Chapter I. Current Developments and Short-Term Prospects
- International Monetary Fund. Research Dept.
- Published Date:
- January 1991
Over the past year the world economy has been buffeted by a series of shocks: the conflict in the Middle East which brought about a sharp rise, and then an equally sharp drop in the price of oil; uncertainties about the likelihood, and later the likely duration and intensity, of military operations in that region; the difficulties associated with the early stages of restructuring in Eastern Europe and unification in Germany; and pervasive uncertainty with regard to the future course of economic policy in the U.S.S.R. On balance, the impact of these developments was to further weaken the world economy at a time when growth was already slowing in a number of large industrial economies. However, the drop in oil prices and the end of the war in the Middle East have helped to boost confidence and to enhance the prospects for stronger growth. And over the longer term German unification and reform in Eastern Europe and the U.S.S.R. could lead to a large improvement of economic conditions in those countries, with favorable repercussions for other countries.
World economic growth is estimated to have slowed from 3¼ percent in 1989 to 2 percent in 1990 reflecting a slowdown in the industrial countries and a fall in economic activity in the developing country regions of Europe, the Middle East, and the Western Hemisphere (Table 1). Owing to continued recession in some industrial countries in early 1991 and to substantial declines in output in the Middle East and in Eastern Europe and the U.S.S.R., world growth is expected to slow further to 1¼ percent in 1991. With recovery in several major industrial countries expected to begin in the course of 1991, and assuming the successful implementation of stabilization policies and structural reforms in a number of developing countries, world growth would rebound to 3 percent in 1992. These developments in global activity would be reflected in the growth of world trade which is projected to fall from 7 percent in 1989 to 2½ percent in 1991, the slowest rate of expansion since 1985, before rising to 5½ percent in 1992.
|Eastern Europe1 and the U.S.S.R.||1.9||-3.8||-4.1||-2.2||-1.0||-4.0|
|World trade volume||7.1||3.9||2.4||5.5||-1.5||-2.9|
|Six-month LIBOR (in percent)5||9.3||8.4||6.7||7.0||—||-1.3|
The near-term prospects for global economic growth have clearly deteriorated since the October 1990 World Economic Outlook. The projection for world growth in 1991 has been revised downward substantially, with weaker growth expected in both the industrial countries (especially in the United States, the United Kingdom, and Canada) and the developing countries (including particularly large downward revisions for Europe, the Middle East, and the Western Hemisphere). The outlook has deteriorated sharply in the countries directly affected by the war in the Middle East and in a number of developing countries that previously received substantial export earnings or workers’ remittances from Kuwait or Iraq.
Prospects for inflation in the industrial countries also have worsened: there were upward revisions for 1991 in all the major economies, reflecting in part the passthrough of the temporary increase in oil prices, with a particularly large revision for Japan. In the developing countries, the projection for inflation in 1991 has been revised upward, but a large decline in the average rate of inflation is still expected from 1990 to 1991.
The more pronounced cyclical divergences among the three largest industrial countries are expected to contribute to a greater narrowing of current account imbalances in the United States and Germany than was envisaged in October. Excluding the one-time effect in 1991 of the official transfers associated with the war in the Middle East, the external deficit of the United States, which was previously projected to widen by $3 billion from 1990 to 1991, is now expected to narrow by $15 billion in 1991. On the same basis, Germany’s current account surplus in 1991 is now expected to be $22 billion smaller than previously projected reflecting, in addition to the factors noted above, the surge in imports associated with unification. In Japan, the current account surplus in 1991 was projected in October to widen by about $8 billion; excluding the one-time effect of the official transfers, the current account surplus is now expected to widen by about $14 billion in 1991, reflecting mainly the lower oil prices assumed for this year.
The economic effects of the crisis in the Middle East—including the rise in oil prices and the impact of heightened uncertainty on consumer and business confidence—may have pushed the U.S. economy from a slow growth path into recession. For a number of reasons, however, the current recession in the United States is likely to have a small impact on growth in the rest of the world compared with the downturns in 1973–74 and 1981–82. First, the U.S. recession is expected to be relatively shallow and short, in part reflecting the comparatively low inflation and the absence of large inventory imbalances. Second, the U.S. share in total world output has declined, while the shares of Japan, west Germany, and the newly industrializing economies of Asia, where growth remains robust, have increased. Third, prior to the two previous recessions there had been a sharp rise in U.S. interest rates that was rapidly transmitted to other countries and was followed by a more or less synchronized slowing of growth; in contrast, U.S. interest rates have been declining for more than a year while most foreign interest rates had been rising until recently. As a result of the different relative cyclical positions, U.S. net imports fell sharply in each of the last two downturns, reducing GNP in the rest of the world by roughly 1 percent; by contrast, U.S. net imports already had been declining for the past two years and the further decline projected for 1991 is expected to have only a limited impact on growth in partner countries.
The level and volatility of oil prices increased sharply after the invasion of Kuwait by Iraq on August 2, 1990. From an average of about $16 per barrel in July, the average petroleum spot price (APSP) rose to nearly $40 per barrel for a brief period in September, declined during the remainder of the year, and then plunged by about $10 per barrel shortly after the outbreak of war in mid-January 1991 (Chart 1).1 The projections presented in this report are based in part on the pattern of futures prices in late March 1991 which implied a further decline in oil prices during the course of the year. In terms of annual averages, the price of oil is assumed to be $17.18 per barrel in 1991, about $5 per barrel less than in 1990 and 25 percent below what had been assumed in the October World Economic Outlook for 1991. In 1992, the price is assumed to be $17.87 per barrel, or 17 percent lower than assumed in October.2
Chart 1.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 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 slowdown in growth in the industrial countries has contributed to the recent declines in nominal and real non-fuel commodity prices (Chart 2). In 1991 and 1992, prices for metals and minerals are projected to decline further in real terms, while the real prices of food, beverages, and agricultural raw materials are expected to remain broadly stable. The terms of trade for the non-fuel exporting developing countries, which declined by an estimated 3 percent in 1990, are expected to rise by ¼ of 1 percent both in 1991 and in 1992.
Chart 2.Real Non-Fuel Commodity Prices1
1 Calculated as the nominal prices deflated by the export price of manufactures of industrial countries. The total is based on world trade weights.
Recent financial market developments have reflected the diverging patterns of growth in the major industrial countries as well as the course of events in the Middle East. Since September 1990, short-term interest rates have fallen markedly in North America and the United Kingdom, and have eased somewhat in France and Japan. Short-term rates increased in Germany and Italy through the end of 1990, but have recently declined somewhat. In all the major industrial countries, long-term interest rates rose in the wake of the invasion of Kuwait by Iraq, but from late September they fell in all countries except Italy before firming when hostilities ended in late February. Equity markets declined during August and September; they generally recovered in the last two months of 1990 and rose sharply following the start of hostilities in mid-January. By mid-April, equity prices in North America and the United Kingdom had recovered to, or exceeded, their pre-invasion levels.
In foreign exchange markets, the U.S. dollar depreciated against most major currencies between August and November 1990—a continuation of the trend that began in mid-1989—in part reflecting different cyclical developments and the associated changes in interest differentials. The dollar subsequently fluctuated within a fairly narrow range, and then weakened in early February following interest rate declines in the United States before recovering sharply after the end of combat in the Middle East. By mid-April, the dollar had regained about three-fifths of its decline from mid-1989 through mid-February 1991. The projections presented in this report are based on the technical assumption that real effective exchange rates will remain unchanged from their March 1991 levels, except for the bilateral rates between the currencies participating in the exchange rate mechanism (ERM) of the European Monetary System (EMS), which are assumed to remain constant in nominal terms. A detailed analysis of recent financial market developments is presented in Supplementary Note 2.
Stance of Policies
Since mid-1990, differences in monetary policies and monetary conditions among the major industrial countries have become more pronounced as divergences in cyclical positions have become more apparent. During 1990, Canada and then the United Kingdom and the United States entered into recession after a period of about three years during which output had exceeded staff estimates of the level that could be sustained without increasing pressures on inflation (Chart 3). In these countries short-term interest rates generally declined during 1990 and early 1991. In Japan and west Germany, by contrast, strong growth in 1988–90 brought output close to or above productive capacity and short-term interest rates rose during 1990 before easing in the first quarter of 1991 (Chart 4). In France and Italy, where output has been near potential, short-term interest rates in general have risen or remained unchanged over the last year although they recently declined somewhat in both countries. The passthrough of the large movements in oil prices since the summer of 1990 has complicated the task of the monetary authorities; in general, however, the temporary rise in oil prices was not allowed to have a sustained impact on the level of inflation, as had been the case after the oil price shock of the early 1970s.
Chart 3.Major Industrial Countries: Output Gaps1
1 Actual and projected GDP/GNP as a percentage deviation from staff estimates of potential output; composites are based on 1988–90 GDP/GNP weights.
Chart 4.Three Major Industrial Countries: Policy-Related Interest Rates1
1 End of month cxcept for the federal funds rate which is the average of daily observations and the repurchase rate which is the average of weekly data.
In mid-1987 and 1988, with economic activity in the United States, Canada, and the United Kingdom approaching or exceeding full capacity, the monetary authorities in these countries allowed interest rates to rise to curb inflation. Short-term rates subsequently fell (beginning in the spring of 1989 in the United States, in mid-1990 in Canada, and toward the end of 1990 in the United Kingdom) as activity slowed in the interest-sensitive sectors of these economies. Since early 1989, the federal funds rate in the United States has dropped by 350 basis points, with the decline steepening in the last quarter of 1990 and early 1991 as economic activity declined. The growth of the monetary aggregates was sluggish during 1990 in the United States, and the aggregates were in the bottom half or below their target ranges at the end of the year, reflecting the slowdown in the growth of nominal GNP and perhaps also increased reluctance to lend by financial institutions. In Canada, short-term interest rates in March 1991 had dropped by more than 400 basis points from their peak in the Spring of 1990. In the United Kingdom, monetary conditions in 1990 reflected weakening activity and heightened inflation pressures, as well as the entry of sterling into the ERM. Beginning in early 1991, the authorities lowered the base rate as sterling strengthened within the wide band of the ERM, and with the reaffirmation of a restrictive fiscal stance in the March budget.
In the other major industrial countries, the tightening of monetary policy in response to the pressure of demand on productive capacity began somewhat later. In west Germany and Japan, domestic demand accelerated and price pressures intensified in 1988, prompting a tightening of monetary policy in mid-1988 in Germany and in early 1989 in Japan. In Germany, the rise in interest rates in 1990 reflected in part the macroeconomic stimulus and higher government borrowing associated with unification. In Italy, there were substantial declines in short-term interest rates from late 1989 to October 1990 when the need to defend the lira within the narrow band of the ERM, together with higher inflation, prompted sharp increases in Italian interest rates in the last quarter of 1990.
Monetary policies in the smaller industrial countries in Europe have generally followed the tightening in the larger European countries, although in some instances the tightening has been more pronounced. In Sweden, for example, interest rates were raised sharply for a brief period in late 1990 in an effort to stem capital outflows and to maintain the exchange value of the krona. In Australia, monetary policies were restrictive in 1989, but over the past year short-term interest rates have fallen considerably as the economy moved into recession.
Fiscal policies in the major industrial countries in 1990 were broadly neutral or moderately restrictive (Chart 5), with the notable exception of Germany where higher spending related to unification and the third stage of tax reform pushed the borrowing requirement of the territorial authorities (including the Unity Fund) to 3½ percent of GNP. The fiscal assumptions underlying the staff’s projections are based on existing policies or on budget proposals that are virtually certain to be adopted. These assumptions imply that the fiscal stance of the general government in 1991 will be more restrictive than in 1990 in all the major industrial countries except Germany, where the budget is again projected to have a strong expansionary impact, and Canada.3 For the major industrial countries as a group, the stance of fiscal policy, which was neutral in 1990, is expected to be slightly contractionary in 1991. In 1992, there would be no change in the stance of fiscal policies for the major industrial countries as a group as the impact of the anticipated reduction in Germany’s deficit and the strongly restrictive stance in Canada would be offset by a somewhat less restrictive stance in the other countries.
Chart 5.Three Major Industrial Countries: General Government Fiscal indicators1
1 A positive fiscal impulse indicates an expansionary policy. Shaded areas indicate staff projections.
2 Data are for west Germany for 1980–90 and for the united Germany thereafter. Because of data problems associated with unification, the fiscal impulse has not been calculated for 1990–92.
Economic Activity and Employment
Economic growth in the industrial countries slowed from 3¼ percent in 1989 to 2½ percent in 1990 as economic activity, and especially investment, weakened in all countries except Japan and west Germany (Table 2). Output growth is projected to slow further in 1991 in most industrial countries—including Japan and west Germany, although growth is expected to remain robust in these two countries—and then to recover in 1992 (Chart 6). The slowdown in growth in 1990–91 can be attributed to a number of factors including a rise in real interest rates in Europe and Japan, higher oil prices, and increased uncertainty related in large measure to oil market developments and the conflict in the Middle East. It is noteworthy that following the invasion of Kuwait consumer confidence dropped sharply in most of the major industrial countries except in the United Kingdom and Canada, where confidence had been falling since mid-1988, and then, with the exception of Germany, rebounded in February and March with the end of the war (Chart 7).
|Gross fixed investment||7.9||5.1||3.4||—||3.3|
|Final domestic demand||4.4||3.3||2.8||1.0||2.7|
|Total domestic demand||4.6||3.4||2.4||1.0||2.8|
|Exports of goods and services||6.1||10.8||6.7||4.6||5.5|
|Imports Of goods and services||9.3||11.5||6.4||4.2||5.8|
|Memorandum items: major|
|Business fixed investment||11.2||7.7||5.5||1.1||3.6|
|United Kingdom||21.3||4.9||-1.1||-11.1||0.5|Chart 6.Industrial Countries: GDP/GNP Growth
1 Annual observations.
Chart 7.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.
The slowdown that had started in mid-1989 in the United States became more pronounced in the second half of 1990. Sharp declines in residential construction, business investment, and consumer expenditure on durables and nondurables resulted in a 1½ percent decline (at an annual rate) in GNP in the last quarter of 1990, and a further decline is estimated to have occurred in the first quarter of 1991. Interest rates in the United States had been falling for more than a year, and therefore the downturn in the fourth quarter does not appear to be attributable to changes in the stance of monetary policy. Moreover, while the direct effect of the increase in oil prices on the U.S. economy was negative, it was not large enough to explain the full magnitude of the downturn. Other factors that appear to have played a role include the increased uncertainty resulting from the situation in the Middle East, the associated drop in consumer and business confidence, and perhaps a “credit crunch” which may have resulted from a tightening in bank lending practices. A recovery is expected to begin in the second quarter of 1991 as purchases of consumer durables and investment begin to respond to lower interest rates. In addition, net exports would increase rapidly, reflecting slow growth of demand in the United States relative to some of its main trading partners and the effects of the real effective depreciation of the dollar from mid-1989 to mid-February 1991.
In the United Kingdom there was a fall in output in the last half of 1990 as private consumption and investment declined sharply.4 Exports remained strong into the middle of 1990, but are projected to weaken considerably in 1991, reflecting the appreciation that preceded sterling’s entry into the ERM in October 1990, a rise in unit labor costs that is projected to exceed the average of other ERM countries by a considerable margin, and weaker growth in export markets. In Canada, the economy entered a relatively deep recession in the second quarter of 1990 as private consumption weakened and investment declined sharply. In both the United Kingdom and Canada, output is expected to fall further in the first quarter of 1991, reflecting primarily a continued decline in fixed investment, before picking up around midyear. In 1992 output is projected to rise by 2 percent in the United Kingdom and 3½ percent in Canada as consumption and investment recover.
In Japan and west Germany, growth is projected to slow in 1991–92 from its unusually rapid pace in 1990 to rates more in line with the estimated rate of increase in potential output. GNP in west Germany is expected to expand by 2¾ percent in 1991 and by 2 percent in 1992, down from 4½ percent last year, reflecting supply constraints, a diminishing stimulus from the process of unification, and the lagged effects of high interest rates. In 1990 there was a sharp decline in output in east Germany, and a further decline is likely in 1991; output in east Germany is expected to expand in 1992. In Japan, domestic demand growth is projected to slow in 1991 as investment spending moderates from the very rapid pace recorded since 1987 and as the growth of consumption declines. The foreign sector is expected to make a further small negative contribution to the growth of output in Japan, which would slow from 5½ percent in 1990 to an average of 3¾ percent in 1991–92.
Growth in France and Italy is also expected to slow in 1991, to about 2 percent and 1¾ percent, respectively, and then to rebound in 1992. Higher real interest rates would reduce the growth of investment and expenditure on consumer durables in 1991, and the external position would be affected by a loss of competitiveness outside the ERM area and by significantly weaker demand from North America and the United Kingdom. Among the smaller industrial countries, output growth is projected to be weak in Australia and in the Nordic countries, reflecting the impact of tight policies in the late 1980s in most of these economies, the loss of international competitiveness in Sweden, and the slowdown of world trade.
Recent developments in labor markets have generally reflected the divergent cyclical developments discussed above (Chart 8). From June 1990 to February 1991, the unemployment rate rose by 1¼ percentage points in the United States and the United Kingdom and by over 2½ percentage points in Canada. The rate of unemployment is expected to peak in the middle quarters of 1991 in North America, but it would continue to rise in the United Kingdom in 1992. In west Germany, by contrast, the unemployment rate has fallen by slightly more than a full percentage point since the end of 1989, despite substantial migration from east Germany, and it is expected to average 6¼ percent in 1991–92. In east Germany, however, the proportion of the labor force that was officially registered as unemployed reached 9¼ percent in March 1991 and the number of short-time workers reached over 2 million or about 25 percent of the labor force; employment is expected to decline substantially during the remainder of the year. The rate of unemployment in France fell to 9 percent in 1990 and it is projected to rise slightly in 1991–92, despite an expected expansion of labor market programs. In Japan, the job vacancy rate rose to historically high levels during 1990, and labor market pressures remain strong. Unemployment also has declined significantly in Belgium, the Netherlands, and Spain from the very high levels that prevailed through much of the 1980s.
Chart 8.Industrial Countries: Unemployment Rate
1 Composites are based on 1988–90 GDP/GNP weights.
Prices and Wages
For the industrial countries as a group, the rate of increase in consumer prices rose from 4½ percent in 1989 to 5 percent in 1990, reflecting in part the impact of higher oil prices in the last half of 1990 (Chart 9). However, inflation was already rising in some industrial countries before the invasion of Kuwait by Iraq, and the effects of higher oil prices were offset to some extent by a significant decline in non-fuel commodity prices and, in the case of Japan and many European countries, by currency appreciation against the U.S. dollar. The staff projects that inflation in the industrial countries will decline slightly to 4¾ percent this year and then fall to 4 percent in 1992, reflecting moderate growth and declines in fuel and non-fuel commodity prices. The rise in oil prices in 1990 contributed to a ¾ of 1 percentage point differential between inflation measured in terms of consumer prices and the GDP deflator; given the projected decline in oil prices, consumer price inflation would fall, and consumer and output prices are expected to increase at broadly the same rate by 1992.
Chart 9.Industrial Countries: Consumer Price Indices
1 Increases in indirect taxes raised consumer prices in 1989 in Canada, west Germany, Japan, and Italy, and are expected to do so again in 1991 in Canada.
2 Annual observations.
In the United States, there was a decline in wage and price inflation before the increase in oil prices in August, owing mainly to domestic factors such as the slowing of growth and the increase in unemployment. However, U.S. import prices, which increased by only 1 percent in 1990 in spite of the 6½ percent drop in the effective value of the U.S. dollar and the rise in oil prices, also contributed to lower inflation. In Canada, the introduction of the Goods and Services Tax in January 1991 is expected to raise consumer prices by about 1¼ percent this year. By 1992, the staff projects that consumer price inflation in the United States and Canada would decline to about 4 percent and 3¼ percent, respectively, reflecting economic slack and the projected drop in oil prices. In Japan, inflation pressures were reduced by the appreciation of the yen in the second half of 1990. Nevertheless, consumer prices (excluding food and energy as well as the impact of the consumption tax introduced in April 1989) accelerated to an annual rate of about 4 percent in the latter part of 1990, compared with a rise of 1½ percent during 1989, owing in part to higher wages associated with tight labor market conditions. Consumer price inflation in Japan is projected to average 3½ percent in 1991–92.
The strengthening of the ERM currencies against the U.S. dollar during 1990, together with the decline in non-fuel commodity prices, effectively offset the impact on inflation of higher oil prices in many of the continental European countries. For example, in 1990 the domestic currency price of imports is estimated to have declined by 2¾ percent in west Germany and by 2¼ percent in France, and there were similar declines in other continental European countries. Among the major European economies, the increase in consumer prices in 1990 was largest in the United Kingdom (9½ percent, due in part to the introduction of the community charge early in the year) and smallest in west Germany (2¾ percent), although German inflation picked up during the course of the year. In the near term, the staff projects a further convergence of inflation in the European Community, including a decline in retail price inflation in the United Kingdom to 4 percent by 1992. However, Italy’s rate of inflation in 1992 would remain well above the average of 3 percent projected for west Germany and France.
Average earnings, measured on an economy-wide basis, increased about 5¾ percent in 1990 in the industrial countries as a group, and the rate of increase is expected to remain broadly stable in 1991–92 (Chart 10). Real wages rose by slightly more than 2 percent in 1990 in Japan, west Germany, and France reflecting strong labor demand and/or moderate inflation; in west Germany, labor shortages were especially acute in the construction sector. Real wages fell in the United States and rose by½ to 1½ percent in the United Kingdom and Canada—where unemployment increased substantially—and in Italy—where unemployment remained relatively high. In the United States unit labor costs increased by 4½ percent in 1990—the largest increase since the early 1980s—owing in part to continued weak productivity growth. The growth of labor costs in the United States is projected to average 4 percent in 1991–92. Productivity rose only marginally in Canada in 1990 and is expected to increase somewhat in 1991–92 with the recovery of output; the increase in unit labor costs would slow in 1991–92 as wage increases fall and productivity growth picks up. Moderate productivity gains are expected in the European Community over the next two years and unit labor costs would rise on average by 5½ percent; unit labor cost growth would decline sharply in the United Kingdom from over 10 percent in 1991 to 4½ percent in 1992.
Chart 10.Industrial Countries: Average Earnings and Unit Labor Costs1
1 Average earnings are defined as total compensation per employed person. Unit labor costs are defined as compensation of employees per unit of output. Shaded areas indicate staff projections.
2 Composites are based on 1988–90 GDP/GNP weights.
Trade and Current Account Balances
The current account imbalances of the three largest industrial countries narrowed again in 1990, reflecting previous exchange rate movements, growth differentials, and, in the case of Japan and Germany, higher oil prices (Chart 11). In 1991, the one-time effect of transfer payments to help defray the cost of military operations in the Middle East will lower the U.S. current account deficit substantially, and reduce the external surpluses of Germany and Japan. The lagged effects of exchange rate changes and divergent cyclical positions will also contribute to the projected $61 billion decline in the current account deficit of the United States in 1991. The same factors, together with higher imports associated with unification, are expected to contribute to a $35 billion drop in the external surplus of Germany in 1991. Germany’s external surplus is expected to widen in 1992 owing mainly to the abatement of the demand stimulus arising from unification. In 1992, the current account deficit of the United States is projected to return approximately to its 1990 level, reflecting in part the narrowing of international growth differentials as well as the technical assumption of unchanged real exchange rates. Japan’s current account surplus is expected to widen somewhat in 1991–92 owing to terms-of-trade gains associated mainly with lower oil prices; in real terms, the external surplus is projected to narrow slightly both in 1991 and in 1992. For the industrial countries as a group, the current account deficit is expected to narrow from $111 billion in 1990 to $108 billion in 1992.
Chart 11.Three Major Industrial Countries: Current Account Imbalances
1 Prior to 1990, the current account balance of west Germany excluding the bilateral balance with east Germany; from 1990 onward, the current account balance of the unified Germany.
In 1990, the process of unification contributed to a surge in the demand for imports in Germany, and there was a sharp increase in German imports from many European countries, particularly France and Italy. In the United States, the growth of exports slowed in 1990 from very high rates in the three previous years as the effects of the improved competitive position of U.S. producers and continued market growth were offset by stagnant demand from Canada. Nevertheless, the volume of U.S. merchandise exports increased by almost 50 percent from 1987 to 1990, and the real trade deficit as a percentage of real GNP declined by more than 2 percentage points. Over the same period, the volume of Japanese merchandise imports increased by one third, and Japan’s real trade surplus fell in relation to GNP by 2¼ percentage points.
In the United Kingdom, where the external position deteriorated sharply from 1987 to 1989, the current account deficit narrowed by $10 billion in 1990 and a further improvement is expected in 1991 owing mainly to the relatively weak cyclical position. However, the current account deficit would widen again in 1992, reflecting the loss of competitiveness stemming from higher inflation in the United Kingdom than in most of its major trading partners and the assumption of constant nominal exchange rates among the ERM currencies. Among the other industrial countries, the trade balance has worsened significantly in Sweden and Spain over the past few years.
In recent years many developing countries have introduced far-reaching structural reforms to enhance the role of market forces in the allocation of resources and to open up their economies to international trade.5 The aim of these reforms has been to establish the foundation for a sustained economic expansion, such as has been achieved over the past 20 years by a number of Asian economies (Chart 12). These structural reforms often have been complemented by monetary and fiscal policies designed to correct large macroeconomic imbalances. A number of developing countries have implemented stabilization programs successfully and the prospects are for continued growth in these countries; in other developing countries, however, macroeconomic imbalances are expected to continue to hinder economic performance in 1991–92.
Chart 12.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.
In 1990, the rise in oil prices, together with continued declines in non-fuel commodity prices, resulted in a sharp deterioration in the terms of trade for the vast majority of the oil importing developing countries. Moreover, a number of countries in the Middle East and Asia have been affected by the disruption of trade and tourism, the loss of workers’ remittances, the costs of repatriating workers and supporting refugees, and the destruction resulting from the war in the Middle East. In the oil exporting countries outside the Middle East, the external position and economic activity were boosted in 1990 by an improvement in the terms of trade and, in some cases, by an increase in oil production; but some of these countries—particularly those in the Western Hemisphere—were adversely affected by the weakness of the U.S. economy.
The pace of economic activity in Africa slowed in 1990 reflecting the effects of the rise in oil prices and a drop in the prices of non-fuel primary commodities—particularly tropical beverages (coffee, cocoa, and tea) which fell to their lowest level since 1980. Regional GDP growth is projected to recover from 2 percent in 1990 to 4¾ percent in 1992 (Chart 13). Little progress is expected to be made in alleviating poverty, however, and real per capita GDP would remain near the level of 20 years ago. The short-term outlook is particularly bleak in Ethiopia, Mozambique, and Sudan where drought, in conjunction with ongoing civil wars, threatens another episode of famine. In Ethiopia, there will also be continued transitional costs in 1991 associated with market-oriented economic reform and with the suspension of economic support from Eastern Europe and the U.S.S.R.
Chart 13.Developing Countries: Real GDP Growth1
1 Composites are 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.
Sluggish growth in Africa has been accompanied by average inflation of about 15 to 20 percent (Chart 14). In 1991, inflation is projected to increase to 22 percent from 16 percent in 1990, reflecting in part the lagged impact of higher oil prices, before falling to 10 percent in 1992. The exchange arrangement of the African Franc Zone has contributed to the containment of inflation, although in 1990 it also resulted in a real appreciation vis-à-vis the U.S. dollar due to the nominal appreciation of the French franc. The current account deficit of the African countries as a group dropped by half in 1990, reflecting higher revenues for the region’s major oil exporters. The deficit is projected to widen to an average of $6 billion in 1991–92 as the terms of trade for all countries, including the oil exporters, are expected to decline by 9 percent in 1991.
Chart 14.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.
Differences in the stance of policies have resulted in considerable differences in economic performance (Table 3). In Cameroon, Liberia, Somalia, Sudan, and Zaire, for example, the economic situation deteriorated during 1990 due to the inability of the authorities to implement needed stabilization policies and structural reforms, and, in some cases, to social and political conflicts. In contrast, policies were tightened in late 1990 to strengthen the stabilization program in Madagascar. In Ghana, Kenya, Nigeria, Togo, and Tunisia, structural reforms and stabilization policies are being successfully carried out and real growth has increased. The modest growth outlook for Africa also reflects the expected declines in the terms of trade and the slowdown in the growth of world trade in 1991.
|Real GDP||Consumer Prices|
The majority of countries in Africa are oil importers and they experienced a decline in real income as a result of the rise in oil prices in 1990. In addition, Sudan suffered from the disruption of trade with Kuwait and Iraq and from the loss of workers’ remittances. Although Africa’s major fuel exporters—Algeria, Cameroon, Gabon, and Nigeria—benefited from the oil price increase, all but Nigeria experienced negative or sluggish growth, in some cases because of unfavorable weather conditions (Cameroon and Gabon) or because of the short-run costs associated with the removal of structural distortions. A number of countries, including Kenya, Madagascar, Morocco, and Mozambique, allowed the changes in world oil prices to pass through to domestic fuel prices; in other countries such as Côte d’Ivoire, Ethiopia, Gabon, and Nigeria, domestic fuel prices remained broadly stable.
As noted above, the sustained increase in real per capita output in the developing countries of Asia during the 1980s is in sharp contrast to the stagnant or declining trend in other regions (see Chart 12). However, the impressive performance of Asia as a whole masks considerable differences among countries within the region. Growth has been stronger and more sustained in China, Hong Kong, Indonesia, Korea, Malaysia, Singapore, Taiwan Province of China, and Thailand than in the rest of Asia. The strength of economic activity in these countries can be attributed in part to the adherence to market-oriented policies—or, in the case of China, to market-oriented reform—coupled with a relatively stable macroeconomic environment, and to the adoption of an outward orientation that encourages export growth. The staff projections suggest that this differential pattern of economic growth in Asia will continue in 1991–92.
Economic activity in Asia weakened slightly in 1990 as growth fell to 5¼ percent, owing to higher energy costs as well as declining export demand in the newly industrializing economies of Asia (NIEs).6 In these economies and in Indonesia, Malaysia, and Thailand, growth was sustained by strong domestic demand and by large inflows of foreign investment. Growth in China increased from 3½ percent in 1989 to 5 percent in 1990, as industrial activity accelerated in the second half of the year and agricultural production rose. In most of South Asia, favorable weather contributed to a strong recovery of agriculture that helped to offset the negative impact of a further decline in the terms of trade. In the Philippines, GDP growth declined from 5½ percent in 1989 to 2½ percent in 1990 as macroeconomic imbalances were compounded by political instability, earthquake damage, drought, and the adverse effects of the crisis in the Middle East.
Inflation in Asia fell from about 12 percent in 1989 to 8 percent in 1990. This decline in the average rate of inflation mainly reflected adjustment policies and price controls in China that reduced the rate of inflation from about 18 percent in 1989 to 2 percent in 1990; however, the median rate of inflation in the region rose from 7¾ percent in 1989 to 9½ percent in 1990. In the most rapidly growing Asian economies, higher inflation in 1990 was due to the rise in energy costs and faster growth of domestic demand, particularly in Korea and Singapore. In India, Pakistan, and the Philippines, slippages in policy implementation also contributed to an intensification of price pressures.
In 1991–92, economic policies are expected to be aimed mainly at lowering inflation in the NIEs and in the rapidly growing economies of South East Asia, and at the continued implementation of structural reforms in China and in the countries of South Asia. In the Philippines, tight monetary and fiscal policies are being adopted in the context of a new stabilization program. Fiscal consolidation and market-oriented reform are being implemented in Bangladesh, Pakistan, and Sri Lanka where growth has been more sustained and inflation less severe than in other countries of South Asia.
Growth in Asia is projected to increase slightly to an average of 5 percent in 1991–92—still robust, but 3 percentage points below the average growth for 1983–89—in response to a recovery in export demand and an improvement in the terms of trade. Inflation in Asia is expected to increase to an average of 9 percent in 1991–92, largely reflecting the easing of financial policies in China during the second half of 1990. By contrast, the median inflation rate would decline from 9½ percent in 1990 to 7 percent in 1992 as many countries tighten policies to curb excessive consumption growth and as the rise in oil prices is reversed. The combined current account surplus of the four newly industrializing economies of Asia declined by $9 billion in 1990, and is expected to narrow further in 1991. Notwithstanding an improvement in China’s external position which moved into surplus, reflecting strong export performance and a sharp compression of imports, the current account deficit for Asia as a whole widened slightly in 1990. For the region, the external deficit is expected to widen by $15½ billion in 1991, owing mainly to a fall in China’s surplus, and then to narrow by almost $4 billion in 1992.
India, Bangladesh, Pakistan, Sri Lanka, and the Philippines lost the remittances from the more than 500,000 of their citizens previously working in Iraq and Kuwait. The combined loss of workers’ remittances and export earnings is estimated at about $550 million in 1990 and is projected to exceed $1 billion in 1991. Altogether, the conflict in the Middle East is estimated to have reduced output in 1990 in Asia’s oil importing net debtor countries by almost ½ of 1 percent. Many countries in the region, including Bangladesh, India, Korea, the Philippines, Singapore, Thailand, and Sri Lanka, passed through most of the changes in the world price of oil into domestic petroleum prices.
The economies of the Middle East have been severely affected by the crisis that began with the invasion of Kuwait by Iraq on August 2, 1990. War damage in Iraq and Kuwait was extensive, and economic activity in large areas of these countries came to a virtual halt during the crisis. Egypt, Jordan, Syria, and Turkey (which is classified among the developing countries of Europe) are estimated to have lost a total of approximately $2 billion in 1990 as a result of the loss of workers’ remittances, tourism receipts, and other export earnings, and are expected to lose about $6½ billion in 1991. Growth prospects for 1991 in the oil importing countries of the region, which were not strong before the conflict started, have worsened significantly. The oil exporting countries (other than Iraq and Kuwait) have benefited from temporarily higher oil prices and an increase in oil production; but some, like Saudi Arabia, have faced increased expenditures associated with the war—including defense outlays and economic aid to other countries—that are expected to exceed the rise in oil revenue.
Output in the Middle East is estimated to have declined by 1½ percent in 1990 reflecting mainly a sharp contraction in Iraq, Kuwait, and Jordan. Economic activity accelerated in some of the other countries of the region as the terms of trade for oil exporting countries improved and oil production increased. The outlook for growth in the Middle East in 1991–92 is clouded with uncertainty. Iraq and Kuwait accounted for about one sixth of regional output before the crisis and hence the severe downturn in economic activity in these countries will have a significant impact on the outlook for the region as a whole. It is currently estimated that total regional output will decline further by 3¼ percent in 1991; output is expected to recover strongly in 1992 mainly because of reconstruction in Kuwait and Iraq, but also because total oil production in the Middle Eastern countries would increase as demand for oil rises with the recovery of world economic activity. Excluding Iraq and Kuwait, growth in the non-oil sectors of the economies in the Middle East is generally expected to strengthen in 1991 and 1992.
In a number of Middle Eastern countries, structural reforms that were being implemented with moderate success before the crisis have been put on hold. Moreover, there were significant macroeconomic imbalances in some countries even before the crisis, and fiscal and current account deficits have increased in these countries and elsewhere in the region. In a number of countries, the pressure on aggregate demand from expansionary fiscal policies was countered by a tightening of monetary policies, which has been only partially successful in restraining demand and has led to increasing pressures on the balance of payments. In Israel, recent immigration from the Soviet Union probably will increase growth over the medium term, but higher expenditures related to the absorption of immigrants have increased the fiscal deficit even though taxes have been raised.
Inflation in the Middle East declined slightly in 1990. The impact of the temporary increase in oil prices on inflation was minimal because most countries, with the exception of Israel, did not raise domestic fuel prices. This has contributed to a worsening of fiscal deficits in some of the oil importing countries in the region. Given that a more restrictive policy stance is not expected in the near term, inflation is projected to remain at about 14 percent in 1991–92. The combined current account position of the Middle Eastern countries is estimated to have moved from near balance in 1989 to a surplus of about $14 billion in 1990, owing mainly to the rise in oil prices, but is projected to shift into deficits of about $50 billion in 1991 and $25 billion in 1992, mainly because of the costs associated with postwar reconstruction.
Output in the developing countries of the Western Hemisphere declined by 1 percent in 1990, following a modest rise in 1989, while inflation continued at a very high level. These developments primarily reflect the combination of severe recession and hyperinflation in Argentina, Brazil, and Peru (see Chart 14). However, economic activity also was sluggish and inflation increased slightly in most other countries of the region, owing to the deterioration in the terms of trade for producers of non-fuel primary commodities and drought in parts of South America. The main exceptions were Ecuador, Mexico, and Venezuela, where growth in 1990 was boosted by higher oil output. Although average inflation in the Western Hemisphere increased to about 770 percent in 1990—largely because of hyperinflation in Brazil and Argentina and the large weight of these two countries—the median rate of inflation fell slightly to 9¾ percent. Inflation has remained high in some countries (Argentina, Brazil, Nicaragua, and Peru) because of widespread indexation practices, excess liquidity, and delays and slippages in policy implementation. A number of countries adjusted domestic fuel prices substantially in response to the changes in world oil prices, including Bolivia, Brazil, Chile, the Dominican Republic, and Mexico, although in Ecuador and Venezuela the increase in oil prices was not fully passed through to consumers.
In some countries the weakness in economic activity in 1990 reflected the transitional adjustments associated with stabilization policies and structural reforms, rather than destabilizing macroeconomic policies that had been the primary factor in previous years. Monetary and fiscal policies were tightened to strengthen stabilization efforts in Bolivia, Chile, and Venezuela. New stabilization programs were implemented in Argentina, Brazil, and Peru to halt hyperinflation; and in El Salvador, Guyana, Honduras, and Jamaica to restore external and internal balance. In many of these countries and in Colombia, structural reforms have also been introduced recently, and in some cases—including Bolivia, Chile, and Mexico—the reforms have been far-reaching. As a result of these policies. Chile has achieved sustained growth since 1984 and Mexico is recovering from a long recession. In some countries—notably Mexico and Venezuela—that concluded debt restructuring agreements with commercial banks, sound economic policies contributed to a reduction in risks, thereby promoting private capital inflows including the repatriation of capital flight. In other countries such as Costa Rica, the beneficial effects of debt restructuring have been eroded by policy slippages.
On the assumption that significant delays or slippages can be avoided, the current stance of policies is expected to result in sharply lower inflation and the resumption of growth in the region in 1991. As stabilization policies take hold and structural reforms start to bear fruit, a marked improvement in economic performance is expected for 1992, with growth reaching 3¼ percent and average inflation falling to 36 percent. These projections for the region as a whole depend crucially upon the success of the anti-inflation programs introduced in Argentina, Brazil, and Peru.
The real effective exchange rate for the Western Hemisphere region appreciated slightly during 1990. This reflected mainly the effects of hyperinflation in the three countries noted above, as most currencies in the region depreciated moderately during the year in real effective terms. Despite higher oil revenues for the major oil exporters—Ecuador, Mexico, Trinidad and Tobago, and Venezuela—the current account deficit of the region increased by about $4 billion to $12 billion in 1990, owing in part to a large widening in the external deficit of Brazil. The external position of Brazil and the other high-inflation countries is expected to improve in 1991–92. However, this improvement will be offset by the deterioration in the current account of the region’s fuel exporters due to the decline in their terms of trade. For the region as a whole, the current account deficit is projected to average about $13 billion in 1991–92.
External Current Accounts and Debt
The current account deficit of the developing countries fell from $14 billion in 1989 to $8 billion in 1990, or less than 1 percent of their exports of goods and services; it is expected to widen to $95 billion in 1991 and then to decline to about $70 billion in 1992, or 6 percent of exports of goods and services (see Tables A33 and A35).7 The net creditor developing countries in the Middle East account for nearly three quarters of the projected surge in the aggregate current account deficit in 1991. Kuwait, Saudi Arabia, and the United Arab Emirates are expected to provide about $34 billion in official transfers to help defray the cost of the war in the Middle East. Large additional imports by Kuwait for postwar reconstruction are also expected to contribute to the projected current account deficits in the net creditor developing countries during 1991–92. Staff projections assume that these current account deficits will be financed by drawing down external assets (including official reserves) and by borrowing, mainly from the commercial banks.
The current account deficit of the net debtor developing countries widened to $33 billion in 1990 and is projected to increase by an additional $26 billion in 1991, reflecting larger deficits in the net debtor fuel exporting countries and surging imports in Hungary, Poland, and a number of creditworthy countries in Asia. The widening in the aggregate current account deficit in 1990 was accompanied by a large increase in net financial flows to net debtor developing countries (from $76 billion in 1989 to over $110 billion in 1990), and these flows are projected to remain broadly unchanged in 1991 and 1992.
Total net external borrowing of the net debtor countries rose sharply in 1990 to an estimated $60 billion—the highest since 1983—largely reflecting increased borrowing by creditworthy countries in Asia and exceptional financing (including the accumulation of arrears) in the Western Hemisphere. The increased availability of external financing is expected to continue in 1991 and 1992 with a larger share of new lending directed to countries without debt-servicing difficulties. During 1991–92, net disbursements from official creditors are likely to range from $32 billion to $38 billion.8 Net financing from commercial creditors is projected to decline, reflecting in part substantial net repayment by a few large debtor countries. Most of the new lending would be concentrated in creditworthy developing countries, including those that only recently have started regaining market access, although some financing is likely in conjunction with debt reduction operations.
The increase in net financial flows, including a high level of external borrowing, allowed developing countries to boost official reserves by $35 billion in 1990 (Chart 15). The rise in official reserves was concentrated in the group of 15 heavily indebted countries that boosted their ratio of reserves to imports of goods and services to 23 percent in 1990. The strong build-up of official reserves and other assets is projected to continue in 1991-92.
Chart 15.Developing Countries: Availability and Use of Foreign Exchange1
1 Shaded areas indicate staff projections.
Much of the additional financing in 1990 took the form of interest arrears even though the number of countries with payments arrears has declined from 59 in 1987 to 53 in 1990 (Chart 16). In some countries, the total stock of payments arrears (including principal) declined in 1990 as a result of reschedulings, debt forgiveness by a number of bilateral official creditors, and debt restructuring operations with commercial banks. In some instances, however, new payments arrears were accumulated when creditors acquiesced to delays in debt servicing pending the full regularization of creditordebtor relations. In a few cases, the build-up in payments arrears reflected delays in concluding debt reduction agreements with commercial bank creditors.
During 1990 and early 1991, several developing countries concluded debt restructuring agreements with creditors, and since September 1990 Niger, Uruguay, and Venezuela have completed debt and debt-service reduction packages with commercial banks. The agreement with Niger, the first package involving a lowincome debtor country, will be supported by official funding from the World Bank’s International Development Association Debt Reduction Facility. In addition, Chile signed a multiyear rescheduling agreement and Senegal concluded an agreement to reschedule repayments of its commercial bank debt over 10 years. Among the low-income countries, Guyana and Niger benefited from concessional options in Paris Club reschedulings. Last year, several proposals were made to increase the concessionality of Paris Club reschedulings for indebted low-income countries.9 Steps were also taken to reduce bilateral debt or interest payments for certain middle-income countries. In September 1990, the Paris Club agreed to provide longer maturities and grace periods in the reschedulings for the lower middle-income countries, as well as limited bilateral debt conversions on a voluntary basis; and in March 1991, Paris Club creditors declared their readiness to reduce by 50 percent Poland’s official bilateral debt in two stages.
Staff estimates indicate that the external debt of the developing countries (excluding Fund credit) increased by nearly 6 percent in 1990 and reached $1,306 billion by the end of the year. The increase resulted from aggregate net new borrowing ($50 billion) and from valuation adjustments reflecting the depreciation of the U.S. dollar vis-à-vis other major currencies ($51 billion), partly offset by the impact of various debt reduction operations and forgiveness by official bilateral creditors ($29 billion). During 1991–92, the stock of external debt is projected to increase by 3¼ percent a year; the Western Hemisphere is the only region where external liabilities are expected to decline.
The anticipated reductions in commercial bank liabilities in 1991–92 are expected to more than offset the modest net lending of commercial banks. In countries with recent debt-servicing difficulties, the staff projects a reduction in the stock of commercial bank debt from $311 billion in 1990 to $257 billion in 1992, reflecting expected debt reduction operations and net repayments by a number of large debtor countries. By contrast, new disbursements from official creditors are projected to remain large. Before 1990, official bilateral debt forgiveness was relatively modest and concentrated in sub-Saharan Africa. In the second half of 1990, the United States announced debt forgiveness for Egypt amounting to about $7 billion, and another $6 billion was canceled by Middle Eastern creditors. In the countries with recent debt-servicing problems, the share of total debt that is owed to official creditors is projected to increase further from 47 percent in 1990 to 52 percent in 1992.
Debt and debt-service reductions are expected to contribute to a significant decline in debt-GDP ratios during 1991–92, and to narrow the differences in these ratios between countries with and without debt-servicing difficulties. In the group of 15 heavily indebted countries, the average debt-GDP ratio is expected to fall by 7½ percentage points to 30 percent in 1992. Only in sub-Saharan Africa—where the debt-GDP ratio at around 77 percent remains the highest of any developing country region—is no significant improvement expected during 1991–92. The modest improvement in the aggregate debt-service ratio from 15½ percent in 1990 to 14¾ percent in 1992 is largely accounted for by countries without debt-servicing difficulties. In the countries with recent debt-servicing problems, a temporary increase in debt-service ratios is expected in 1991, owing mostly to the acceleration in amortization payments associated with debt conversions and debt and debt-service reduction operations.
The first section of this Appendix explains the methods used by the staff to formulate the oil price assumption underlying the projections presented in the World Economic Outlook, and in particular the use of the information contained in futures prices. The second section discusses the cost to the world economy of the temporary increase in oil prices and the war in the Middle East. In that section, the staff presents estimates of the short-run economic effects in industrial and developing countries of the higher oil prices in the second half of 1990 and those currently assumed for 1991–92, using the pre-August oil price assumption as a basis for comparison, and discusses the budgetary costs of the conflict.
Oil Price Assumptions
The assumptions for the average petroleum spot price (APSP) in the World Economic Outlook traditionally have been based on a simple technical rule: constant nominal prices for the near term (roughly the next 12 months) and constant real prices thereafter.10 As oil prices increased sharply after the invasion of Kuwait on August 2, 1990, and then fluctuated widely over the next several weeks, it became clear that this technical rule would not provide an adequate basis for the oil price assumption. Therefore, a more judgmental approach was adopted in the October 1990 World Economic Outlook. In particular, it was assumed that most of the production shortfall in Kuwait and Iraq would be gradually offset by increased supplies by the other members of the Organization of Petroleum Exporting Countries (OPEC), which had announced such an intention shortly after the invasion. On this basis, oil prices were assumed to average $26 per barrel in the final quarter of 1990—roughly the market price at the time the assumption was finalized—and then to decline steadily to $21 per barrel (the OPEC reference price that had been agreed on July 27, 1990) by the fourth quarter of 1991 (Chart 17). The usual medium-term rule of constant real oil prices was applied thereafter.
Chart 17.Average Petroleum Spot Prices1
1 The average petroleum spot prices is the simple average of U.K. Brent, Dubai, and Alaska North Slope. Dates in parenthesis indicate the last quarter for which historical data were available.
As the situation in the Middle East remained unsettled and gyrations in oil prices continued during the fall of 1990, it became apparent that any projection of oil prices would have to take into account not only the current balance between the supply and demand of crude oil, but also the speculative and precautionary demand for stocks, which would require judgments about the evolution of the political and military situation in the Middle East. Because of the extraordinary difficulties involved in making such judgments, and because publicly available information and market expectations should be reflected in the price of oil traded in futures markets, it was decided to rely on futures prices as the basis for the short-run oil price assumption. More specifically, the oil price assumption for 1991 in this World Economic Outlook report is based on futures prices on the New York Mercantile Exchange for West Texas Intermediate (WTI) crude—the broadest and the deepest market for oil futures—adjusted to account for the historical difference between WTI and the APSP.11 Empirical tests indicate that oil price projections based on this procedure perform better than alternative statistical methods, such as a random walk or a simple time-series model.12
Since the initial jump in prices in August 1990, the term structure of futures prices has changed considerably (Chart 18). Prior to the invasion of Kuwait, oil prices for delivery over the next 12 months typically exceeded the prevailing spot price. At the end of June 1990, for example, the price of WTI for delivery 12 months ahead was 15 percent above the prevailing spot price. By contrast, futures prices in September 1990—when political uncertainties and thus speculative and precautionary demand were high—dropped off steeply from about $40 per barrel to about $28 per barrel for oil delivered in September 1991. The term structure of futures prices shifted down dramatically in the last months of 1990 and following the start of armed conflict on January 16, 1991, particularly at the short end, and then remained broadly stable even after the end of hostilities in late February. The current oil price assumption is based on the pattern of futures prices in mid-March 1991, which suggested that oil prices would average $17.18 per barrel in 1991; applying the constant real assumption to this annual average, oil prices are assumed to average $17.87 per barrel in 1992.
Economic Effects of Crisis in the Middle East
Economic Impact of Higher Oil Prices
The staff’s multicountry models for the industrial and developing countries have been used to evaluate the impact of the higher oil prices from August to December 1990, using the pre-August 1990 assumption as a reference (the two assumptions are shown in Chart 17). The average petroleum spot price in 1990 was about $5 per barrel, or 28 percent, higher than the pre-August assumption; for 1991 and 1992, oil prices are now assumed to be slightly lower (about 3¾ percent) than the pre-August assumption.
The economic effects of an increase in oil prices will depend importantly on whether it is perceived by economic agents to be permanent or short lived. The staff’s simulation results indicate that the higher oil prices during the fall of 1990 would have had only a very small impact on economic activity if consumers and investors had correctly anticipated that oil prices would return to their pre-August levels by February 1991. However, given the uncertainties in the fall of 1990 about the prospects for, or the outturn of, military operations in the Middle East and the effect on world oil prices, it is clear that the subsequent drop in oil prices was not fully anticipated, as is apparent in the pattern of futures prices discussed above (see Chart 17). Accordingly, the simulation results discussed below assume that in 1990 economic agents expected oil prices only to fall back by about one-half of the initial increase, which would have left expected oil prices for 1991 and thereafter 14 percent higher than in the baseline; in 1991, oil prices decline by more than was previously anticipated and expectations about the future course of oil prices are assumed to be correct.
The temporary rise in oil prices is estimated to have raised the level of consumer prices in the industrial countries by ½ of 1 percent in 1990 (Table 4). In 1991, with the decline in oil prices and weaker demand, the level of consumer prices would be somewhat lower than in the baseline. In subsequent years, there would be no impact on the level of consumer prices reflecting no change in underlying money growth. In Japan and west Germany, the initial rise in consumer prices results mainly from an increase in the price of imported oil, while in the United States it reflects higher prices for both imported and domestically produced oil. The rise in the GNP deflator—which does not directly reflect changes in import prices—is estimated at roughly ¼ of 1 percent for the industrial countries as a group in 1990. The level of short-term interest rates also would be raised by about ¼ of 1 percentage point in most industrial countries in 1990. In 1991, there would be little impact on either the GNP deflator or interest rates.
|Industrial Countries||United States||Japan||west Germany||Other|
|Real GNP (billions|
of U.S. dollars at 1990 prices)
|Short-term interest rate2||0.2||0.1||—||0.2||0.1||—||0.2||0.1||—||0.2||0.1||—||0.2||0.1||—|
|Current account balance3||-0.1||—||—||-0.1||—||—||-0.3||—||—||-0.2||—||—||—||—||—|
|Current account balance|
|(billions of U.S. dollars)||-16.6||1.4||2.4||-5.0||-1.7||0.5||-7.8||1.5||1.5||-2.6||0.3||0.5||-1.2||-1.3||-0.1|
|Average petroleum spot price||28.4||-3.8||-3.9||…||…||…||…||…||…||…||…||…||…||…||…|
The level of real GNP in the industrial countries is estimated to have been reduced by about ¼ of 1 percent (or about $25 billion) in 1990, but would return to the baseline level in subsequent years. The time pattern of the impact on activity is somewhat different for the group of industrial countries other than the major three countries because this group includes a number of net oil exporters (the United Kingdom, Canada, and Norway). For the majority of industrial countries that are net importers of oil, the rise in the price of oil resulted in a deterioration in the terms of trade and a decline in real disposable income which, together with the rise in interest rates, lowered private consumption and investment. In addition, all industrial countries were adversely affected by lower exports to the oil importing industrial and developing countries—although this may have been offset in part by higher exports to the oil exporting countries other than Iraq and Kuwait. As a result, the external current account balance of the industrial countries taken as a group may have deteriorated by $17 billion in 1990 about 1/10 of 1 percent of GNP).
Developments in the Middle East are estimated to have reduced real GNP in the net debtor developing countries taken as a group by ¼ of 1 percent in 1990, and may reduce output by 1 percent in 1991 and by ½ of 1 percent in 1992 (left panel of Table 5). The estimated reductions in output are the net result of a number of factors, including terms-of-trade effects, the impact on activity in industrial countries, and the destruction and disruption of normal economic activity in some countries as a result of the war. The largest losses are in the Middle East where the dominant effect is the sharp decline in GNP, particularly in 1991, estimated for Iraq as a result of the trade embargo, the diversion of resources to the war, and the losses incurred in the war. The impact on real GNP in the indebted, fuel exporting countries—such as Nigeria, Mexico, Venezuela, and Indonesia—is estimated to have been an increase of 3 percent in 1990 and a decline of about ½ of 1 percent in 1991 and 1992. In contrast, real GNP in the net debtor, oil importing developing countries—which includes the majority of developing countries—is estimated to have been lowered by slightly more than ½ of 1 percent in 1990 and somewhat less than that in 1991 (right panel of Table 5). These reductions reflect the deterioration in the terms of trade in 1990, the detrimental effect on exports of the reduced demand for imports in the industrial countries, and the rise in debt-service obligations resulting from higher world interest rates.
|All Net Debtor Countries||Oil Importing Net Debtor Countries2|
|Net debtor countries|
|Terms of trade||0.9||-0.3||-0.1||-2.2||0.2||0.3|
|Current account balance3||0.1||-1.4||-0.5||-0.4||0.2||0.2|
|Terms of trade||7.5||-1.1||-1.1||-1.7||0.1||0.2|
|Current account balance3||2.1||-1.5||-0.3||-0.1||-0.1||0.1|
|Terms of trade||-0.4||—||0.1||-1.8||0.2||0.3|
|Current account balance3||—||-0.2||—||-0.5||0.5||0.1|
|Terms of trade||-2.7||0.1||0.5||-2.7||0.1||0.5|
|Current account balance3||-0.4||-0.3||0.6||-0.4||-0.3||0.6|
|Terms of trade||0.2||-0.4||-0.5||-2.6||0.2||0.3|
|Current account balance3||-7.6||-25.6||-9.3||-1.7||-1.5||0.4|
|Terms of trade||3.0||-0.6||-0.5||-3.9||0.4||0.5|
|Current account balance3||1.7||-1.1||-0.4||-0.3||0.1||0.1|
The results reported in Table 5 include estimates of the losses in workers’ remittances and exports of goods and services suffered by some developing countries as a direct result of developments in the Middle East. These losses account for the persistence of negative effects on GNP in the oil importing countries in 1991, despite an improvement in their terms of trade. The staff estimates that the loss of workers’ remittances and other revenues might reach $3 billion in 1990 and $9 billion in 1991 for the group of most severely affected countries, with particularly large losses for some individual countries. For example, the average reduction in GNP in 1990-91 stemming from the Middle East crisis is estimated to be more than 15 percent in Jordan, about 2½ percent in Egypt and Turkey, and 1 to 1½ percent in Morocco, Poland, and Yugoslavia.13
Notwithstanding the sharply higher prices for imported oil in 1990, the simulated effects on the current account position of oil importing countries shown in Table 19 are relatively small. This result reflects the assumption that most developing countries have limited access to external finance, and therefore that an incipient deterioration in the current account would be largely offset by cutting back imports. In some cases, the estimated reduction in import volumes could be quite large. In recognition of the difficulties some countries might face in making this adjustment, the Fund’s Executive Board adopted in November 1990 a series of decisions designed to provide additional financing to member countries seriously affected by the Middle East crisis. Additional official bilateral assistance has also been provided to some countries in the region.
For the group of net creditor developing countries— which consists predominantly of large oil exporting countries—the most dramatic effect of the crisis is obviously the loss of human lives and the large-scale destruction of physical assets in Kuwait.14 For the other countries in this group—including the Islamic Republic of Iran, Libya, Saudi Arabia, and the United Arab Emirates—there has been a sharp, albeit partly temporary, improvement in the terms of trade (on the order of 13 percent) although for some countries this has been offset, at least in part, by the budgetary costs of the war (see below). The impact on the combined current account balance of these countries is estimated to have been an improvement of about $17 billion in 1990—roughly equal to the estimated deterioration in the external position of the industrial countries.
Economic and Budgetary Effects of the War
In addition to its influence on oil market developments and to the uncertainties that it has generated, the crisis in the Middle East will have a number of economic and budgetary implications, including a rise in military expenditure in the countries involved in the armed conflict. At this stage, any estimate of the magnitude of this rise is subject to a large degree of uncertainty because the length of the period over which the forces of various countries might be maintained in the Middle East is not known, and because information on some of the key parameters involved—including actual losses in equipment and the extent to which these losses are likely to be replaced—is not available.
For illustrative purposes, it might be assumed that the end of combat on February 28 is followed by a phase-down period lasting three to four months; and that the stocks of munitions (including missiles) will be fully replenished. Under these assumptions the incremental rise in military expenditures for the industrial countries that are members of the coalition—including transportation, basic support, operations and maintenance, as well as replacement of munitions—might be estimated to be in the range of $50 to $56 billion, of which the bulk (around $45-$50 billion) would correspond to the United States.15 There would also be a significant rise in the military expenditures of the developing countries involved in the conflict but the information required to make even a rough estimate for these countries is unavailable.
In the near term, the effect of higher military expenditure would be to increase aggregate demand and output in the industrial countries involved in the war. On the basis of the estimates provided above, the impact would be relatively small: for 1991, the estimated rise in spending would represent less than½ of 1 percent of the combined GNP of the industrial countries involved in military operations. Moreover, only the share of this rise that involves domestically produced goods and services would represent a net stimulus to the economy of these countries; a part of the incremental spending would be in the form of imports (e.g., fuel) or local expenditures in the Middle East.
The budgetary cost of the war for most of the industrial countries involved in the military operations is likely to be much smaller than the rise in military expenditures. Other countries (including Saudi Arabia, Kuwait, Japan, Germany, and the United Arab Emirates) reportedly have made or have pledged contributions to the war effort of the United States in the order of $45 billion. Significant sums also have been contributed or pledged to help defray the military costs of other members of the coalition and to compensate the front line states for the economic losses suffered as a result of the conflict.
The reconstruction of Kuwait and Iraq will involve a large increase in the demand for construction services and materials which, in the short run, is likely to stimulate production and employment in other countries, particularly in the industrial world. But, of course, the expenditures associated with reconstruction will need to be financed either by drawing down external assets or by borrowing abroad on the part of these two countries, or through financial assistance or other capital inflows from other countries. Thus, for the world as a whole the combined effect of the war in the Middle East and reconstruction will be a substantial net budgetary cost, thereby reducing the supply of saving that otherwise would have been available to finance investment in new capital goods.