Chapter

World Economic Outlook: Current Situation and Short-Term Prospects

Author(s):
International Monetary Fund
Published Date:
August 1984
Share
  • ShareShare
Show Summary Details

Introduction

Recent indicators suggest that activity in the world economy is strengthening more rapidly than projected by the staff six months ago.1 This is especially true of the United States, but the staff has also revised upward its growth projections for most other industrial countries—in the case of Japan and several of the smaller industrial countries by significant amounts. As a result, output in the industrial world is expected to increase by almost 5 percent in 1984, a revision of 1¼ percentage points from the estimate made six months ago, and the best growth performance in eight years. This quickening in the pace of recovery has not thus far been accompanied by any significant change in inflationary prospects. Indeed, price performance in the United States in the first half of 1984 has been somewhat better than expected, while that in other industrial countries has been much as foreseen in the April 1984 World Economic Outlook.

Economic recovery in the industrial countries is by now beginning to exert a significant impact on the developing world. The exports of developing countries have been growing vigorously for more than a year, and the effect of this on economic growth is becoming apparent. Output in these countries has been reviving since early 1983, and the rate of growth seems to be gathering pace in 1984. The staff now expects gross domestic product (GDP) in developing countries to increase by about 3¾ percent in 1984, the first time in five years that output will have grown significantly faster than population.

Recovery is also changing somewhat the contours of the adjustment and financing problem facing developing countries. The current account deficit of these countries continues to recede and now seems likely to be rather smaller in 1984 than was foreseen in the April 1984 World Economic Outlook. Perhaps more significant, however, is that the developing countries have clearly passed from the import-compression phase of adjustment to the export-expansion phase. As a result, it should become increasingly possible to combine the restoration of external creditworthiness with the resumption of more satisfactory domestic growth.

Looking ahead to 1985, the staff’s projections for growth and inflation are much as they were in the April 1984 World Economic Outlook. They involve rates of growth in the industrial countries close to the underlying trend in productive potential, little further change in these countries’ inflation rates, and a modest acceleration in output growth in developing countries (although still to a rate well below that achieved during the 1960–80 period). These projections should be regarded as highly tentative, however. Among the factors that differentiate the present conjuncture from earlier periods of cyclical recovery, and thus complicate forecasting, are the unprecedentedly high level of real interest rates; the still precarious financial position of many heavily indebted developing countries; the sizable disparities in fiscal policy and growth performance among industrial countries; and growing imbalances in the current account positions of some major countries. Other sources of concern include the very high level of unemployment in Europe, the weakness of growth among the smaller low-income developing countries, and the continued pressure in many countries for the protection of domestic industry from foreign competition.

The developments and prospects touched on above are elaborated in the remainder of the present report. The report begins with a review of the domestic economic situation in member countries, dealing with industrial countries and developing countries in turn. Next, attention is turned to external developments. The balance of payments and financing position of developing countries is dealt with first, and the report closes with an assessment of payments trends and exchange rate developments among industrial countries.

Domestic Economic Developments

Industrial Countries

Output and Employment

The economic recovery in the industrial world that began in early 1983 continues to be dominated by the strong pace of expansion in the United States (Appendix Table 1). However, there are increasing signs that other industrial countries are now beginning to participate more fully in the improving situation. The staffs latest projections for gross national product (GNP) involve growth estimates for 1984 that have been revised upward from those made in April for 16 of 19 industrial countries.2

The weighted average increase in real output in the industrial countries as a group, which was 2½ percent in 1983, is now projected to be almost 5 percent in 1984 (against a forecast of just over 3½ percent in the April 1984 World Economic Outlook). However, while all but 2 countries are expected to achieve increases in growth from 1983 to 1984, only 7 are projected to record a rate of expansion of 3 percent or more; the median growth rate for the industrial group is estimated to be 2½ percent. A key feature of the situation thus remains the disparity in output performance among industrial countries, with robust growth being achieved in the United States, moderate expansion taking place in Canada and Japan, and a much more tentative recovery occurring in Europe. For 1985, with expansion in the United States decelerating, the disparity in growth rates should become less pronounced, and the weighted average increase in real GNP of the industrial countries is expected to recede to 3½ percent.

As implied by the foregoing, growth rates rapid enough to absorb significant economic slack are concentrated in relatively few countries. For this reason, and also perhaps because of some procyclical increases in the size of the labor force, widespread improvements in the unemployment rate are not anticipated in 1984, With a very significant reduction in joblessness in the United States, the weighted average unemployment rate for the industrial countries is expected to decline to 8 percent from 8¾ percent in 1983, but for most countries decreases in unemployment, if any, will be modest. Unemployment rates of 10 percent or more are forecast in 8 of the 21 countries in the industrial group in 1984, one more than in 1983. A gradual improvement of the employment outlook is projected for 1985, with the weighted average unemployment rate declining by about ¼ of 1 percentage point to 7¾ percent.

The economic recovery began in the United States and Canada and its driving force continues to come from the North American industrial economies (Chart 1). Encouraged by moderating inflation, improving confidence, and an expansionary fiscal policy, the growth of domestic demand has outstripped that of productive potential for over a year and a half, especially in the United States. As a result, economic slack has been reduced and the net external balance has deteriorated, providing a strong output stimulus to other countries. While originating in the private consumption and residential construction sectors, the demand expansion has now spread to business fixed capital investment as well. (Relative to the cyclical output trough, business fixed investment in the United States rose by over 25 percent by the sixth quarter of the current recovery, compared with only 5½ percent at the same point in the recovery following the 1974–75 recession.)

Chart 1.Major Industrial Countries: Industrial Production and Real GNP, 1979-June 1984

(Indices, fourth quarter 1982 = 100)

1 Seasonally adjusted.

2 Average for three months ending in month indicated.

3 The United States and Canada.

4 The Federal Republic of Germany, France, Italy, and the United Kingdom.

Because of the stronger-than-anticipated output performance in the first two quarters of 1984, the 1984 growth projection for the United States has been revised upward to 7¼ percent (from 5 percent in the April 1984 World Economic Outlook). For 1985, the 4 percent growth forecast implies that the pitfalls of overheating will be avoided and that a more or less smooth reversion to a trend rate of expansion will be achieved. While such a scenario appears attainable, it is by no means assured; some factors that could threaten a “soft landing” of the U.S. economy onto its potential growth path are discussed below.

In contrast to the United States, growth rates in Europe, by and large, have not been sufficiently high to have had an appreciable impact in lowering unemployment and have been below those of previous recoveries. Moreover, with the exception of the United Kingdom, the other major countries have generally been net recipients of stimulus from abroad. The estimated growth of the Japanese economy in 1984 has been revised upward to 5 percent (compared with 4 percent in the April 1984 World Economic Outlook), with both domestic and foreign demand showing faster expansion. However, the strength emanating from the external sector has only recently taken hold in the domestic economy. A continuation of this tendency is of considerable importance, as the projected growth rate of 4 percent for 1985 is predicated on a substantial measure of support from domestic demand.

In the case of the Federal Republic of Germany and the United Kingdom, there was some faltering of the pace of expansion in the early part of 1984. The coalminers’ strike in the United Kingdom and the repercussions on output and competitiveness of the recent settlement of the metalworkers’ strike in the Federal Republic of Germany are additional factors making for uncertainty in the current outlook. The staffs projections for output growth in these two countries are little changed from the forecasts made in April—about 2½ percent in both 1984 and 1985.

Mainly because of the existence of more severe inflation and balance of payments constraints, recovery in France and Italy, and in many of the smaller industrial countries, has been slower in coming and more tentative. However, prospects now seem more favorable than they did six months ago. In France, real GDP is expected to increase by 1¼ percent in 1984 and by 1¾ percent in 1985. In Italy, estimated growth rates have been revised upward to 2½ percent for both 1984 and 1985. Some improvement is also becoming evident in the situation of the smaller industrial countries, reflecting their close economic ties with the larger countries and, in the case of Sweden, the impact of the large devaluation late in 1982. More complete data for 1983 show that recovery in the smaller countries was stronger in that year than the staff had initially estimated, with output having grown by almost 2 percent (compared with an estimate of 1 percent in the April 1984 World Economic Outlook). As a group, these countries are now expected to grow by 3 percent in 1984 and by 2¾ percent in 1985. These composite figures comprise a wide variety of individual country outlooks, but the trend toward a strengthening of growth prospects is characteristic of most countries; particularly robust gains are forecast for Australia and Finland.

As regards the main components of demand, private consumption growth in the industrial countries is projected to remain fairly strong through 1985, although concentrated in the North American economies and Japan. With the composite household saving rate tending to stabilize, this growth is due to improvements in real disposable income. Government final expenditure, on the other hand, is expected to continue to grow slowly, reflecting policies to limit public sector claims on the economy. Housing investment, after a very sharp turnaround in 1983, has come under the pressure of rising interest rates, and no further increase in this component of final expenditure is expected in 1985. Business fixed investment appears to be less affected, however, and in fact has been expanding at an unusually rapid pace for this stage of the cycle. The exceptionally buoyant trend of business fixed investment in the United States was mentioned above, but such investment spending has also shown strength recently in Japan, the United Kingdom, and the Federal Republic of Germany. In the seven major industrial countries as a group, business fixed capital formation has increased roughly twice as fast during the first year and a half of the present recovery as during the same period of the recovery that began in 1975, even though the growth of real GNP has been somewhat slower. This type of investment is projected to continue to expand vigorously through 1985. Demand for inventory accumulation is expected to exert a positive influence on output in the industrial countries, equivalent to about 1 percent of GNP in 1984, before becoming a neutral factor in 1985. The effect of the net foreign balance is forecast to be negative in 1984, reflecting the surge in imports from developing countries, and to turn positive in 1985.

Inflation and Interest Rates

Because of the steadfastness with which anti-inflationary policies have been pursued, the fall in the inflation rate in industrial countries has been dramatic. The rise in the composite GNP deflator of these countries fell from 9¼ percent in 1980 to 5 percent in 1983 (Appendix Table 1), while consumer price inflation fell from 11¾ percent to 5 percent during the same period. Not only did the composite inflation rate decrease considerably, there was also a significant reduction in the dispersion of individual countries’ rates (Chart 2), with the standard deviation about the mean rate dropping from 4.7 percentage points in 1980 to 3.6 percentage points in 1983.

Chart 2.Major Industrial Countries: Consumer Prices, 1979–July 19841

(Change, in percent)

1 Average of three months ending with month indicated over corresponding three months a year earlier.

2 The figures for the second half of 1979 and the first half of 1980 were affected by the approximately 3¾ percent increase in value-added tax rates, effective June 18, 1979.

Some further progress in reducing inflation is expected in 1984, with the composite GNP deflator of the industrial countries projected to increase by only 4¼ percent and consumer price inflation expected to be at or below 6 percent by the end of the year in the majority of countries. However, as depicted in Chart 3, which shows year-over-year changes in the inflation rate in the seven major industrial countries (as measured by the composite consumer price index), progress in reducing inflation appears to be coming to an end. As measured by the rise in the GNP deflator, inflation in industrial countries is expected to stabilize at about 4½ percent in 1985, a low rate by comparison with most of the post-1973 period, but still well above the average recorded in the 1950s and 1960s.

Chart 3.Major Industrial Countries: Changes in Consumer Price Inflation, 1979–July 19841

(In percent)

1 Rise in composite consumer price index over 12-month period ended in month indicated minus that for same 12-month period a year earlier; a positive (negative) number indicates a year-over-year increase (decrease) in the inflation rate.

From the second half of 1981 to about mid-1983, nominal interest rates in the major industrial countries moved progressively downward. After mid-1982, this decline exceeded the fall in the concurrent rate of inflation, so that ex post real interest rates (defined as the nominal interest rate deflated by the actual inflation rate) also fell (Chart 4). However, from about the middle of 1983, nominal interest rates began rising in the United States. Up to now, this rise in nominal interest rates has not been accompanied by any significant increase in inflation; therefore estimated real interest rates have also risen. In the 12 months to mid-1984, real interest rates in the United States, both short-term and long-term, increased by about 1½ percentage points, the bulk of the rise occurring after March 1984. Among the other large economies (Japan, France, the Federal Republic of Germany, and the United Kingdom), real interest rates changed relatively little, on balance, over the 12 months to mid-1984.

Chart 4.Five Major Industrial Countries: Interest Rates, 1979-August 1984

(In percent per annum)

1 Monthly averages of daily rates on money market instruments of about 90 days’ maturity.

2 Monthly averages of daily or weekly yields on government bonds, with maturities ranging from 7 years for Japan to 20 years for the United States and the United Kingdom.

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

4 Short-term interest rates deflated by a weighted average of the increase in the private final domestic demand deflator in the current and the following two quarters; for the most recent periods, staff projections of the deflator are used.

5 Long-term interest rates deflated as indicated in footnote 4.

Uncertainties in the Present Situation

Although the prospects for the industrial countries described in this report are better than for some considerable time, a number of recent developments generate uncertainties concerning the path of economic activity and could undermine the sustainability of the present recovery. In fact, it could be argued that present risks and uncertainties are greater than usual for this phase of an expansion.

Perhaps the most noteworthy recent development was the rise in interest rates on dollar-denominated instruments during the second quarter of 1984. This firming of interest rates had several aspects that were significant. First, it took place from a level of rates that was already very high both in nominal and in real terms. Second, the excess of long-term rates over short-term rates was also very large and for a time was widening. Third, the upturn in rates appears to have occurred at an earlier point in the cycle, and when the recovery was less well established outside the United States, than had been the case previously. And fourth, it took place while corporate balance sheets in a number of industrial countries were still weak and the balance of payments positions of many highly indebted developing countries remained precarious.

Despite its recent strength, business fixed capital formation in the industrial countries could be undermined by high interest rates, especially if they were to increase further from present levels, with investment in longer-lived capital items being particularly vulnerable. Homebuilding has already been affected, and interest-sensitive consumption expenditures could also be curtailed. A sudden reversal of the inventory cycle could amplify the impact of such a cutback in final demand on output. With both higher debt-servicing costs and less buoyant export markets, the problems of the debt-burdened developing countries would be compounded.

Of course, a main reason for higher interest rates in the United States, where such increases have been most significant, has been the very strength of the expansion, particularly in investment. The issue is whether tighter monetary conditions will be capable of restraining aggregate demand adequately without sending the economy into a downturn. A number of forecasters see a “growth recession,” or even declining real output for a period during 1985, as demand adjusts under the pressure of higher interest rates. On the other hand, because the tightening of monetary conditions occurred relatively early in the upswing and because of the underlying strength in most sectors of the U.S. economy, the staff believes that a slowing of output growth can be achieved without disruptive overshooting. Even assuming the U.S. authorities are successful in this, however, the higher level of interest rates will continue to present difficulties for other industrial and developing countries.

The rapid pace of expansion in the United States raises the question of the stage at which capacity constraints may be encountered, leading to an inflationary bidding up of the prices of available supplies. Obviously, the growth of output cannot exceed that of productive potential indefinitely, with the length of time during which such a divergence can exist depending on the amount of capacity that was initially unutilized. However, potential capacity is not easy to define, especially following periods of sharp changes in relative factor prices and utilization rates, and serious bottlenecks could arise in certain sectors well before aggregate measures of capacity utilization reach critical levels.

Table I contains some data on utilization of physical capital and labor in the seven major industrial countries since 1977. To give an indication of when concern about the level of resource utilization might be justified, data on capacity utilization in manufacturing and overall unemployment are presented for two years: the peak year of the 1977–80 upturn and the year of lowest unemployment since 1977 in which there was no significant acceleration of inflation. These two years (in the Federal Republic of Germany they were the same) may be taken as indicating a zone in which attention needs to be paid to the rate of resource utilization.3

Table I.Major Industrial Countries: Physical Capital and Labor Utilization Indicators

(In percent)

Capacity Utilization Rate in ManufacturingOverall Unemployment Rate
1977–80

annual peak1
Non-

accelerating

inflation

year

with lowest

unemployment2
Recent

period3
1977–80

annual peak1
Non-

accelerating

inflation

year

with lowest

unemployment2
Recent

period4
Canada85.778.671.77.47.511.2
United States86.079.481.755.97.67.5
Japan−126−436−205,62.02.02.8
France81.980.077.96.25.010.1
Germany, Fed. Rep. of84.784.779.13.33.38.3
Italy76.6774.4772.077.77.210.4
United Kingdom4183583785.15.512.8

Year of peak capacity utilization: 1980 for Japan, 1979 for the other six countries.

Year of lowest unemployment rate since 1977 in which the rise in the inflation rate, if any, was less than one half of a percentage point: 1977 for Japan and France, 1978 for Italy and the United Kingdom, 1979 for the Federal Republic of Germany, and 1981 for Canada and the United States.

First quarter 1984 except as indicated.

August 1984 for Canada, the United States, the Federal Republic of Germany, and the United Kingdom; July 1984 for Japan and France; April 1984 for Italy.

Second quarter 1984.

Judgment on capacity utilization (percent of respondents indicating insufficient capacity, minus percent indicating excess capacity).

Total industry.

Percent of firms operating at full capacity.

Year of peak capacity utilization: 1980 for Japan, 1979 for the other six countries.

Year of lowest unemployment rate since 1977 in which the rise in the inflation rate, if any, was less than one half of a percentage point: 1977 for Japan and France, 1978 for Italy and the United Kingdom, 1979 for the Federal Republic of Germany, and 1981 for Canada and the United States.

First quarter 1984 except as indicated.

August 1984 for Canada, the United States, the Federal Republic of Germany, and the United Kingdom; July 1984 for Japan and France; April 1984 for Italy.

Second quarter 1984.

Judgment on capacity utilization (percent of respondents indicating insufficient capacity, minus percent indicating excess capacity).

Total industry.

Percent of firms operating at full capacity.

Data for a recent period are shown in columns 3 and 6 of Table I. There appears to be no problem as regards available labor supplies, except perhaps in the United States. In that country, the very rapid decline in the unemployment rate to below the threshold level given by the nonaccelerating inflation year indicates that the situation requires monitoring, especially in light of the current contract negotiations in the automobile industry. Unduly large wage settlements could lead to a revival of inflationary expectations that would undermine the basis for sustained growth. Even in some countries where overall unemployment remains high (e.g., the United Kingdom and the Federal Republic of Germany), prospects for price stability could be adversely affected if labor disputes result in increases in unit labor costs that subsequently spread to other industries. With respect to the physical capital stock, the United States, Japan, and the United Kingdom all have capacity utilization rates above the level at which, in the last cycle, inflation began to accelerate.

Inflation and growth prospects are also dependent on trends in productivity. Increases in output per man-hour, adjusted for cyclical factors, remain well below the rates achieved in the late 1960s and early 1970s in virtually every country. As the transitory positive effect of the recovery passes, potential growth rates of output and real income will continue to remain below those of the pre-1973 period unless means can be found to restore more rapid productivity gains. With the postwar “baby boom” generation having been absorbed into the labor force, demographic factors could contribute to improved productivity performance, especially in the United States. Both in that country and in Europe, however, truly significant improvements will be dependent on greater rates of investment and increased flexibility of factor utilization.

An aspect of the present recovery that has been a source of concern from the beginning is its unbalanced nature. Not only have growth rates of real GNP diverged significantly across countries, as indicated above, but growth rates of real total domestic demand, which reflect the stimulus to output originating in the economy concerned, have differed even more. This can be seen from Chart 5, in which indices of real GNP and real total domestic demand for 1983 and 1984 (estimated) are plotted. The 1982 values of these variables are set equal to 100 and are plotted at the origin; the first point on the country vectors represents 1983 and the second point 1984. Measured horizontally, the differences between the country points represent variations in GNP growth; measured vertically, they represent variations in growth of total domestic demand. Points along the 45-degree line indicate GNP and total domestic demand growth at the same pace.

Chart 5.Major Industrial Countries: Growth of Real GNP and Real Total Domestic Demand, 1983–841

(Indices, 1982 = 100)

1 First point from origin represents 1983 and second point 1984 (estimated).

A striking fact illustrated by Chart 5 is the extent to which relatively rapid growth of domestic demand contributed to strong output expansion in the United States, Canada, and the United Kingdom in 1983, and is projected to continue to contribute in the United States in 1984. On the other hand, domestic demand grew at a much slower pace than output in 1983 in Japan. With the relative contribution of domestic demand forecast to decline in 1984 in Canada and the United Kingdom as well as in the Federal Republic of Germany, as indicated by the flattening of their respective vectors, some counterweight is provided by the strengthening of domestic demand projected for Japan. Such a spreading of sources of growth in the world economy is important to underpin the expansion and for the sustainability of global current account balances.

Developing Countries

Because of the recovery in industrial countries, output trends in the developing world are tending to firm. Largely as a result of stronger-than-expected exports, there has been a modest upward revision in the staff’s estimate of non-oil developing countries’ growth in 1983, and a similar upward revision has been made to the projections for these countries for 1984. The new figures show that economic growth in non-oil developing countries, which had slowed continuously from over 6 percent in 1978 to about 1¾ percent in 1982, edged up in 1983, and is projected to accelerate to about 3¾ percent in 1984. Prospects for 1985 are more uncertain, but the staff believes a further increase in growth, to 4¼ percent, is possible in that year.

A better appreciation of the timing and magnitude of the shift in output trends in the non-oil developing country group is provided by short-term indicators for some of these countries. Especially noteworthy in this context are the data on industrial production. While such data are available on a current basis for only 13—relatively advanced—developing countries, those that do exist point to a marked turnaround. By the first quarter of 1984, industrial production in these countries was increasing at an annual rate of 12 percent and had reached a level 6 percent above that a year earlier (Chart 6).

Chart 6.Non-Oil Developing Countries: Exports and Industrial Production, 1980–First Quarter 1984

(Percentage changes over corresponding period in preceding year)

1 Imports of industrial countries from non-oil developing countries, as reported in the Fund’s Direction of Trade Statistics, deflated by export unit values for non-oil developing countries.

2 Sample of 13 countries for which up-to-date monthly industrial production data are shown in the Fund’s International Financial Statistics. Country indices weighted by the dollar value of GDP in 1979–81.

Although considerable, these increases in output are broadly what would be expected given the rate of growth of industrial country demand. Industrial country imports from non-oil developing countries, which had stagnated in 1981, increased by 3½ percent in 1982 and by over 5 percent in 1983. Further, the rate of increase accelerated sharply throughout 1983, and, by the first quarter of 1984, the volume of non-oil developing countries’ exports to industrial countries was some 17–18 percent above the level of a year earlier. Since these exports account for roughly one tenth of the aggregate GDP of the non-oil developing countries, this acceleration in industrial country import demand would, by itself, account for a 1½ percentage point increase in developing country growth rates, even before allowance is made for secondary effects.

The recovery in the industrial world is, however, benefiting some countries more than others. Asian countries are registering well above average increases in both industrial production and exports and are expected to grow by an average of 6½ percent in 1984. This good performance is partly accounted for by such traditionally strong exporting countries as Korea and Singapore, but other Asian countries, including China, India, and Malaysia, have also had substantial increases in output. In Africa and Europe, on the other hand, the growth of output and exports, while significant, has nevertheless tended to be less marked than in Asia. This is partly because of the relative concentration of these countries’ exports in the European market where the cyclical surge in imports has been less pronounced. It is in the Western Hemisphere countries that the recovery in output has been weakest thus far. In that region, the considerable expansionary pull stemming from the rise in exports has been counteracted by the need to reorient policies so as to curb inflationary pressures, adjust relative prices, and improve government finances. While these policies are expected to enhance the prospects for durable growth in the longer term, they serve to limit the rate of output increase that can be achieved in the short term. GDP growth in the Western Hemisphere is projected to average only about 1 percent in 1984 and about 3½ percent in 1985. Nevertheless, the resumption of growth in Latin America represents a significant change from the 1¼ and 2¾ percent declines in output in 1982 and 1983.

The weakness of GDP growth rates in non-oil developing countries is only a partial measure of the hardships faced by these countries over the past several years. When allowance is made for the concurrent growth of population, per capita output levels in 1983 may be seen to have been little changed from what they had been three years earlier. When it is also taken into account that much of the increase in output went to improve the balance of payments, per capita absorption in 1983 was, on average, probably about 3–4 percent below its 1980 level, despite an increase of almost 7 percent in aggregate GDP. Such an average, moreover, conceals a wide diversity of experience among regions. Whereas Asian and Middle Eastern countries had satisfactory increases in domestic demand from 1980 to 1983, the other regions experienced an absolute decline in living standards, ranging up to some 15 percent, on average, in Western Hemisphere countries. In this connection, mention should also be made of the many low-income countries in Africa, where the recent declines in living standards are from an already low level and follow several years of virtually no growth in per capita incomes.

Output among the oil exporting countries is also being stimulated by the recovery of demand in the industrial countries. In the oil sector, output is expected to rise by about 4–5 percent a year in 1984 and 1985. This represents a significant change from the continuous declines in output (averaging some 12½ percent per annum) that prevailed during the years from 1980 to 1983. With an improvement in economic conditions in a few countries that had experienced severe financial difficulties in 1983, and some easing of the restraints on government expenditures in other countries in the group, activity in the non-oil sectors of these countries is also strengthening. Average growth in non-oil output of the oil exporting group had slackened from over 5 percent in 1981 to less than 2 percent in 1983, owing mainly to cutbacks in public sector spending prompted by the fall in oil revenues. This adjustment in public sector expenditure now seems largely complete, as the level of government spending, which had been virtually stagnant in 1983, is expected to increase moderately in 1984. Reflecting this, average output in the non-oil sectors is projected to rise by 3½ percent in 1984 and by almost 5 percent in 1985. However, the beneficial impact of the recovery in the industrial countries on oil exporting countries has not been sufficient to offset other factors making for a downward revision to the staff’s previous projection of oil production in the latter countries. These factors include higher oil output in other areas and somewhat weaker inventory demand than earlier anticipated. Overall, the total rise in output among oil exporting countries in 1984 is now put at 3¾ percent, or 1 percentage point less than estimated earlier.

The slowing of inflation among developing countries projected by the staff in the early months of 1984 no longer seems likely to be realized (Appendix Table 3). Inflation in 1984 is now expected to remain at least as high as in 1983, both in oil exporting countries and among the non-oil group. The failure of rates of price increase to decline as expected is, however, wholly accounted for by higher inflation (on a year-over-year basis) in five countries that already had triple digit rates of price increase.4 Average inflation in these five countries, taken together, had risen continuously from 66 percent in 1978 to 170 percent in 1983 and is now projected to reach some 226 percent in 1984. For the other non-oil developing countries, inflation is slowing, from an average rate of 21 percent in 1983 to an estimated 17 percent in 1984. With much of this deceleration reflecting developments in a few of the larger countries, most notably Mexico, inflation in the “typical” developing country, as represented by the median rate of price increase, seems to have stabilized at about 10 percent. Looking ahead to 1985, the staff expects a significant decrease in average inflation as adjustment programs begin to exert a stronger influence on price trends in countries with above-average inflation; the median rate of price increase is expected to be little changed, however.

The increasing disparity between the price performance of the five high-inflation countries and that of other non-oil developing countries has been associated with a divergence in growth trends also. Output in the five countries, which during the second half of the 1970s had risen in line with that of other non-oil developing countries, declined by close to 1½ percent per annum from 1980 to 1983, whereas output of other non-oil developing countries rose at an annual average rate of 3 percent.

The output and price developments described above are to a considerable extent reflections of corresponding developments in some of the main financial aggregates. The sluggishness of GDP in 1983 and 1984 relative to that of industrial countries, for instance, stems in part from the widespread adoption of measures to curtail unsustainable fiscal deficits. The weighted average budget deficit of non-oil developing countries has declined from the peak of 4¾ percent of GDP reached in 1982 to a projected 3¾ percent in 1984. Since the adjustments that are under way are relatively larger in smaller countries, the median deficit is expected to drop by some 2 percent of GDP over this period. As already noted, these developments improve the prospects for durable growth in the longer term, even if their immediate impact is to restrain output. Monetary policy developments have also affected the inflation trends noted above. In the five countries with triple-digit inflation referred to earlier, average rates of monetary expansion have accelerated from 79 percent in 1980 to 204 percent in 1983. In the main, however, financial policies in developing countries are distinctly less accommodative than they were a few years ago. For the developing countries as a whole, the median rate of expansion in broad money has dropped from 21 percent in 1980 to 16½ percent in 1983.

Balance of Payments and Exchange Rate Developments

Overview

Global payments prospects now seem rather more favorable than in the staff’s assessment of six months ago. World trade is expanding more rapidly than foreseen at that time; current account deficits among non-oil developing countries are likely to be lower than previously expected; and the financing situation of these countries seems, if anything, to have eased. Against these signs of improvement must be set two developments that cloud the outlook: the renewed appreciation of the U.S. dollar despite the continuing slide in the U.S. current account balance (see section on “External Developments in Industrial Countries,” below); and the rise in dollar interest rates, by some 2 percentage points during the first half of 1984.

In the short term, the main factor influencing the global payments situation has been the rapid rise in industrial country imports. In the second quarter of 1984, these imports were some 14 percent above year-earlier levels in real terms and 19–20 percent above their levels in the fourth quarter of 1982. Year-on-year, industrial country imports are expected to increase by almost 12 percent in 1984 (Appendix Table 9). Although imports of developing countries are projected to be much more subdued, they also are expected to rebound from the 4½ percent declines registered in 1982 and 1983 and to increase by 4 percent in 1984. As a result, the volume of world trade is now forecast to grow by 8½ percent in 1984, 3 percentage points more than projected six months ago.

Despite the buoyancy in trade volumes, world trade prices have remained quite subdued (Appendix Table 10). Prices for both manufactures and primary commodities were broadly stable in terms of U.S. dollars during the first half of 1984. Despite the decline in commodity prices in mid-1984, world trade prices are expected to rise moderately (3–4 percent per annum) over the balance of the forecast period (apart from oil prices, which are assumed to remain unchanged to end-1985). If these projections materialize, terms of trade changes would be relatively small. For the non-oil developing countries, a 1¾ percent gain in the terms of trade is expected in 1984 as a result of lagged adjustments to the rise in spot commodity prices that occurred in 1983. Such a gain must be regarded as quite small given the strength of the upturn in industrial countries and the fact that, in historical perspective, commodity prices remain low relative to those of manufactured products. For the oil exporting countries, terms of trade losses of 2¼ percent and 3¼ percent are projected for 1984 and 1985, respectively.

The surge in industrial country imports is changing the global distribution of current account balances. The combined balance of industrial countries is projected to shift from approximate balance in 1981–83 to deficits of some $30 billion in 1984 and $45 billion in 1985 (Appendix Table 17). This shift is a fairly normal cyclical phenomenon and is of concern primarily because it is associated with large disequilibria for individual countries (see section on “External Developments in Industrial Countries,” below).

The recovery-induced weakening in the payments balance of the industrial countries is reflected in an improvement in the position of developing countries and also in a widening of the “statistical discrepancy” in global current account balances. The combined deficit of the oil exporting countries is expected to be halved from 1983 to 1984, while the deficit of non-oil developing countries is expected to continue falling. The improvement for the latter countries is essentially attributable to growing exports, a development that also serves to finance a considerable rise in imports and interest payments. The financing situation appears to have stabilized, with many creditworthy countries probably reluctant to borrow significant sums at prevailing interest rates and with many others having reduced their deficits to manageable, even if not spontaneously financeable, proportions.

Payments Situation and Prospects of Developing Countries

Current Account Developments

The most notable feature of the external position of non-oil developing countries continues to be the size of the reduction in their current account deficit. For the group as a whole, the deficit has been more than halved, from $109 billion in 1981 to less than $53 billion in 1983 (Appendix Table 17). This adjustment is continuing, albeit at a reduced pace, and the deficit is expected to be $45 billion for 1984 as a whole. The deficit during the first half of the year was probably even less than that at an annual rate, but some reversal is expected during the second half of the year as import levels are adjusted. In 1985 the deficit is expected to stabilize at about $45 billion. Deficits of this magnitude would represent 9 percent of exports of goods and services in 1984 and just over 8 percent in 1985 (compared with a ratio of 24 percent in 1981). Viewed in these terms, prospective deficits among the non-oil developing countries are the lowest in at least 20 years.

The adjustment in the non-oil developing countries’ current account balances has had two quite distinct phases. The first was a massive import-compression phase. The second was an equally impressive, and still continuing, export-expansion phase.

The import-compression phase. By 1981, the rapid worsening in current account balances stemming from terms of trade shifts, the international recession, and the sharp rise in real interest rates had prompted a number of countries to undertake measures aimed at alleviating external imbalances. These efforts were given added impetus by a reappraisal of the credit-worthiness of developing country borrowers by private creditors who became increasingly reluctant to provide additional financing. Reflecting these factors, imports of developing countries from industrial countries fell by about 20 percent in U.S. dollar terms from early 1981 to late 1982 (Chart 7). From that time on, the financing packages put together in association with Fund-supported programs seem to have been sufficient to stabilize the level of imports, although these remained at their significantly reduced level for all of 1983 before beginning to move up in 1984.

Chart 7.Non-Oil Developing Countries: Trade with Industrial Countries, 1980–April 19841

(In billions of U.S. dollars, seasonally adjusted annual rates)

1 Three-month moving averages of data as reported by industrial countries. Hence, imports are f.o.b. and exports are c.i.f.

The export-expansion phase. The trough in imports of non-oil developing countries in the fourth quarter of 1982 coincided with the beginning of recovery in output in the industrial countries. From then on, GNP growth in the latter countries gathered strength and their imports increased markedly. As a result, exports of non-oil developing countries increased from some $190 billion (at an annual rate) in the fourth quarter of 1982 to some $240 billion in the first quarter of 1984. This surge in exports—which, at annual rates, matches the earlier compression of imports—is wholly attributable to the growth of industrial country markets and does not seem to reflect gains in the developing countries’ share of these markets (Chart 8). Such lack of observed share gains is somewhat surprising given the extensive array of policy actions, including exchange rate adjustment, taken by non-oil developing countries to spur their exports. To some extent it may reflect protectionist actions in the importing countries.

Chart 8.Non-Oil Developing Countries: Performance of Exports to Industrial Countries, 1978–84

(Indices, 1980 = 100)

1 Exports to industrial countries, as reported by the latter, deflated by export unit values of non-oil developing countries.

2 Imports, in volume, of 19 industrial countries weighted by their respective shares of non-oil developing countries’ exports in 1980.

3 Ratio of exports to market growth.

In combination, the compression of imports and the expansion of exports have brought about a dramatic change in the non-oil developing countries’ trade balances. In terms of the data shown in Chart 7, the trade balance vis-à-vis industrial countries has improved more or less continuously since the second quarter of 1981, with the improvement by the first quarter of 1984 having reached $70 billion at an annual rate. The continuing expansion of exports is expected to provide the “room” to finance a resumption in the growth of imports. Such a resumption, which is discernible in the most recent figures shown in Chart 7, could in any case be expected if the expansion of exports, as well as that of GDP generally, is to be sustained. Imports, therefore, are projected to rise significantly during the remainder of 1984. On a year-over-year basis, however, the acceleration is less sharp, with imports being expected to rise in volume terms by about 6 percent in both 1984 and 1985.

A factor limiting the extent to which imports can increase in response to higher exports is interest payments. Having stabilized in 1983, these payments are expected to increase both in 1984 and in 1985, in large part because of higher U.S. dollar interest rates. Such rates rose by about 2 percentage points during the first half of 1984, an increase that would in itself eventually lead to an increase in non-oil developing countries’ annual interest charges (net of interest earned) of $6 billion. Since these effects only come through with a lag, their full impact will not be evident until 1985. Given the projected moderation in the pace of expansion in industrial countries, the staff has assumed that the London interbank offered rate (LIBOR) in 1985 will average 11½ percent. On this basis, and after allowance for the concurrent rise in indebtedness, net interest payments of non-oil developing countries are expected to rise by about $4 billion in 1984 and by a further $5–6 billion in 1985.

While all developing countries have been subject in some degree to the general developments described above, differences across countries have been quite marked (Table II). The external position of the Asian group of countries, for example, is significantly stronger than that of the other regional groups. Not only are Asian countries’ deficits in 1983–84 estimated to be the lowest in relation to exports of goods and services among the five regions, they are also unusually low in relation to that region’s own past deficits. The opposite is true of the African and Middle Eastern regions, where the sustainability of external positions is very much dependent on the continuance of large flows of official transfers. In the European and Western Hemisphere regions, deficits in 1983–84 are much reduced from those that prevailed in the 1973–81 period and generally below those that prevailed in the late 1960s and early 1970s. However, this rather favorable comparison must be seen in the light of the very large accumulation of debt by these regions in the 1973–81 period.

Table II.Non-Oil Developing Countries: Current Account Deficits

(In percent of exports of goods and services)

Average

1967–72
Average

1973–81
19831984
Non-oil developing countries117.120.113.410.1
Africa217.530.934.028.7
Asia121.311.68.54.1
Europe5.917.49.14.7
Middle East25.934.331.826.4
Western Hemisphere19.828.815.615.5

Excluding China.

Excluding South Africa.

Excluding China.

Excluding South Africa.

Of all the sources of uncertainty attaching to the current account prospects of non-oil developing countries, probably the greatest is with respect to the future course of their imports. Some analysts have argued that resumption of GDP growth on the scale contemplated by the staff for 1984 and 1985 will require a large upward adjustment in imports to compensate for the import compression of 1981–82. On the other hand, it should be recognized that carefully conceived policies can bring about significant changes in the import intensity of domestic output and thus enable countries to adapt to changes in the availability of foreign exchange. A perspective on the key relationship involved, that between imports and GDP, is provided by the data plotted in Chart 9. In each of the panels in this chart, output is shown on the horizontal axis and imports on the vertical axis, both in log scale. Two conclusions are suggested by this chart: in normal times, the relationship between the growth of imports and that of GDP is indeed reasonably stable and not much above unity; but, in times requiring large external adjustments, the relationship can depart significantly from its trend value. Further, the reversion to trend following periods of external adjustment appears to occur only slowly. Thus, real GDP rose by 19 percent from 1974 to 1978 in the Western Hemisphere, whereas imports over this period increased by less than 1 percent.

Chart 9.Non-Oil Developing Countries: Apparent Relationship Between Imports, in Volume, and Real GDP, 1967–85

(Indices, 1967–85 = 100; ratio scale)

1 Excluding China.

2 Excluding South Africa.

This apparent adaptability of imports to changes in the external situation needs to be taken into account when assessing prospects for developing countries. It remains the case, however, that the compression of imports in the Western Hemisphere has been extraordinarily large in relation to that of output—a fact that necessarily increases the uncertainty concerning the projections for these countries. The staff’s estimates presume a relatively high growth of imports in 1984–85, although one that would go only part way toward restoring the relationship between imports and output that obtained before 1982.

The recovery in industrial countries is also contributing to a strengthening of the current account positions of oil exporting countries in 1984. Oil export volumes have already risen from the low levels they reached in the first half of 1983 and are expected to increase by some 4–5 percent in both 1984 and 1985. However, the turnaround in oil demand has been uneven, and the further rise in demand is expected to be moderate. The current weakness of spot prices for crude oils, despite the uncertainties surrounding oil shipments through the Strait of Hormuz, reflects in part the current relatively sluggish state of demand. Nevertheless, oil export earnings are expected to rise by some 3½ percent in U.S. dollar terms in 1984. In combination with a small further decline in imports, this is expected to reduce the current account deficit of the oil exporting countries from $17½ billion in 1983 to $8 billion in 1984. Little further change in the current balance is anticipated in 1985.

Of the $8–9 billion deficits projected for 1984 and 1985, only some $2–3 billion is attributable to the non-Middle Eastern countries included in the group (Algeria, Indonesia, Nigeria, and Venezuela). These countries have relatively large external debts, totaling $96½ billion at the end of 1983, and have recently faced financing difficulties similar to those of many non-oil developing countries. The compression of imports that these difficulties have made necessary has resulted in a marked reduction in the combined current account deficit of the four countries, from $17 billion in 1982 to a projected $2½ billion in 1984.

Financing and Debt

Because of lower projected current account deficits and higher projected lending by official creditors, the easing in the overall financing situation of developing countries is likely to be more marked than was allowed for in the staff’s assessment of six months ago. At that time, the staff had expected relatively stable capital flows (non-debt-creating flows and long-term lending by official creditors) to provide all but $9 billion of the financing required to cover current account deficits and capital flight5 in 1984. The staff now expects the gap not covered by these flows to be only $3 billion. With such a small net residual financing need, projected inflows from commercial sources are largely matched by reserve accumulation.

The amelioration in the aggregate financing situation conceals significant differences in the situations faced by individual countries. This point may be illustrated by comparing the financing situations of Asian and Western Hemisphere countries. Examination of these data, presented in Table III, shows that, while the two groups of countries have a number of features in common (notably, the improvement in their current account position in the period 1981–84 and the prospective accumulation of reserves in 1984), the pattern of their financing in 1984 is quite different. The situation of the Western Hemisphere countries is characterized by (1) much greater reliance on Fund credit than Asian countries, even though their exports of goods and services are only half as large; and (2) the continuation of borrowing from private creditors (“Other net external borrowing”) on a substantial, even if reduced, scale. In 1984, indeed, such borrowing by Western Hemisphere countries is expected to absorb virtually the entire amount of all net private lending to non-oil developing countries. These features of the Western Hemisphere’s situation, as well as the unusually heavy borrowing from official creditors, reflect the impact of the large financing packages put together in conjunction with Fund-supported programs for several of these countries. Hence, whereas the projected rise in these countries’ reserves points to their financing situation having become relatively more manageable, the non-spontaneous character of much of the lending that is taking place suggests that the region’s financing situation will remain difficult for some time to come. Such would not seem to be the case for the Asian countries. Collectively, this group has a low current account deficit ratio, a low debt ratio, and a low interest payments ratio—all signs of creditworthiness.

Table III.Non-Oil Developing Countries of Asia and the Western Hemisphere: Current Account Financing

(In billions of U.S. dollars)

Western Hemisphere

Countries
Asian Countries
197719811984197719811984
Current account deficit946172236
Non-debt-creating flows385387
Long-term borrowing from official creditors3511299
Errors and omissions−3−17−7−1−1
Other flows, net6508−37−9
Reserve-related transactions−54−8−5−3−9
Of which, use of Fund credit431
Other net external borrowing114616210
Memorandum items1
Debt ratio203.9220.3285.981.970.481.0
Interest payments ratio11.726.032.12.95.15.1
Current account ratio−15.9−41.0−15.5−1.9−11.9−2.7

In percent of exports of goods and services.

In percent of exports of goods and services.

In the main, the financing situation of European developing countries resembles that of Asian countries. A much less comfortable situation, however, prevails among the African and Middle Eastern countries. Although improving slightly in 1984, current account deficits in these countries remain high. The same is true of the financing gaps to be covered by reserve-related transactions or bank lending. Consequently, prospects in most of these countries are for at best no increases in reserves.

As far as the aggregate volume of financial flows is concerned, private lending seems to have stabilized, albeit in the differentiated pattern noted above. The estimates shown in Table IV point to an annual flow of $18 billion in 1983–85, compared with $66 billion in 1981. At the new level, such flows imply an expansion in bank claims on developing countries of about 5 percent per annum.6 Official lending has been much better sustained than private lending. While the growth of private lending (to non-oil developing countries) slowed from 21 percent per annum in the 1978–81 period to some 5 percent currently, official lending slowed only from 14 percent to 12 percent, and in real terms actually increased. However, the increase is entirely attributable to increased lending in conjunction with “concerted financing” packages, much of which is to countries in the Western Hemisphere. Official lending to other countries, and especially those in the African region, has been much more restrained.

Table IV.Non-Oil Developing Countries: Current Account Financing

(In billions of U.S. dollars)

Average

1976–77
19811982198319841985
Current account deficit3110986534545
Relatively “stable/autonomous” financing flows265150464946
Non-debt-creating flows132726212325
Long-term borrowing from official creditors1132424252621
Errors and omissions−6−14−20−12−7−7
Other flows, net1172561936
Use of reserves−13−45−10−16−15
Other financing flows, net247652291921
Reserve-related liabilities510151113
Liabilities constituting foreign authorities’ reserves211−11
Use of Fund credit1671072
Arrears2372−5
Other net external borrowing2196637181818

Not including monetary institutions.

Essentially net borrowing from private creditors. For the most recent period, amounts shown are likely to pertain almost exclusively to bank lending. However, relative to bank lending as measured from creditor-reported data, the estimates shown here net out changes in external assets held by private residents of the reporting (debtor) countries, and they exclude officially guaranteed export credits that are channeled to these countries through banks. In principle, the latter are recorded here as long-term borrowing from official creditors.

Not including monetary institutions.

Essentially net borrowing from private creditors. For the most recent period, amounts shown are likely to pertain almost exclusively to bank lending. However, relative to bank lending as measured from creditor-reported data, the estimates shown here net out changes in external assets held by private residents of the reporting (debtor) countries, and they exclude officially guaranteed export credits that are channeled to these countries through banks. In principle, the latter are recorded here as long-term borrowing from official creditors.

Overall, the growth in the external indebtedness of non-oil developing countries is expected to stabilize at about 6 percent per annum over 1983–85. Given the high growth projected for exports in real terms, indebtedness as a percentage of exports of goods and services for the non-oil developing countries would decline from a peak value of 154.4 percent in 1983 to 139.8 percent in 1985. Although markedly improved, such a ratio would still be well above the average 124 percent ratio of the 1976–80 period.

Despite the slowing of the rise in indebtedness, higher interest rates mean that debt service payments are projected to continue to mount rapidly. For non-oil developing countries, this increase is estimated at an annual average of 12 percent in 1984 and 1985, more or less in step with the rise in export earnings. The underlying situation is, however, obscured by the impact of rescheduling. Rescheduling agreements reduced debt service payments of non-oil developing countries by $23–24 billion in 1983 and are expected to do so again in 1984. As a result, the debt service ratio, which had risen from 18.1 percent in 1980 to 25.0 percent in 1982, and which would have risen to 27.6 percent in 1983, declined to 22.3 percent in the latter year. The cash flow position of many borrowing countries was further eased by debt maturity restructurings. Largely as a result of these operations, short-term debt declined from almost 30 percent of non-oil developing countries’ exports of goods and services in 1982 to 25 percent in 1983 and, prospectively, to less than 20 percent this year.

The debt service ratio is expected to recede some-what in 1984, but is likely to rise in 1985 unless further rescheduling agreements again result in the postponement of scheduled amortization payments. The interest payments ratio, which is not affected by decisions to reschedule amortization payments, doubled from 1978 to 1982, when it reached 14½ percent. The subsiding of international interest rates in 1982–83 and some rescheduling of interest payments to official creditors caused this ratio to recede to 13.3 percent in 1983. Despite the renewed rise in interest rates since then, this ratio is expected to remain at about 13 percent in 1984–85 because of the rapid rise in these countries’ export earnings.

The situation described above should be seen in the light of the very uneven distribution of indebtedness to banks among non-oil developing countries. Interest payments of the Western Hemisphere countries amount to some 30 percent of exports of goods and services, or five times as much as is the case for Asian countries. Because of this exposure, the Western Hemisphere countries account for the bulk of reductions in debt service payments resulting from rescheduling agreements. These agreements are estimated to have lowered the region’s debt service payments by a third in 1983 and are projected to have almost as large an impact in 1984.

External Developments in Industrial Countries

Exchange Markets

The renewed strength of the U.S. dollar has been the dominant feature of exchange market developments since about April 1984. After depreciating during February and March, the dollar resumed the general upward course that it had followed over the preceding three years. From December 1983 to July 1984, the nominal effective exchange rate of the dollar rose by 4¾ percent, with the sharpest increases occurring vis-à-vis the Swiss franc, the pound sterling, and the Canadian dollar. As a result, the dollar’s nominal effective rate was approximately 48 percent above its low level in the third quarter of 1980 (Chart 10), while its real value (measured by an index of normalized unit labor costs adjusted for exchange rate changes) reached a level some 28 percent above its average value for the decade to 1983 (Chart 11).

Chart 10.Indices of Monthly Average U.S. Dollar and Effective Exchange Rates, January 1980–August 1984

(Indices, average value for 1974–83 = 100)

Chart 11.Major Industrial Countries: Relative Prices of Manufactures Adjusted for Exchange Rate Changes, 1980–Second Quarter 1984

(Indices, average value for 1974–83 = 100) 1, 2

1 Indices of the type shown here are frequently referred to as indices of real effective exchange rates.

2 Data for the second quarter of 1984 are based on preliminary staff estimates.

3 Annual deflators for GDP originating in manufacturing with quarterly interpolations and extrapolations (beyond the latest available data) based on wholesale price data for manufactures.

The currencies of the European Monetary System (EMS), though declining against the U.S. dollar between December 1983 and July 1984, showed little net change in nominal effective terms as they generally strengthened against sterling and the Canadian dollar. Pressures emerged within the EMS in February and March, when the deutsche mark appreciated against the U.S. dollar, and for a short time the deutsche mark and the Belgian franc were at opposite extremes of the narrow EMS band. Thereafter, however, with the deutsche mark remaining weak against the U.S. dollar, the EMS currencies traded comfortably within their 2¼ percent intervention margins.

The movement in the U.S. dollar value of the Japanese yen from December 1983 to July 1984 has been similar to that of the EMS currencies, while the Canadian dollar and the pound sterling have experienced somewhat larger declines. During the seven-month period, the yen’s net decline of approximately 3½ percent against the U.S. dollar was associated with a depreciation of slightly more than 1 percent in nominal effective terms. The Canadian dollar and the pound sterling fell by 6 percent and 8½ percent, respectively, against the U.S. dollar, and by smaller amounts vis-à-vis the yen and the EMS currencies. In nominal effective terms, the Canadian dollar depreciated by about 4½ percent from December to July, while the pound declined by about 5 percent.

As in 1983, exchange rate movements thus far in 1984 have been more closely related to financial market developments than to shifts in current account positions. The renewed strengthening of the U.S. dollar in the second quarter of 1984, following a sequence of record quarterly trade deficits, was associated with a movement of real interest rate differentials in a direction favoring U.S. dollar-denominated assets. Expectations that higher real returns on dollar assets would persist have been fostered by the unexpectedly strong growth of private credit demand in the United States, combined with the large ongoing financing requirements of the Federal Government and the nonaccommodating stance of U.S. monetary policy. The dollar’s continued strength also appears to be attributable to factors—such as the relative safety of the U.S. financial system and expectations of improved rates of return on real investment in the United States as the economic expansion proceeds—which have proved attractive to foreign capital.

During the first half of 1984, the tightening of credit conditions in the United States was reflected in movements of real long-term interest rates in the United States relative to those abroad. Nominal and real interest rates rose significantly in the United States in this period, while those in Japan, the Federal Republic of Germany, and the United Kingdom either declined or rose less than commensurately. By June 1984, the average real long-term interest differential favoring the U.S. dollar against the currencies of Japan and the major industrial countries of Europe—measured in terms of long-term bond yields adjusted for current inflation rates—was almost 5 percentage points, compared with 3¾ percentage points in December 1983 (Chart 12). Not until early July did the U.K. monetary authorities, in the face of labor difficulties and a sharp depreciation of the pound, allow U.K. interest rates to rise abruptly and move above comparable U.S. rates. During the period the Canadian authorities endeavored to moderate movements in the Canadian dollar/U.S. dollar rate by keeping interest rates above those in the United States. Nevertheless, the Canadian dollar depreciated against the U.S. dollar by 6 percent from December 1983 to July 1984.

Chart 12.Monthly Average Real Long-Term Interest Rates,1 January 1980-August 1984

(In percent per annum)

1 Monthly averages of daily or weekly yields on government bonds deflated by an estimate of the rate of inflation. The maturities range from 7 years for Japan to 20 years for the United States and the United Kingdom.

2 The dashed line represents the average value of the U.S. real long-term interest rate during the period 1974 to 1983.

Current Account Developments

Current account projections for the industrial countries for 1984 and 1985—based on the working assumption that nominal exchange rates remain at their average level of June 1984-are shown in Appendix Table 17 (excluding official transfers) and Appendix Table 19 (including official transfers). The most notable revision to the projections made six months ago is a substantial increase in the projected current account deficit of the United States. This further worsening of the U.S. external position is accounted for entirely by the deteriorating trade balance, which reflects partly the loss of competitiveness from recent exchange rate changes, but mainly the stronger-than-expected pace of expansion in the United States relative to abroad.

For the industrial countries as a group, the combined current account position (excluding official transfers), which was close to balance in each of the three preceding years, is projected to deteriorate by $34 billion in 1984 and by a further $15 billion in 1985. This weakening in the overall current account position of the industrial countries is partly explained by developments in oil trade. The aggregate deficit of the industrial countries on oil trade is projected to widen by some $10 billion in 1984 and to continue to widen in 1985. This is a sharp contrast to 1982–83, when rather large reductions in the aggregate oil trade deficit broadly offset declines in the surplus on non-oil trade, leaving the aggregate trade balance approximately unchanged. Among the oil importing industrial countries, the largest increases in net payments for oil are projected for the United States, Japan, and Canada, as the declining trend of oil imports during 1979–83 gives way to increases. The rise in the demand for oil in these three countries in the first half of 1984 was associated both with the growth of output and with the fall in oil prices, but it also reflected the relatively cold winter. The oil trade balances of other industrial countries, where recovery is expected to be generally less robust, are projected to show little net change over the forecast period.

Changes in the terms of trade of the industrial countries are expected to have relatively less effect on the aggregate current account in 1984–85 than they did in 1982–83. Following improvements of 2 percent annually in 1982–83, the aggregate terms of trade are projected to improve by less than ½ of 1 percent per annum in 1984–85.

Projected movements in the external positions of individual industrial countries during 1984–85 reflect changes in their relative cyclical and competitive positions, as well as differences in the growth of their export markets. For the United States, the stronger-than-expected expansion of domestic demand since mid-1983 is the principal factor underlying the large revision in the estimated U.S. current account deficit for 1984 noted above. Import volumes, which were relatively flat in the first half of 1983, grew at an annual rate of 30 percent in the second half of 1983 and 34 percent in the first half of 1984, owing mainly to the acceleration of domestic demand growth from an annual rate of 5 percent in the first half of 1983 to 9–10 percent during the next 12 months. As the growth of U.S. domestic demand slows in the coming period, increases in import volumes are projected to decelerate to an annual rate of 16 percent in the second half of 1984 and to 11 percent in 1985. There has been little change in the outlook for U.S. export volumes, which are expected to grow substantially less than import volumes, owing to the moderate pace of growth in the United States’ foreign markets and to the lagged effects of prior losses in price competitiveness. The U.S. trade deficit is now projected to widen by $54 billion in 1984 and by another $24 billion in 1985, bringing the current account deficit (including official transfers) to $90 billion in 1984 and to $115 billion in 1985.

Among the other industrial countries, the major offsets to the deterioration of more than $70 billion in the U.S. current balance in 1984–85 are found in a strengthening of the current balances of Japan ($20 billion), France ($4 billion), the Federal Republic of Germany ($2 ½ billion), and the group of smaller industrial countries ($6 billion). Although the trade surplus of Canada shows a modest increase over the forecast period, a widening deficit in net service transactions is expected to cause a weakening in the Canadian current account of $1 billion between 1983 and 1985. The current accounts of both Italy and the United Kingdom are projected to weaken by about $3 billion each from 1983 to 1985, owing primarily to deterioration in their trade balances.

Aside from the greater-than-expected recent strength of U.S. domestic demand, the factors underlying the current account projections are not materially different from those discussed in the April 1984 World Economic Outlook. Briefly, the improvement in the external positions of Japan and the Federal Republic of Germany is attributable mainly to the growth of demand in their export markets and, to a rather lesser extent, to the effects of improving competitiveness. In contrast, for both Italy and the United Kingdom, a worsening of the trade balance is projected. This is attributable largely to the relatively strong growth in domestic demand, as well as, in Italy, to some deterioration in competitiveness resulting from the continuing inflation differential between Italy and its principal trading partners. The current account of France, which deteriorated in the first half of 1984 because of special factors, including the bunching of oil imports in the first quarter, is projected to move into balance by 1985 as a result of domestic demand restraint and the maintenance of competitive gains derived from past exchange rate adjustments. Among the smaller industrial countries, Belgium, Spain, and Sweden are projected to improve their current account positions by about $2 billion each, reflecting a pickup in foreign demand, the lagged effects of prior gains in competitiveness and, for Belgium and Spain, relatively weak domestic demand. The current account positions of the other countries in this group are projected to remain stable or to change by less than $1 billion over the forecast period.

Chart 13.Major Industrial Countries: Payments Balances on Current Account, Including Official Transfers, 1980–84

(In billions of U.S. dollars, seasonally adjusted annual rates)

See World Economic Outlook: A Survey by the Staff of the International Monetary Fund (Washington. April 1984), published as No. 27 in the Fund’s Occasional Paper series.

Iceland and Luxembourg are not included in this comparison

While these data for the most recent full cycle are regarded as the most appropriate for this purpose, it needs to be remembered that they are not necessarily typical of experience in other cycles.

Argentina, Bolivia, Brazil, Israel, and Peru.

The errors and omissions item is taken here as a proxy for capital flight, although it undoubtedly includes other components.

The statistics reported in Table IV are derived from the balance of payments and debt statistics of debtor countries and are thus not directly comparable with creditor-reported statistics.

    Other Resources Citing This Publication