large rise in unemployment; in 1992, however, economic activity appears likely to recover, and the unemployment rate should stabilize during the course of the year. In Japan, growth is projected to average around 4 percent in 1991-92, compared with an annual average of 5 percent from 1987 to 1990. Domestic demand would account for nearly all of the expansion in output, with gross fixed investment continuing to expand rapidly, albeit somewhat below the rapid pace of the previous four years. The anticipated slowdown in investment would reflect the tightening in monetary policy in 1989 and 1990 and a weaker outlook for profits.
A significant slowdown also appears likely this year in both France and Italy, with only a weak recovery expected next year as final domestic demand remains subdued by the standards of the previous three years. The weakness in 1991 would result in part from a marked deceleration in gross fixed investment and purchases of consumer durables (especially automobiles) from the rapid pace of recent years. Among the smaller industrial countries, Australia, Finland, Greece, New Zealand, Sweden, and Switzerland are expected to be in recession for at least part of this year, and these countries are projected to experience only a modest recovery in 1992.
Recent developments in labor markets generally have mirrored the cyclical positions of industrial countries as described above (Chart 9 and Table 3). In the two countries that have experienced the most severe recessions—the United Kingdom and Canada—unemployment rates have increased by 2½ and 3 percentage points, respectively, from early 1990 to mid-1991. In 1992 the unemployment rate is projected to decline slightly in Canada, albeit from a high level, but it would continue to rise in the United Kingdom, where the resumption in output growth is projected to be modest. In the United States, the unemployment rate is expected to decline moderately in 1992. With output growth not far from the growth of potential, labor markets are projected to remain tight in Japan. Tight labor markets are also projected to persist in west Germany, with the jobless rate remaining below 6 percent in 1991-92. In east Germany, however, the rate of unemployment was 12 percent in August 1991, with short-time workers accounting for an additional 16½ percent of the labor force. Even with some recovery in economic activity next year, unemployment could rise to an average of over 17 percent. In France and Italy, the unemployment rate is expected to average around 9½ and 11 percent, respectively, this year and next.
Chart 9.Industrial Countries: Unemployment Rates
1 Based on labor force weights.
The industrial countries experienced a rise in consumer price inflation in 1990, partly because of the sharp increase in oil prices in the second half of the year (Chart 10).4 Inflation is projected to decline from 5 percent in 1990 to 4½ percent this year, and to moderate further to 3¾ percentin 1992. In 1991 and 1992, output is projected to fall below potential for the major industrial countries as a group, which would exert downward pressure on wages and prices (Chart 11). In addition, the fall in oil prices in 1991 has already helped to reduce inflation this year.
Chart 10.Industrial Countries: Consumer Price Indices
1 Increases in indirect taxes raised consumer prices in 19S9 in Canada, west Germany, Japan, and Italy, and are expected to do so again in I99I in Canada and west Germany.
2 Annual observations, as quarterly data are not available for some countries.
Chart 11.Major Industrial Countries: Consumer Price Inflation and Output Gap1
1 The output gap is calculated as the percentage deviation between actual or projected GDP/GNP and staff estimates of potential output; composites are based on 1988-90 GDP/GNP weights.
The decline in inflation is expected to be most pronounced in the United Kingdom and Canada, where the margin of unused resources is greatest. In the United Kingdom, inflation (as measured by the retail price index) peaked at nearly 11 percent in October 1990, owing partly to the high initial level of the community charge (poll tax) and higher mortgage interest rates. With the elimination of excess demand, lower interest rates, and the diminished effects of the community charge, retail price inflation fell to 4¾ percent in August 1991, and it is projected to drop to slightly under 4 percent in 1992. Similarly, in Canada, measured inflation was boosted by the introduction of the Goods and Services Tax in January 1991; however, with rising unemployment and spare capacity, inflation has already started to fall and is projected to average 2¾ percent in 1992.
In Germany, tight markets for goods and labor, together with the introduction of higher excise taxes in July 1991, are expected to raise consumer price inflation to nearly 4½ percent in the second half of 1991 from 2¾ percent in 1990; reflecting the diminished effects of the recently introduced tax increases, inflation in 1992 would decline to 3½ percent. In 1992, a moderate decline in inflation is expected in France, Japan, and the United States; inflation is also projected to moderate in Italy in 1992, but the rise in consumer prices would still be 1½ percentage points above the average European Community (EC) rate (4¼ percent). Diminishing pressures on resource use are also expected to lead to a fall in consumer price inflation in the smaller industrial countries, from 5½ percent in 1991 to 4½ percent in 1992.
Notwithstanding a rise in the average unemployment rate in the industrial countries from 6¼ percent in 1990 to 7 percent in 1992, the growth in hourly earnings in manufacturing is expected to remain unchanged over this period (Statistical Appendix Table A10). However, the rise of manufacturing wages would decelerate substantially in the countries that are projected to experience the largest increase in unemployment—Canada and the United Kingdom. In particular, after increasing by over 9 percent in 1990, U.K. manufacturing wages are expected to rise by the EC average of 6 percent in 1992. In the United States, by contrast, hourly earnings in manufacturing are projected to increase by 3¾ percent in both 1991 and 1992, compared with 3¼ percent in 1990. In Italy and Japan, the rate of wage increase in 1992 is projected to be in the range of 5½ to 6 percent, broadly unchanged from 1990. However, the continuing strong productivity performance in Japan will limit the increase in unit labor costs over this period to close to the average of all industrial countries. Tight labor markets are also evident in Germany, where wage increases in manufacturing are expected to average 7 percent this year, compared with 5¾ percent in 1990; the projected slowdown in economic growth in 1992, however, should help moderate the growth in wages.
Trade and Current Account Developments
The current account deficit of the industrial countries as a group is projected to narrow from almost $ 100 billion in 1990 to about $35 billion in 1991. Approximately one half of this decline would reflect the one-time receipt of official war-related transfers from countries in the Middle East. Such transfers also would contribute to the narrowing of the external imbalances of the three largest countries in 1991, with the receipt of $45 billion by the United States and payments of $8 billion and $9 billion by Germany and Japan, respectively (Chart 12). About one third of the decline in the combined current account deficit of the industrial countries also reflects an improvement in the terms of trade of ¾ of 1 percentage point resulting primarily from the recent drop in oil prices. The terms-of-trade gain would be particularly large in Japan and result in a substantial widening in the current account surplus in 1991. By 1992, the terms-of-trade effect is projected to be largely reversed and war-related transfers will be completed; mainly for these reasons, the external deficit of the industrial countries would rise to about $100 billion, the same level as in 1990.
Chart 12.Three Major Industrial Countries: Current Account Imbalances
1 Prior to July 1990. the current account balance of west Germany excluding the bilateral balance with east Germany; from July 1990 the current account balance of the unified Germany. The shaded area indicates staff projections.
The slowdown in economic activity in 1991 in North America and the United Kingdom would contribute to a fall in import volumes and a reduction in the external deficits in these countries. While a particularly strong rebound in imports in 1992 is expected in the United States, the U.S. current account deficit is nonetheless projected to be only 1½ percent of GNP next year, slightly below its level in 1990. Canada’s external deficit would remain above 2 percent of GDP in 1991-92, whereas in the United Kingdom the current account deficit would drop to 1¼ percent of GDP by 1992. Over the near term, current account deficits would remain small as a percent of GDP in France and Italy.
The rise in import volumes in the industrial countries would slow in 1991 to its slowest pace since 1982, despite continued strong growth of imports in Germany. As a consequence, export market growth would continue to weaken in 1991, reinforcing the slowdown in domestic demand in many countries (Chart 13). A rebound in the growth of export markets is projected for 1992.
Chart 13.Major Industrial Countries: Export Market Growth1
1 Export market growth is defined as the weighted average of non-oil impon growth in partner countries, where weights reflect average expon market shares in 1987-89.
The expansion of German imports in 1990 benefited major trading partners to varying degrees. The value of exports to Germany (measured in deutsche mark) increased most rapidly in Italy. Austria, and Belgium-Luxembourg (13-15 percent); gains were smaller for France and the United Kingdom (7-8 percent) and even smaller for Japan (2¼ percent), while U.S. exports to Germany fell. The rapid expansion in German imports in 1990-91, coupled with slow export growth this year (1½ percent), is expected to contribute to a reduction in Germany’s trade surplus from almost $80 billion in 1989 to $22 billion in 1991; this narrowing is projected to result in a small deficit in Germany’s current account in 1991, the first such deficit in ten years.
World Commodity Markets
Oil Market Developments
In response to the crisis in the Middle East, world oil prices rose sharply from about $16 a barrel in July 1990 to an average of more than $33 a barrel in October (Chart 14). With an increase in OPEC supplies, prices declined during the fourth quarter of 1990 and then fell sharply after the outbreak of the war in mid-January 1991.5 By February 1991, the average spot market price had fallen back to about $17 a barrel, and it remained in the $17-18 a barrel range through mid-1991.
Chart 14.Average Petroleum Spot Price1
1 The average petroleum spot price (APSP) is defined as the equally weighted average of the spot prices of U.K. Brent (light). Dubai (medium), and Alaska North Slope (heavy). The shaded area indicates staff assumptions.
2 The real price of oil is calculated as the nominal price deflated by the export price of manufactures of industrial countries.
3 The OPE-C 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 demand for oil has been relatively weak so far in 1991, owing largely to the recession in some of the major industrial countries. In response to the weakness in demand, OPEC members announced in March 1991 a reduction in output of about 5 percent through voluntary production cuts to support the price of oil. At the same time, there has been a significant further decline in oil output in the U.S.S.R., the world’s largest producer. With oil consumption and production in rough balance, total world oil inventories did not change significantly in the first half of 1991, and they remained at relatively comfortable levels at mid-year.
The outlook for 1992 is somewhat uncertain. World oil consumption is expected to pick up, reflecting the projected recovery of economic activity in the industrial countries and in many developing countries. While increased demand could put some upward pressure on oil prices, particularly during the winter months, higher output may be forthcoming from some OPEC members with spare capacity. An important consideration affecting the evolution of oil prices in the period ahead will be the extent to which oil production and exports resume in Kuwait and Iraq. While progress has been limited so far, owing to technical and political factors, increased output from these two countries would help maintain balance in the oil market in 1992 and beyond and thereby temper any upward movement in oil prices. As a resumption of exports on a significant scale from Kuwait and Iraq would probably be accompanied by a reduction in output on the part of other OPEC members, the margin of spare capacity in the world oil supply system would increase, which would help limit the impact on prices of any new supply interruptions.
In this report, the staff is assuming—on the basis of the pattern of futures prices prevailing in mid-August 1991—that the annual average price of oil will decline by 16½ percent to $18.43 a barrel in 1991 and increase by 1 percent to $18.61 a barrel in 1992. For the period 1993-96, the staff maintains the technical assumption that oil prices will remain unchanged in real terms, implying an increase of about 3 percent a year in the nominal (U.S. dollar) price.
Non-Fuel Commodity Prices
The slowdown in the expansion of the world economy, together with increasing production and stocks of agricultural commodities, contributed to a fall in non-fuel commodity prices in 1990 (Chart 15). In U.S. dollar terms, the average world price of non-fuel commodities fell in 1990 by 8 percent, reflecting declines in all major commodity groups, in particular tropical beverages (13 percent) and minerals and metals (10 percent). The fall in these prices contributed to a 3 percent deterioration in the terms of trade of the oil importing developing countries.
Chart 15.Non-Fuel Commodity Prices,1
1 The total is based on world trade weights.
2Non-fuel, commodity prices deflated by the export price of manufactures of industrial countries.
In 1991, non-fuel commodity prices are expected to decline again, by 5¾ percent in terms of U.S. dollars. The largest decline is projected in the prices of minerals and metals (10 percent), which are quite sensitive to cyclical conditions in the industrial countries. Another factor contributing to the decline has been some increase in exports of metals and weak import demand for these commodities on the part of the U.S.S.R. In 1992, however, the prices of almost all major commodity groups would rebound. The terms of trade of developing countries as a group are expected to deteriorate by 2 percent in 1991, but they would improve in 1992 except for exporters of fuel and minerals.
Output in the developing countries as a group is projected to drop by ½ of 1 percentage point in 1991, mainly on account of a sharp fall in economic activity in Eastern Europe and the U.S.S.R. The decline in these countries reflects the substantial contraction in regional trade among these countries as well as adjustments associated with the implementation of measures to transform centrally planned economies into market economies. Output is also expected to drop sharply in the Middle East largely because of the destruction caused by the war in Kuwait and Iraq. The outlook for many developing countries is also projected to be adversely affected by a weakening in export markets caused by recession or slower growth in the industrial countries, food shortages caused by drought, and a projected weakening in the terms of trade for producers of non-fuel primary commodities to the lowest level since 1980. While rapid growth will continue in many countries in Asia, the majority of the other developing countries would continue to exhibit modest economic growth in 1991. As a result, GDP per capita would continue to stagnate in most regions (Chart 16). For the group of least developed countries (LDCs)—comprising most of sub-Saharan Africa and a few other small, low-income economies—growth is projected to rebound from 2 percent in 1990 to 3 percent in 1991.6
Chart 16.Developing Countries: Real GDP per Capita by Region1
1 Composites are averages for individual countries weighted by the average U.S. dollar value of their respective GDPs over the preceding three years. Shaded areas indicate staff projections
Economic growth in the developing countries (excluding Eastern Europe and the U.S.S.R.) is expected to rebound in 1992. The projected rebound is based in part on the improvement in the stance of policies that is taking place this year, the recovery of output growth in the industrial countries, and the regularization of trade and reconstruction activity in the Middle East.
In 1991 economic conditions in Africa continue to be adversely affected by the external environment—particularly slower growth in export markets and declining terms of trade—and by political instability, civil wars and inappropriate policies in many countries. In the sub-Saharan region, where the majority of the least developed countries are located, real GDP growth in 1991 is projected to remain approximately unchanged at 2¼ percent, which would imply a decline of 1 percent in per capita GDP from 1990. Average inflation in that region is expected to rise from about 22¾ percent in 1990 to 24 percent in 1991. For Africa as a whole, a modest improvement in economic growth is projected this year, with real GDP increasing by 3¼ percent (Chart 17), but inflation would rise by 3 percentage points to 18½ percent (Chart 18); the aggregate current account deficit of the African countries is projected to widen from $3 billion to $9 billion.
Chart 17.Developing Countries: Real GDP1
1 Composites are indexes based on arithmetic averages of country growth rates weighted by average U.S. dollar value of GDPs over the preceding three years. Shaded areas indicate staff projections.
Chart 18.Developing Countries: Consumer Prices1
1 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. Shaded areas indicate staff projections.
An improved external environment is expected in 1992, reflecting the recovery of world markets, the restoration of trade with the Middle East, and a slight increase in non-fuel commodity prices. On the basis of this improvement, and assuming the implementation of sound policies in a number of countries, the growth of real GDP in Africa would increase slightly, average inflation would fall to 13½ percent, and the current account deficit would narrow by $1½ billion. In sub-Saharan Africa, economic growth is also projected to rise, but not sufficiently to arrest the decline in per capita GDP, and inflation is expected to moderate.
In general, African countries that have consistently implemented structural reforms and stabilization policies have performed significantly above average. In those countries that had medium-term arrangements with the Fund for more than a year at the end of 1990 (all of them in sub-Saharan Africa), output rose at an average annual rate of 4 percent between 1988 and 1990.7 This compares with a weighted average growth rate for all sub-Saharan countries of 2½ percent during the same period. Similarly, Table 4 shows that among the large countries of Africa, growth during 1988-90 was higher and more sustained in Kenya, Nigeria, and Tunisia, where structural reforms and prudent financial policies were implemented as programmed. In contrast, in countries such as Cameroon, Côte d’Ivoire, and Sudan, where large macroeconomic imbalances emerged, short-lived spurts in economic activity alternated with deep recessions.
|Real GDP||Consumer Prices|
|Eastern Europe and|
Many countries—including Algeria, Benin, Equatorial Guinea, The Gambia, Ghana, Kenya, Lesotho, Nigeria, and Tunisia—responded to the adverse external environment prevailing in 1990 and the first half of 1991 by continuing with structural reforms and strengthened efforts to keep stabilization programs on track. These policies helped mitigate the effects of external shocks in 1990 and early 1991, and they provide the foundation for the strong recovery expected for 1992. Other countries—for example, Burkina Faso, Comoros, Rwanda, and Tanzania—introduced structural reform programs and tightened macroeconomic policies in the first half of 1991; the sustained implementation of these policies should permit a gradual recovery in real per capita GDP growth by 1992. However, in such countries as Madagascar, Mozambique, Senegal, Togo, and Uganda, programs of adjustment and structural reform have been affected by delays and slippages in the last 12 months, with adverse effects on growth prospects. Moreover, in Cameroon, Côte d’Ivoire, Morocco, Sudan, and Zaïre, structural reforms were delayed or aborted and fiscal and monetary policies remained broadly unchanged in the presence of increasing macroeconomic imbalances; as a consequence, the outlook is for continued sluggish economic activity in 1991 followed by only a modest recovery in 1992.
The importance of sound policies and the serious costs of social and political conflicts in Africa is illustrated by the region’s recurrent episodes of famine. At present, a number of countries in the sub-Saharan region are in need of relief to cover a shortfall of grain estimated by the UN World Food Programme at 1.8 million metric tons. About 30 million people in this region are at risk of starvation, the majority of them in Ethiopia and Sudan, but also in Angola, Burkina Faso, Liberia, Mozambique, and Somalia. In these countries food shortages caused by drought are magnified by the obstacles imposed on relief operations by civil wars, inadequate infrastructures and distribution networks, and by the scarcity of foreign exchange stemming from large internal and external imbalances. In contrast, in other countries affected by drought, such as The Gambia and Ghana, access to food imports has been facilitated by the availability of foreign exchange resulting from a stable macroeconomic environment supported by prudent economic policies and structural reforms.
Continuing the trend of recent years, the short-term outlook for Asia features marked differences in economic performance between the group of seven rapidly growing countries8 and the rest of the region. Growth in the first group is projected to remain at nearly 7 percent in 1991, somewhat lower than in the past five years. Inflation for the group as a whole is expected to fall by 1 percentage point to 6 percent; this would still be somewhat above the average of the 1980s. In most of the rest of Asia—including Bangladesh, India, Pakistan, the Philippines, and Sri Lanka—growth is expected to be lower than in the seven rapidly growing countries, and inflation would remain broadly unchanged from 1990, except in Bangladesh and Sri Lanka where a significant decline is expected. Growth in China is projected to increase this year following a relaxation of macroeconomic policy, but inflation is expected to rise and the current account surplus to narrow substantially. For Asia as a whole, real GDP growth is expected to fall from 5½ percent in 1990 to 5 percent in 1991, while average inflation would rise from 8 percent to 8¾ percent.
In 1992, the growth of real GDP in Asia is projected to continue at a rate slightly above 5 percent, helped by a recovery of export markets, while inflation is expected to remain unchanged, reflecting mainly a tightening of policies aimed at curbing demand pressures in the seven rapidly growing economies. In these countries, growth is expected to fall slightly to 6¼ percent. In most of the other countries of Asia, except China, growth would increase somewhat and inflation would fall significantly.
The seven rapidly growing economies of Asia entered a period of overheating in 1990 that continued during the first half of 1991. Inflation and real wages increased and labor shortages and bottlenecks in infrastructure became more pronounced. Over this period the impetus to growth in these countries shifted from exports to domestic demand—including capital formation financed by foreign investment—as world markets weakened and domestic goods became less competitive. This development, together with faster growth of imports of capital and consumer goods and the increased cost of oil imports contracted before energy prices declined, contributed to a drop in the current account surplus. Credit conditions were tightened to curb the growth of imports and domestic demand and to achieve a more balanced expansion of productive capacity. However, in part because of large capital inflows, tighter credit conditions were not completely successful in moderating the growth of broad money. Moreover, except in Indonesia, Malaysia, Singapore, and Thailand, a relaxation of fiscal policy—reflecting in part increased public investment in infrastructure projects—partly offset the effects of a more restrictive monetary policy.
The other economies of Asia—particularly India, Pakistan, the Philippines, and Sri Lanka—were more seriously affected by the crisis in the Middle East than the NIEs because of their closer economic links with that region. Pakistan and Sri Lanka have been introducing market-oriented reforms since 1988, and thus were in a better position to cope with the worsening of the external environment, despite delays in the privatization of public enterprises and the liberalization of the financial system and despite a relaxation of macroeconomic policy in Pakistan during 1990-91. In contrast, in India and the Philippines, the sharp deterioration of economic conditions in 1990 and the first few months of 1991—which was worsened by the Middle East crisis—reflected structural weaknesses characterized by large fiscal and current account imbalances. In these two countries, the worsening external situation underscored the need to tighten monetary and fiscal policies and implement far-reaching structural reforms, and both countries have reoriented policies in this direction. In the Philippines, progress was made in reducing fiscal and external imbalances in the first half of 1991, but the eruption of Mount Pinatubo in June has put additional pressure on the fiscal position. India introduced in July an economic package that included a sharp tightening of financial policies and announced plans for extensive structural reforms.
Recent developments in the centrally planned economies of Asia are generally less encouraging, except in the Lao People’s Democratic Republic, where a SAF arrangement approved in 1989 is progressing as planned and the economy is expected to achieve positive growth in GDP per capita in 1992, with a stable macroeconomic environment. In China, continuing financial imbalances, reflecting in part large losses by public enterprises, has resulted in rapid monetary expansion and has increased the risk of higher inflation.
Eastern Europe and the U.S.S.R.
In all the Eastern European countries and the U.S.S.R., production declined sharply in the first half of the year and output projections for 1991 were revised downward by considerable margins.9 Real GDP in Eastern Europe (excluding the U.S.S.R.) is now expected to fall 12 percent this year, implying a cumulative drop of 19 percent in 1990-91. In Bulgaria, the Czech and Slovak Federal Republic (Czechoslovakia), Hungary, Poland, and Romania—where comprehensive programs of macroeconomie stabilization and systemic reform have been introduced—the recent contraction of output reflects to some extent the elimination of production by enterprises that are no longer viable. In addition, the general climate of uncertainty, declining real wages, and tight macroeconomic policies have contributed to weaker demand.10 In the U.S.S.R., social and political upheaval, the continued disintegration of supply links, and uncertainty about the future course of economic policies have led to a significant contraction of economic activity. Political unrest has also disrupted production and hindered stabilization efforts in Yugoslavia.
The recent downturn of economic activity in Eastern Europe has been amplified by the virtual collapse of intra-regional trade, reflecting mainly a contraction of import demand in the U.S.S.R., the reorientation of import demand in east Germany, and to some extent the spillover effects of weak economic activity throughout the region.11 In the U.S.S.R., the decline of production and the strengthening of foreign exchange constraints appear to have curtailed imports, which in turn constrained import demand in several Eastern European trading partners. 12 Although some countries have negotiated special temporary arrangements with the U.S.S.R. and some recovery of trade is expected in the second half of the year, the volume of exports to former CMEA trading partners is expected to decline in 1991 by 35-65 percent in Bulgaria, Czechoslovakia, Hungary, Romania, and the U.S.S.R., and by almost 75 percent in Poland.
The sharp contraction of intra-regional trade has had a severe impact on the Eastern European economies owing to their strong orientation toward trade with other former members of the CMEA.13 The staff estimates that the direct effects on domestic production of the decline in foreign demand would account for one third to all of the projected fall in output in 1991. Even Yugoslavia, with a diversified export base, and countries such as Hungary and Poland, which recently have expanded exports to the convertible currency area on a significant scale, appear to have been severely affected. In Bulgaria and Romania, the adverse effects of lower demand from other countries in the region have been compounded by the loss of traditional markets in the Middle East as a result of the war; in addition, shortages of imported inputs resulting from difficulties in obtaining foreign financing have hampered production and the shift to other export markets.
The contraction of output in early 1991 has led to a rapid increase in unemployment in all Eastern European countries. By May 1991. the unemployment rate in Poland had reached 7½ percent, compared with 3 percent in June 1990, while measured unemployment in Bulgaria, Czechoslovakia, Hungary, and Romania had risen from negligible levels to a range of 2 to 4 percent of the labor force. Further substantial increases in unemployment are expected during the remainder of this year, notwithstanding the prospect for continued expansion of employment in the private sector. With the projected contraction of output this year, unemployment is also likely to rise in the U.S.S.R. and in Yugoslavia.
In the face of unfavorable external conditions and the sharp fall in output, the Eastern European countries—except Yugoslavia, which has experienced severe political turmoil—have persevered with their efforts to stabilize macroeconomic conditions and implement systemic reforms. Fund-supported stabilization programs aimed at containing pressures on prices and the balance of payments have been adopted in Bulgaria. Czechoslovakia. Hungary, Poland, and Romania. These programs combine tight macroeconomic policies with wage controls as a nominal anchor. Czechoslovakia and Poland also have fixed their nominal exchange rates to help control inflation, although in Poland a nominal devaluation was required in early 1991 to correct for a substantial real appreciation during 1990.
The conduct of monetary and fiscal policy in the Eastern European countries continues to be hampered by structural weaknesses, such as the lack of well-developed market-based instruments of monetary control, the absence of competition in the financial sector, a banking system that is burdened with weak balance sheets, and inadequate fiscal revenue systems. Even so, monetary conditions have been tightened significantly during the first half of 1991 in all Eastern European countries except Yugoslavia. In Bulgaria, Czechoslovakia, and Romania, real money balances contracted sharply as monetary expansion was constrained while inflation surged temporarily following the recent liberalization of prices. All Eastern European countries, except Yugoslavia, have also made considerable efforts to strengthen fiscal positions by cutting expenditures. However, fiscal revenues, which continue to rely heavily on profit and turnover taxes, have been hurt by the economic downturn and budget deficits are expected to widen this year in some countries.14
Fiscal and monetary conditions appear to have deteriorated considerably in Yugoslavia and the U.S.S.R. In Yugoslavia, a comprehensive stabilization program was introduced in late 1989, but more recently stabilization efforts have been thwarted by the federal authorities’ inability to exercise effective control over the key instruments of economic policy. In the U.S.S.R., uncertainty about the course of political and economic reform has severely hampered the budgetary process. Fiscal conditions worsened sharply during the first half of the year, notwithstanding a partial reform of retail prices in April that was designed to contain burgeoning subsidies. In the event, wages and transfers to households were increased to offset most of the price increases, and credit to the government continued to expand rapidly.
Inflation in Eastern Europe is projected to average over 100 percent in 1991, compared with nearly 150 percent in 1990. The projected average annual rate of inflation for 1991 has been revised upward mainly because of larger-than anticipated price increases associated with price liberalizations in late 1990 and early 1991 in Bulgaria, Czechoslovakia, and Romania. While the removal of most price controls in these countries had been expected to lead to significant increases in the price level—particularly in Bulgaria and Romania where excess liquidity was estimated to be substantial—it appears that the lack of competition in domestic goods markets and the lagged pass-through of the large devaluations that preceded price liberalizations also contributed to the temporary surge in inflation. However, tight monetary control and incomes policies prevented a wage-price spiral, and inflation came down significantly in subsequent months. Hungary and Poland also have succeeded in lowering inflation during the first half of 1991, but price increases appear to have accelerated again in Yugoslavia. In the U.S.S.R., the adjustment of retail prices in April 1991 resulted in a sharp increase in the price level. However, with most of the price increase matched by a rise in nominal incomes, excess demand pressures are likely to persist. Nonetheless, because of continuing price controls, these pressures are more likely to be reflected in shortages than in further price increases.
Real wages fell in early 1991 in most Eastern European countries as nominal wage increases were kept under control while prices rose sharply. In several countries—notably Bulgaria, Czechoslovakia, and Romania—nominal wage increases remained below official guidelines as incomes policies were reinforced by tight monetary conditions. By contrast, in the U.S.S.R. nominal incomes continued to rise substantially during the first half of the year, and real incomes—measured in terms of the official price index and not in terms of actual purchasing power—appear to have been broadly maintained.
The combined current account deficit of the Eastern European countries is projected to increase considerably in 1991, reflecting mainly a surge of imports in Poland and a substantial decline in exports, travel receipts, and transfers in Yugoslavia; both countries would record a sharp turnaround in the current account balance, from a sizable surplus in 1990 to a large deficit in 1991. With cuts in imports offsetting most of the contraction of exports during the first half of the year, the combined external deficit of the other Eastern European countries is expected to increase relatively little in 1991. Foreign financing constraints also have led to a sharp fall in U.S.S.R. imports, which should contribute to a considerable narrowing of the current account deficit in 1991.
The outlook for the Eastern European countries and the U.S.S.R. for 1992 is highly uncertain and depends critically on the stance of economic policies. Assuming that efforts to stabilize macroeconomic conditions and to implement systemic reforms are sustained in Bulgaria, Czechoslovakia, Hungary, Romania, and Poland, the contraction of output is expected to come to a halt and a moderate increase in real GDP is projected for 1992. The onset of a recovery would contain, or begin to reverse, the rise in unemployment. At the same time, inflation would decline significantly, and current account deficits would narrow.
The projected recovery of growth in the Eastern European economies in the coming years assumes rapid progress on privatization and restructuring of public sector enterprises as well as financial sector reform. Moreover, given the current weakness of economic activity throughout the region, and particularly in the U.S.S.R., most countries would need to stimulate growth by expanding exports to alternative markets; the projections assume that they will have access to these markets. Finally, the projected recovery in the Eastern European countries could be jeopardized if the assumed financing flows were not forthcoming.
In the U.S.S.R., a recovery of economic activity in the years ahead would require the expeditious implementation of a comprehensive program of macroeconomic stabilization and systemic reforms.15 The continuation of recent policies of piecemeal reforms in an environment of widening fiscal imbalances and increasing excess liquidity may involve a somewhat smaller contraction of output in the short run, but it would result in a long recession, rising unemployment, and growing shortages in the coming years.
The crisis in the Middle East has had severe consequences for the region. There has been extensive war damage in Iraq and Kuwait, considerable disruption of trade in goods and services, heavy costs to support refugees and repatriate workers, and, in some countries, significant costs to finance the war. Economic prospects for 1991-92 depend critically on the assumptions regarding the speed of reconstruction in Iraq and Kuwait, on whether economic sanctions against Iraq will be lifted, on the implementation of stabilization policies and structural reforms, and on access to external financing or debt relief to cover large current account deficits. For the Middle East as a whole, real GDP is projected to decline by 4 percent in 1991, the current account is expected to shift from a surplus of $10 billion to a deficit of $43 billion, and the rate of inflation to rise from 13 percent in 1990 to nearly 15½ percent in 1991.
These projections mask considerable differences in performance within the region. Output in Saudi Arabia would continue to grow rapidly, reflecting an expansion in oil production and increased expenditures associated with the war. Growth is also expected to be strong in Iran—where a booming oil industry has helped to offset the adverse effects of the Middle East crisis and the economic disruptions resulting from earthquake damage. In Israel, massive immigration from the U.S.S.R. is projected to sustain a high rate of GDP growth, but it would also increase unemployment, inflation, and the fiscal deficit. In contrast, output in Iraq and Kuwait is expected to fall even more sharply in 1991 than in 1990, and other countries—such as Egypt. Jordan, and Yemen, and some of the oil exporters in the region—-are likely to experience slower, or in some cases slightly negative, growth. The slowdown in some oil exporting countries in 1991 would reflect a substantial decline in terms of trade owing to the fall in oil prices.
The outlook for 1992 is highly uncertain. Under current assumptions GDP growth would rebound to 11 percent, inflation would fall to 12 percent, and the current account deficit would narrow by $25 billion. Repairs of war damage and the reopening of trade would permit a rapid recovery in Iraq and Kuwait after two years of sharp output declines. A recovery is also expected in the rest of the region, except in Saudi Arabia where the lagged effects of the decline in oil prices and the cessation of war-related expenditures would result in slower growth, and in Egypt, where adjustment policies needed to contain inflation are expected to dampen economic activity in the short run.
Fiscal and current account deficits are expected to widen in some countries as a result of the relaxation of fiscal and monetary policies and the disruption of trade flows after August 1990, and because delays and slippages have affected the implementation of structural reforms. In such countries as Egypt, Jordan, and Yemen, large macroeconomic imbalances existed prior to the crisis, and economic conditions have worsened significantly since then as rigidities have limited the operation of market-based, self-correcting mechanisms. In May 1991, however, Egypt introduced a far-reaching program of adjustment and structural reform supported by a stand by arrangement with the Fund; the program seeks to give market forces the dominant role in allocating resources, while macroeconomic policy would be tightened to reduce the fiscal deficit and strengthen the balance of payments. Policies in Iran have been managed prudently; macroeconomic policy was not relaxed in 1990 and is expected to remain tight in 1991 and 1992, and some progress has been made in introducing structural reforms.
Economic activity in the Western Hemisphere is expected to be sluggish in 1991, with a small rise in GDP reversing a decline of almost 1 percentage point last year. In a few large countries of the region, such as Brazil and Ecuador, output is expected to decline, but above-average growth is projected for Argentina, Bolivia, Chile, Colombia, Costa Rica, Jamaica, Mexico, Paraguay, and Venezuela. Average inflation for the region as a whole in 1991 would remain above 150 percent and the combined current account deficit would widen by $12 billion to $18 billion. To a large extent, however, the high rate of inflation expected for this year is attributable to developments in a few countries, such as Argentina, Brazil, Nicaragua, and Peru. Inflation in most other countries is expected to range from 10 to 35 percent, well below the average for the region.
With the recovery of export markets and lower energy costs, growth for the region as a whole is expected to rebound to 2¼ percent in 1992, and average inflation would decline to 55 percent. There are, however, marked differences in the outlook for countries in the region, owing in part to sharp differences in the stance of macroeconomic policies and the degree of structural adjustment that has been achieved. Delays and slippages in the execution of adjustment programs have been evident in Argentina and Brazil, while Nicaragua and Peru failed to tighten macroeconomic policies or introduce structural reforms until 1990. The latest program introduced in Argentina in April 1991—supported by a Fund stand-by arrangement approved in July—has already produced positive results: inflation and the primary government deficit have declined, economic activity is starting to recover, privatization of public enterprises is progressing, and foreign reserves have stabilized.16 In Peru, where GDP has fallen to its level of 15 years ago, an array of measures to stabilize the economy was introduced in 1990 and in the first half of 1991; these include the elimination of some restrictions on the exchange and payments systems, a reduction of trade barriers, the deregulation of interest rates, adjustments of fuel and utility prices, tax reform, and the liquidation or privatization of public enterprises. In Brazil, monetary policy has not been kept tight long enough to achieve a sustained decline in inflation, and insufficient progress has been made in reducing the fiscal deficit. In addition, widespread indexation continues to hamper efforts to control inflation.
Except for some of the high-inflation countries, many countries have made progress in reducing the fiscal imbalances that had previously contributed to high inflation. In particular, Bolivia, Colombia, Chile, El Salvador, Jamaica, Mexico, and Paraguay have consistently managed macroeconomic policies prudently and have introduced structural reforms. The external debt of Costa Rica, Mexico, Uruguay, and Venezuela has been reduced in the context of comprehensive debt and debt-service reduction packages with commercial banks, thereby freeing resources for investment. Adherence to sound policies and structural reforms also helped Chile and Mexico regain limited access to private international capital markets in 1991, after almost a decade of absence, and Chile has reduced its total debt to banks by over half in the past four years through market-based debt conversion. In Costa Rica, a new program of adjustment and structural reform was introduced in April 1991 to correct imbalances that developed after a similar program went off track in 1989. In the structural area, countries such as Argentina, Bolivia, Chile, Colombia, El Salvador, Mexico, Paraguay, Uruguay, and Venezuela are moving ahead with privatization programs, financial sector reform, and the elimination of restrictions on foreign investment. They have also begun discussions on regional trade arrangements aimed at achieving a Continental free-trade zone envisaged in the Enterprise for the Americas Initiative.
Current Accounts, External Financing, and Debt
The aggregate current account deficit of the developing countries is projected to surge from $25 billion in 1990 to $104 billion in 1991 before declining to $64 billion in 1992.17 These changes in the current account deficit would result from a swing in the aggregate trade balance from a surplus of $38 billion in 1990 to nearly a balance in 1991 and 1992, and a temporary drop in net unrequited transfer receipts from $32 billion in 1990 to $3 billion in 1991, followed by a rebound to $34 billion in 1992.
Three major factors would account for a turnaround in the aggregate trade balance in 1991-92. First, the surplus of the Middle East is projected to drop sharply from 1990 to 1992, as the expected rebound in the volume of oil exports from Iraq and Kuwait would be more than offset by a strong rise in imports related to postwar reconstruction and by the projected decline in oil prices from 1990 to 1992. Second, the combined trade surplus of the four newly industrializing Asian economies is expected virtually to disappear in the face of strong domestic demand, and China’s trade surplus is expected to decline; as a result, the aggregate trade deficit of the developing countries in Asia would widen substantially. Third, the combined trade surplus of the Western Hemisphere would narrow from 1990 to 1992, reflecting largely a fall in the surpluses of Argentina and Venezuela and the emergence of a large deficit in Mexico.
The decline in net transfer receipts by the developing countries in 1991 would stem largely from substantial outward transfers by Kuwait, Saudi Arabia, and the United Arab Emirates to the United States, France, and the United Kingdom to help defray the cost of the military conflict. Official transfers to the net debtor developing countries in 1991 would, however, be well above the levels recorded in the 1980s. This would reflect a one-time surge in official transfers for war-related assistance to front-line states in 1991, and the projected financial assistance by Germany to the U.S.S.R., mostly to facilitate the evacuation of Soviet military personnel from east Germany (Statistical Appendix Table A40).
The developing countries’ deficit on goods, services, and private transfers is projected to rise from $43 billion in 1990 to $83 billion in 1992. This would be accompanied by an $8 billion increase in net external borrowing by all developing countries (to $79 billion in 1992). Major creditor countries in the Middle East would more than account for this increase, reflecting in part substantial new borrowing by Kuwait and Saudi Arabia to finance the reconstruction effort and pay for the cost of the war (Statistical Appendix Tables A40 and A42). In addition, net inflows of foreign direct investment would increase by $11 billion (from $19 billion in 1990 to $30 billion in 1992), reflecting larger inflows to Argentina, Brazil, and Mexico, and reduced outflows from Taiwan Province of China. Finally, net outflows associated with the acquisition of private and official financial assets abroad are projected to fall in 1991-92.
Aggregate net external borrowing by net debtor developing countries is projected to decline in 1991-92 from its exceptionally high level in 1990, partly as a result of a substantial reduction in exceptional financing in the Western Hemisphere and the expected settlement of arrears by several large debtor countries. In Asia, the largest borrowers would include Korea, which resumed large-scale borrowing in the face of re-emerging current account deficits. In addition, some countries with recent debt-servicing difficulties (for example, Chile, Mexico, and Venezuela) have regained limited access to spontaneous financing on increasingly favorable terms, while other developing countries have issued convertible bonds or experienced inflows of equity capital through direct sales of equities to foreign investors or through “country funds” listed on international stock exchanges.
The prospective current account and financing developments in developing countries imply significant changes in the pattern of accumulation of official foreign exchange reserves. During 1990, these countries added $40 billion to their reserves, the largest increase since 1987, and further increases are projected for 1991 and 1992. In contrast with the recent past, when additions to foreign exchange holdings were concentrated in the four newly industrializing Asian economies, the increase in reserves in 1990-92 would reflect substantial accumulation in both the Western Hemisphere (principally Argentina, Chile, Mexico, and Venezuela) and Asia (China, Indonesia, and Singapore). In addition, in 1991 a substantial drawdown of reserve assets is projected for several Middle Eastern countries and Korea, and the accumulation of reserves by Hong Kong and Taiwan Province of China is expected to be much slower in 1991-92 than in previous years.
During the first half of 1991, several important debt-restructuring agreements were completed. In April and May the Paris Club concluded far-reaching debt-restructuring agreements with Poland and Egypt, two middle-income countries that are undertaking comprehensive medium-term adjustment programs and have about 70 percent of their debt with bilateral official creditors. These agreements provided for a 50 percent reduction in the present value of some $60 billion of debt. The Paris Club also reached rescheduling agreements with Argentina, Bulgaria, Burkina Faso, Costa Rica, Nigeria, the Philippines, Peru, and Senegal. In May, Brazil reached agreement with its commercial bank creditors on the treatment of $8.5 billion in interest arrears, thereby setting the stage for negotiations on comprehensive restructuring of medium- and long-term debt. At their London summit meeting in July 1991, the participating countries agreed on the need for additional measures going well beyond the relief already granted under Toronto terms to the poorest and most indebted countries, on a case-by-case basis, and called on the Paris Club to continue discussions on how these measures can be implemented promptly.
According to staff estimates, the total external debt of the developing countries (excluding use of Fund credit) reached $1,466 billion at the end of 1990, and is projected to increase to $1,530 billion at the end of 1992 (Chart 19), reflecting largely a $53 billion increase in the external debt of Middle Eastern countries. The external debt of net debtor developing countries is projected to rise by $20 billion, but the debt of the group of countries with recent debt-servicing difficulties is expected to fall by $20 billion; debt owed to commercial banks would drop by $36 billion, partly a result of debt-reduction operations. The projected change in the stock of debt would contribute to a 1 percentage point decline in the aggregate debt-GDP ratio from 1990 to 1992; this ratio would fall in all regions and analytical groups except the net creditor countries in the Middle East and the U.S.S.R.18 No improvement is projected in aggregate debt-service ratios, however, partly because of payments related to debt-restructuring agreements that have been or are expected to be concluded during 1991-92.
The Collapse of Trade Among the Former Members of the CMEA
The Council for Mutual Economic Assistance (CMEA) was effectively disbanded in 1991.19 The end of CMEA trading arrangements—together with the switch to world market prices and settlement in hard currencies, an acute shortage of foreign exchange in a number of countries, and the organizational and administrative crisis in the U.S.S.R.—resulted in a precipitous decline in trade among the former CMEA members in the first half of 1991. The contraction of trade, which was much more severe than originally expected, contributed to a large drop in output and employment in all of the former CMEA members of Eastern Europe. This appendix discusses recent trade developments in these countries, the impact of these developments on output and employment, and future prospects for trade among the former members of the CMEA.
Recent Developments and Outlook for 1991
Trade within the CMEA was traditionally organized on a bilateral basis, largely vis-à-vis the U.S.S.R; there was substantially less trade among the non-U.S.S.R. members of the CMEA, which generally produced competing rather than complementary goods. Production in each of the Eastern European countries, including the former German Democratic Republic (GDR), was structured to absorb imports of raw materials and energy from the U.S.S.R. and to supply the Soviet Union with manufactured goods and, in some cases, agricultural products. For most of the former Eastern European members of the CMEA (CMEA/EE), exports to the U.S.S.R. in 1991 are still expected to be at least twice as large—in the case of Bulgaria and Romania four times as large—as those to the other CMEA/EE combined.
The volume of exports to former CMEA trading partners in 1991 is expected to decline by 35 to 45 percent in Hungary and the U.S.S.R.; by 50 to 65 percent in Bulgaria, Czechoslovakia, and Romania: and by about 75 percent in Poland. In Bulgaria, Czechoslovakia, and Romania, exports to former CMEA members other than the U.S.S.R. are expected to fall this year by at least as much as those to the U.S.S.R. The sharp drop in trade between the former Eastern European members of the CMEA also reflects a switch in the pattern of imports of the former GDR, which is substituting “imports” from west Germany for imports from its former CMEA trading partners—a switch that had already begun in 1990.
The decline of imports into the U.S.S.R. during the first half of 1991, which was not confined to imports from the CMEA/EE, reflected a number of interrelated factors. A severe foreign exchange constraint in the U.S.S.R. was worsened by a bunching of debt-service payments in the spring of 1991, by delays in disbursements of foreign credits, and by declines in petroleum production and exports. Trade was further affected by the decision in principle to conduct all trade between the CMEA countries in convertible currencies and at world market prices starting on January 1, 1991, and by the prohibition of baiter arrangements for most products announced by the U.S.S.R. in December 1990, although this was lifted six months later. Nonetheless, most trade continued to take place through temporary buffer accounts in transferable rubles established in January-March 1991 for settlement of trade committed during 1990, and through clearing accounts established with some partner countries. Other factors hampering trade with the U.S.S.R. include uncertainty about decision-making authority over trade and payments—owing partly to the limited experience in managing decentralized foreign trade transactions—and a weakening of central economic controls.
This year is the first since the introduction of central planning in which the U.S.S.R. is operating without an economic or foreign trade plan. By mid-year, state orders had been issued for only one third of the 1990 volume of transactions with former CMEA trading partners and indicative lists had been agreed on the goods to be traded, generally “hard goods” such as oil and gas, raw materials, and intermediate products. In 1991, the volume of petroleum exports from the U.S.S.R. to the former CMEA/EE is expected to decline to about half the level of 1990, after a contraction of about one quarter from the previous year. The sharpest decline over the two-year period is expected for petroleum exports to Bulgaria and Romania. Trade in goods not on the indicative list was to have been arranged with individual republics or enterprises within the U.S.S.R. This trade accounted for only about 10 percent of total trade in the early months of 1991, in part because the sharply depreciated commercial exchange rate of the ruble reduced the republics’ demand for imported investment goods—notably transport equipment—traditionally exported by the CMEA/EE to the U.S.S.R.
The former members of the CMEA differ in their dependence on trade with the CMEA area, and thus in their vulnerability to the collapse in regional and Soviet trade. In Bulgaria, about 70 percent of exports in 1990 were to former CMEA members—primarily to the U.S.S.R.—and more than half of Bulgarian exports are expected to go to these countries in 1991. In Czechoslovakia, Hungary, Poland, Romania, and the U.S.S.R., 25 to 45 percent of exports in 1990 were to former CMEA trading partners. In 1991, Poland is expected to sell only 10 to 15 percent of its exports to former CMEA members. Less than 20 percent of imports into Poland, Romania, and the U.S.S.R. are projected to come from former CMEA trading partners in 1991.
The Impact on Output of the Collapse of Trade
Real output is expected to contract by 5 to 25 percent in 1991 in the Eastern European countries and in the U.S.S.R. The drop in export demand has been a major element depressing economic activity in all the CMEA/ EE countries, although it is difficult to quantify the direct impact. This difficulty reflects the ambiguity surrounding calculations of the weight of trade in output because of the severe price distortions under the former CMEA trading system. In general, CMEA trade was conducted at prices below world market prices, although the divergence varied across goods and markets. Thus, calculations based on domestic prices of traded goods imply a much lower weight in output than calculations using world market prices. In a number of countries, the value of CMEA trade in 1990 measured in domestic prices—and therefore the ratio of trade to output—is about half as large as it is if calculated on the basis of estimated world market prices.
Bearing in mind this caveat, the direct effects of the collapse of exports in the former Eastern European members of the CMEA may account for as little as 3 to as much as 15 percentage points of the decline in total output in 1991 in the individual countries. Except in Hungary, the direct impact of the drop in exports is generally expected to account for one half to three quarters of the total output decline. The projected drop in output in Hungary is smaller than suggested by the calculation of the direct impact from the fall in exports, suggesting that past and current economic reforms have helped to sustain growth in the face of declining demand from traditional markets. Output is expected to decline the most in heavy industrial sectors such as machinery, electro-engineering, mechanical engineering, and metallurgy where production has been most concentrated on supplying the Soviet market.
The large declines in trade expected in 1991 in the former CMEA/EE are likely to have multiplier effects throughout the economy. These indirect effects are difficult to estimate, in part because of distorted relative price structures prevailing before the implementation of reform programs. In Hungary, the authorities estimate that the successful rechanneling of exports has reduced by half the impact on output of the projected decline in demand from the CMEA area.
Effects on Individual Eastern European Countries20
Exports from Bulgaria to the CMEA have traditionally been a strong component of demand and were expected to provide a cushion for domestic enterprises during the transition to a market economy. Instead, the loss of these markets led to a dramatic reduction in liquidity in the affected enterprises, contributing to a decline in real wages by about two thirds in the first half of 1991. Output declined substantially in those industrial sectors dependent on CMEA trade in the first half of 1991; output in electrical engineering, chemicals, and in some branches of machine building and metal processing fell by about twice as much as the decline in the industrial sector as a whole. In some industries with export potential—such as glass, porcelain, textiles, and food processing—output fell considerably less, or even increased, in the first half of 1991. Unemployment in Bulgaria rose from less than 2 percent of the labor force at the end of December 1990 to about 5-6 percent at the end of June 1991, although total employment declined only slightly.
In Czechoslovakia, the high level of industrialization and the importance of exports of machinery and transport equipment—much of which is designed for the Soviet market—are expected to limit the redirection of exports from former CMEA markets. The decline in trade also reflects the uncompetitiveness of some industries after the change in the trade regime in 1991 and reduced exports of armaments, including to the CMEA area. Exports to the CMEA of machinery—the largest industrial sector in Czechoslovakia in terms of employment and sales—accounted for about one half of total industrial exports to the CMEA area and for 25 percent of the machine industry’s total sales in 1990. In 1990, sales of machinery to the Soviet Union dropped by almost 30 percent in volume terms, with further declines in early 1991. In other sectors, such as chemicals and electro-technical products, where exports to the former CMEA area were important, the volume of exports fell by 25 to 30 percent in 1990. The heavy machinery sector is not highly labor-intensive, so the impact on employment of lower CMEA trade is expected to be smaller than the impact on output.
In Hungary, sharp declines in CMEA exports are expected in 1991 in most industries including metallurgy—where exports to the CMEA area dropped by almost 50 percent in 1990—and chemicals and machinery, which accounted for about 15 percent of total exports to the CMEA in 1990. Machinery exports to non-CMEA trading partners, however, have been increasing rapidly. Exports of agricultural and food products in 1991 are expected to be hurt by lower demand and, to some extent, competition from western suppliers offering favorable credit terms. Agricultural and food exports to the CMEA area—which accounted for about 15 percent of total CMEA exports in 1990—are projected to drop by about two thirds in 1991, but these exports represented a relatively small proportion of total agricultural and food output. The sectors most affected by the fall in CMEA exports are relatively labor-intensive, and—partly as a result—unemployment is projected to rise from about 2 percent of the labor force at the beginning of 1991 to 6-8 percent by year-end.
In Poland, exports to the CMEA have been relatively less important than in Hungary. Such exports were equivalent to about 6 percent of GDP in 1990, and they are projected to account for about 12 percent of total exports in 1991. Nevertheless, the steep decline in these exports during 1991 is likely to have a substantial impact on output. The authorities estimate that about half of the projected decline in GDP in 1991 is due to lower CMEA trade. The sectors most affected by the decline in exports to the former members of the CMEA are electro-engineering, fuel and energy, and food processing. Final producers most dependent on exports to the U.S.S.R. accounted for an estimated 4 to 5 percent of total industrial employment at the end of March 1991. Enterprises exporting to the U.S.S.R. tend to be large, often dominating employment in the cities or regions where they are located; hence, the impact on the local economy in these areas of the collapse in exports to the U.S.S.R. is expected to be substantial.
In Romania, the projected contraction of exports in 1991 is expected to have an important effect on output, even though CMEA exports were equivalent to only about 6 percent of GDP in 1990. Industrial production in the first half of 1991 was 17 percent below the same period last year, with the decline concentrated in such heavy and energy-intensive industries as coal mining, metallurgy, transport equipment, machine building, and chemicals. Foreign exchange shortages also contributed to a sharp decline in energy and raw materials imports from the former CMEA trading partners—particularly troni the U.S.S.R.—which is expected to have a significant depressing effect on industrial production and output this year. The contraction of trade with former CMEA trading partners could account for half of the projected increase in unemployment from about 2 percent of the labor force earlier this year to about 8 percent by year-end. So far, most of the workers laid off have been from large industrial enterprises in the state sector.
In the short run, the scope for rechanneling exports from the former CMEA to markets outside the CMEA area appears to be limited for most Eastern European countries. Among the former CMEA trading partners, only Hungary, which had previously established diversified trading links outside the region, has managed to rechannel a significant part of its exports to new markets. Although Poland’s export performance outside the CMEA area so far this year has met expectations, the authorities consider that many of the goods manufactured under cooperation agreements and exported to former CMEA trading partners are unmarketable in other areas.
It is thus critically important for the Eastern European countries to accelerate structural change to a more market-oriented system of production and trade. This would involve industrial restructuring to update outmoded production techniques so as to compete at world market prices in those areas where Eastern European countries have a comparative advantage. Demand from outside the CMEA area for the goods currently produced in Eastern Europe is limited in many cases by poor quality and design, the same factors that limit domestic and regional demand. Moreover, most Eastern European countries lack trading and marketing links with industrial and developing countries outside the region. It will take time and improved market access to develop these links and the necessary skills to exploit them. This points to the importance of a successful conclusion of the Uruguay Round of multilateral trade negotiations to reduce trade barriers that Eastern European exports face in Western Europe and elsewhere.
While the immediate impact on trade of the dissolution of the CMEA was more severe than had been anticipated, the staff expects some recovery of trade among most of the former members of the CMEA during the second half of 1991. This expectation reflects some recent evidence that the decline in trade has bottomed out, and a number of other considerations. Clearing arrangements for the settlement (in clearing dollars) of trade in goods on the indicative list between the U.S.S.R. and Bulgaria, Czechoslovakia, and Romania have been reinitrodueed, and barter transactions for specific goods have again been allowed in the U.S.S.R. since the end of June 1991. In addition, some accounts have been allowed in nonconvertible currencies to settle specific trade operations between the U.S.S.R. and Czechoslovakia.
The reintroduction of harter trade and bilateral clearing arrangements, even on a temporary basis, tends to sustain the uneconomic and distorted production and trade structures of the region. It may also limit the ability of enterprises to make their own deals and thereby to develop needed marketing skills and trading experience. Such arrangements should therefore be gradually replaced with a more market-oriented system in order to accelerate integration with the world economy.
The establishment of a multilateral clearing arrangement covering Eastern Europe alone—or together with the U.S.S.R.—has been suggested. Such schemes are somewhat less likely than bilateral arrangements to maintain inefficient production and trade flows. However, they could not by themselves resolve the underlying difficulties stemming from a shortage of hard currency and a lack of demand for the goods produced by former CMEA members. Moreover, to the extent that trade with the U.S.S.R. has been hindered by administrative problems, new clearing schemes could only succeed if the situation in the U.S.S.R. improves. More fundamental responses to the trade collapse than those provided by temporary clearing or barter arrangements, involving both structural reforms in these countries and more open markets for their exports abroad, are needed to underpin a long-lasting trade recovery.