II World Economic Situation and Short-Term Prospects
Author: International Monetary Fund. Research Dept.
Language:
English
Keywords:
WEO; asset price inflation; net creditor country; exchange market tension; net debtor countries; inflation rate; deutsche mark; nonfuel commodity price; spot price; price liberalization; equity price; Inflation; Commodity prices; Consumer prices; Current account deficits; Asia and Pacific; Eastern Europe
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Abstract

The world economy, following the third major slowdown since the early 1970s, is expected to recover gradually during 1992 and 1993. Although the forces at work should on balance support a resumption of stronger growth, many of the uncertainties in the outlook involve downside risks, suggesting that the recovery may well be modest compared with previous cyclical upturns. This chapter discusses the global economic situation and the short-term outlook. Subsequent chapters analyze the role economic policies could play in improving conditions for sustained growth in the future.

The world economy, following the third major slowdown since the early 1970s, is expected to recover gradually during 1992 and 1993. Although the forces at work should on balance support a resumption of stronger growth, many of the uncertainties in the outlook involve downside risks, suggesting that the recovery may well be modest compared with previous cyclical upturns. This chapter discusses the global economic situation and the short-term outlook. Subsequent chapters analyze the role economic policies could play in improving conditions for sustained growth in the future.

Economic Activity

Economic growth in the industrial countries fell from 2½ percent in 1990 to about ½ of 1 percent in 1991, with almost all countries experiencing either a recession or a slowing of growth (Table 1 and Chart 2). In 1992, a moderate recovery in the United States and some pickup in the EC is expected to more than offset a slowdown in Japan, allowing real GDP in the industrial countries to increase by 1¾ percent. As the pace of the expansion gathers strength, growth in the industrial countries is expected to rise to nearly 3 percent in 1993, about ½ of 1 percentage point lower than projected in the May 1992 World Economic Outlook.

Table 1.

Overview of the Projections

(Annual percent change, unless otherwise noted)

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Note: Real effective exchange rates are assumed to remain constant at the levels prevailing during the first week of August 1992, except for the bilateral rates among the exchange rate mechanism (ERM) currencies, which are assumed to remain constant in nominal terms. This implies an effective depreciation of the U.S. dollar by about 6 percent relative to the assumption underlying the May 1992 World Economic Outlook.

Simple average of the U.S. dollar spot price of U.K. Brent, Dubai, and Alaska North Slope crude oil; assumption for 1992 and 1993.

In U.S. dollars; based on world export weights.

London interbank offered rate on six-month U.S. dollar deposits.

Chart 2.
Chart 2.

Industrial Countries: Real GDP1

(Percent change from four quarters earlier)

1GNP for Germany. Shaded areas indicate staff projections.2Annual observations, since quarterly data are not available for some countries.

Among the major industrial countries, the United States, Canada, and the United Kingdom experienced declines in output in 1991. In the United States, the weak performance in 1991 was followed by real GDP growth of less than 2 percent at an annual rate in the first half of 1992, with increases in both domestic demand and net exports.1 Although recent indicators have remained sluggish (Table 2), prospects for continued growth are favorable: the private sector has strengthened its financial position, short-term interest rates have fallen to 20-year iows, and consumer and business confidence has improved somewhat (Chart 3). Led by the recovery of the interest-sensitive components of demand, output is projected to increase 2 percent in 1992 and 3 percent in 1993.

Table 2.

Major Industrial Countries: Cyclical Indicators1

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Seasonally adjusted.

The source for these data is the Deutsche Bundesbank, whose estimates of the annual unemployment rate differ slightly from the data reported in Chart 4 and Table A4 of the Statistical Appendix.

Chart 3.
Chart 3.

Six Major Industrial Countries: Indicators of Consumer Confidence

Sources: For the Untied States, the Conference Board; for Canada, the Conferente Board of Canada: and for the lower panel, European Community.1Quarterly observations.2Percent of respondents expecting an improvement in their situation minus percent expecting a deterioration.

The recovery in Canada has also been hesitant. A resumption of growth in the spring of 1991 was not sustained, and the economy stagnated in the second half of the year. Output then grew by only ¾ of 1 percent at an annual rate in the first half of 1992. However, with a wide margin of unused resources, substantial progress in reducing the structural budget deficit, an inflation rate that is the lowest among the major industrial countries, and sharply lower interest rates, a solid foundation for a strong economic expansion seems to be in place. On this basis, growth is projected to rise to 2 percent this year and to 4½ percent in 1993. Signs of economic recovery have remained elusive in the United Kingdom, where real GDP declined by a further 1¾ percent at an annual rate in the first half of 1992. Major private sector financial adjustments and persistently high real interest rates have contributed to what has become the longest recession in the postwar period. Improvements in financial balance sheets and a sharp fall in inflation, however, have laid the basis for a resumption of growth in the second half of 1992. On an annual basis, however, output is likely to decline by ¾ of 1 percent in 1992 and then expand by 2 percent in 1993.

The near-term outlook for Japan is weak relative to past performance. Following several years of exceptionally strong growth, investment spending decelerated abruptly, and overall activity slowed during 1991. Although growth resumed in the first quarter of 1992, more recent indicators tend to confirm the weakness of the economy; in July 1992, for example, industrial production was 6¼ percent below its level a year earlier.2 As discussed in Annex I. the impact of the large declines in real estate and equity prices engenders particular uncertainty. At this stage, however, the adjustments in both the financial and nonfinancial sectors appear to have been contained, and policy measures announced in August—intended to boost confidence in the business, financial, and household sectors—are likely to have a positive effect. Stronger growth is expected to resume later this year and to continue in 1993.

In west Germany, output continued to grow strongly in the first quarter of 1991 but declined through the remainder of the year. Economic activity recovered in the first half of 1992, however, and the expiration of a one-year surcharge on personal and business income taxes on July 1 is expected to stimulate demand in the second half of this year. In the eastern Länder, activity is also expected to continue to recover, supported by substantial increases in public and private investment. Domestic demand is thus expected to remain strong despite further increases in short-term interest rates and a deterioration of external competitiveness. For Germany overall, real GNP, following an increase of only 1 percent in 1991, is projected to expand by 1¾ percent in 1992 and by 2½ percent in 1993.

In France, growth slowed to 1¼ percent in 1991, although it strengthened in the second half of the year. Real GDP increased by 4 percent at an annual rate in the first quarter of 1992, in part because of strong increases in exports and consumer expenditure. Although there are indications that activity moderated again in the second quarter, both domestic and external demand are expected to be sources of strength for the remainder of 1992 and in 1993, supported by recent improvements in competitiveness. Output is projected to increase by 2¼ percent this year and by 2¾ percent in 1993. The outlook is clouded, however, by structural impediments in labor markets and by continued high interest rates.

Economic growth in Italy dropped to 1½ percent in 1991, reflecting the slower pace of growth in Europe, a loss of competitiveness, and the impact of high interest rates. Activity is expected to be supported by consumption, but it could be adversely affected by declining competitiveness and uncertainty surrounding the budgetary and monetary situation. Thus, growth in Italy is likely to remain subdued and is currently projected to average less than 1½ percent during 1992–93.

Among the smaller industrial countries, output declined in 1991 in Australia, Finland, New Zealand, Sweden, and Switzerland. Most other countries experienced a slowdown in growth. The sources of the weakness varied from country to country. In some—such as Sweden and Switzerland—tighter fiscal and monetary policies to curb inflation restrained aggregate demand. In others—such as Ireland and Spain—the slowdown constituted a return to more sustainable rates of growth. The collapse of demand from the former Soviet Union triggered a sharp decline of output in Finland. Economic activity is expected to recover gradually in the smaller industrial countries as a group, with output growth projected to rise from ½ of 1 percent in 1991 to 1¾ percent in 1992 and to 2¼ percent in 1993. In several countries, continuing adjustment of private sector balance sheets may restrain growth for some time.

In 1991, unemployment rates increased in all the major industrial countries except Japan and Italy (Chart 4). In North America and the United Kingdom, this increase entailed a widening in the gaps between the actual and the estimated noninflationary levels of output (Chart 5). Because the recoveries in these countries are projected to be moderate, excess capacity and unemployment are not expected to be reduced substantially in the short term. By contrast, in Japan and west Germany output was probably still slightly above capacity in 1991, but this gap is expected to disappear in 1992 and 1993.

Chart 4.
Chart 4.

Industrial Countries: Unemployment Rates1

(In percent of labor force)

1Shaded areas indicate staff projections.2Aggregation based on labor force weights.
Chart 5.
Chart 5.

Major Industrial Countries: Output Gaps1

(In percent)

1The output gap is calculated as the percentage difference between actual or projected GDP and staff estimates of potential output; composites are based on 1988–90 GDP weights (GNP for west Germany). The shaded area indicates staff projections.

Growth in the developing countries remained relatively strong, at 3¼ percent in 1991, despite the crisis in the Middle East and the slowdown in the industrial countries. Output rebounded in the Western Hemisphere after a period of low growth in the late 1980s and stagnation in 1990, and economic expansion in Asia continued at a rapid rate. The economies of the developing countries are projected to expand on average by 6¼ percent in both 1992 and 1993, supported by stronger growth in the industrial countries, a rebound in economic activity in the Middle East, and the continued effects of improved macroeconomic policies and structural reforms (Table 3).

Table 3.

Selected Developing Countries: Real GDP and Consumer Prices1

(Annual percent change)

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Data for 1992 are largely projections; for 1991, and in some cases 1990, data are IMF staff estimates. Output and price data for some countries are subject to significant weakness and should be interpreted carefully. Aggregates are GDP-weighted averages. Price data for India are at the wholesale level and for Brazil correspond to the general price index. Data for Cameroon, Egypt, India, and the Islamic Republic of Iran (GDP) are for fiscal years.

Classified as a fuel exporter.

Changes in GDP growth reflect mainly changes in oil production.

In the Middle East and Europe, economic activity—after increasing by 4½ percent during 1989–90—stagnated in 1991 because of the dramatic output losses in Iraq and Kuwait. Nonetheless, growth remained strong in a number of countries, such as Saudi Arabia, where oil production was maintained or increased. The improvement in economic performance projected for 1992-93, with output growth averaging 9¼ percent, reflects a normalization of oil production in Iraq and Kuwait and continuing strong growth in the Islamic Republic of Iran. Strong inflationary pressures are expected to constrain growth in some countries, particularly Turkey.

In the developing countries of the Western Hemisphere, reforms in macroeconomic policies, trade liberalization, economic deregulation, and the privatization of public enterprises have contributed to higher growth in a number of countries. This has been most notable in Argentina, Chile, Colombia, and Mexico, but growth in many smaller countries in the region is also expected to be higher in 1992-93. In contrast, and notwithstanding significant progress in structural reforms, the implementation of policies needed to combat high inflation in Brazil is expected to restrain economic activity. Growth in the developing countries of the Western Hemisphere is expected to remain broadly stable at about 2¾ percent in 1992 and then to increase to 4 percent in 1993.

Output in Asia grew by 5¾ percent in 1991. Strong domestic demand and rapid growth of regional trade helped to offset several adverse developments, including the effects of the crisis in the Middle East. These effects were also mitigated by structural reforms and improved financial policies in Bangladesh, Pakistan, and Sri Lanka. India and the Philippines, where there were large macroeconomic imbalances before the Middle East crisis, were less resilient: India was also adversely affected by developments in the former U.S.S.R. and by shortages of foreign exchange. The fast-growing economies continued to be China, Hong Kong, Indonesia, Korea, Malaysia, Singapore, Taiwan Province of China, and Thailand, and they also accounted for much of the expansion of regional trade. Growth in Asia is expected to increase to about 6¾ percent during 1992–93.

In Africa, real GDP increased by 1½: percent in 1991 following an increase of 1 percent in 1990. Economic activity was constrained by a worsening in the terms of trade of about 6¼ percent, by severe drought in southern Africa, and by political unrest in several countries. In recent years, strengthened stabilization and structural reform efforts have led to an improvement in growth for a majority of the countries that have arrangements under the IMF’s structural adjustment facility (SAF) and enhanced structural adjustment facility (ESAF); growth in this group of countries averaged nearly 2½ percent in 1991. Economic activity has weakened this year in some of these countries, however, because of the drought, and slippages may occur in their reform efforts. On the basis of an expected improvement in the terms of trade, a resumption of growth in the industrial countries, and the assumption of continued implementation of appropriate policies, growth in Africa is projected to increase to 2 percent in 1992 and to 3¼ percent in 1993.3

In Eastern Europe, economic conditions improved during the first six months of 1992 in Hungary and Poland, and the decline in output slowed significantly in Bulgaria, the Czech and Slovak Federal Republic, and Romania. In Czechoslovakia, Hungary, and Poland, the substantial increase in the volume of exports to convertible currency markets suggests that supply has begun to respond to economic reforms. There are also indications that certain industries are beginning to compete successfully with imports. In contrast, output continued to decline sharply during the first half of 1992 in Albania and has collapsed in most of the former Yugoslavia as a result of civil war. In 1992, output is likely to decline further in Eastern Europe as a whole, but it may expand moderately in 1993 for the first time since 1988.

The economic situation in the former Soviet Union has continued to deteriorate. Output in Russia is estimated to have fallen by 14 percent in the first half of 1992, compared with a year earlier, following a drop of some 9 percent in 1991. In most of the countries of the former Soviet Union, the decline in output is expected to steepen in 1992, reflecting the disruptions associated with the breakdown of the old system and uneven progress in structural reform, sharp reductions in trade, lack of financing for imports, a deterioration in the terms of trade of net energy importers, and large increases in the price of energy imports. Overall, output in the countries of the former Soviet Union is projected to contract by about 18 percent in 1992. Any projection for the countries of the former Soviet Union is, of course, subject to considerable uncertainty.

Inflation

The weakness of economic growth brought about a significant reduction of inflationary pressures in the industrial countries in 1991 and the first half of 1992, reversing the general rise in inflation seen in the late 1980s. In many cases, inflation is now at levels not seen since the 1960s, with New Zealand, Canada, and Australia having the lowest price increases in mid-1992, about 1 percent from a year earlier (Table 4). However, underlying inflation remains substantially above the authorities’ objectives in several of the major countries: in Italy, the large budget deficit remains a major factor influencing inflationary expectations; in the United Kingdom, growth of earnings has remained relatively strong despite the substantial margin of slack that has developed; in Germany, unification has contributed to demand pressures. In the United States, consumer prices increased by 3¼ percent in the 12 months to July 1992, but underlying inflation (excluding food and energy prices) is close to 4 percent. Inflation remains a major problem in Greece and Portugal and is of concern in Austria, the Netherlands, Spain, and Switzerland.

Table 4.

Industrial Countries: Inflation

(Consumer prices: year-on-year)

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The cyclical situation will remain an important influence on countries’ inflation performance during the period ahead, as will the budgetary outlook and the functioning of labor markets. In the United Kingdom, the projected weak recovery should permit a further reduction in inflation. The inflation outlook in Italy is somewhat uncertain pending the implementation of recent fiscal measures and initiatives in the area of incomes policy; without strong fiscal action, inflation is unlikely to be reduced much. In Germany, inflationary pressures are expected to remain relatively strong for at least another year. In France and the United States, inflation is expected to stabilize at around present levels of 3 percent. For the industrial countries as a group, average inflation is projected to fall from 4 percent in 1991 to about 3 percent in 1992–93.

Inflation in the developing countries was halved to about 40 percent in 1991 and is projected to recede further to an average of 28 percent in 1993. The median inflation rate—the rate indicating the midpoint for developing countries on an unweighted basis—is expected to decline from 10 percent in 1990 to 6 percent in 1993 (see Chart 1). Inflation has declined most dramatically in the Western Hemisphere, as a result of macroeconomic stabilization and fiscal and structural reforms in several countries (Chart 6). Although inflation in Brazil is projected to increase in 1992 on an annual year-over-year basis, it has declined somewhat from the high levels reached at the end of 1991, which were caused by large corrective price adjustments and the elimination of price controls. On the basis of the economic program that is being implemented in Brazil, further declines in inflation are expected during 1992-93. In China and a number of other countries in Asia, capacity constraints and excessive credit expansion are expected to continue to exert upward pressure on prices, although inflation is likely to fall somewhat in 1992-93 in the region as a whole. Inflation is also expected to decline in some Middle Eastern countries, to rates that prevailed before the conflict in the region. In Africa, the average inflation rate is projected to rise further in 1992, in part because of wage increases, the continuing impact of price liberalization in Algeria, the impact of domestic financing of the public sector deficit in Nigeria, and the effect of the drought in the southern part of Africa.

Chart 6.
Chart 6.

Developing Countries: Consumer Prices1

(Percent change)

1Composites 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.

In Eastern Europe, tight financial policies following price liberalizations contributed to a decline in inflation from 142 percent in 1990 to 135 percent in 1991. Inflation has declined further in 1992 in all countries except Romania, reflecting, in part, the effects of price liberalizations. The civil war in the former Yugoslavia has resulted in hyperinflation, which accounts for the substantial rise of inflation in 1992 in Eastern Europe as a whole. Further progress in reducing inflation is expected in all of the Eastern European countries during 1993, including an end to hyperinflation in the former Yugoslavia.

In the countries of the former Soviet Union, the liberalization of most consumer and producer prices early in 1992 caused an additional jump in the overall price level following steep price rises in 1991. In Russia, retail prices are estimated to have increased by 875 percent in the first six months of 1992. Although the rate of inflation has abated somewhat after the large price adjustments early in the year, the lack of monetary and fiscal control poses a serious risk of a further intensification of inflationary pressures. Recent policy measures should help to dampen price increases in the second half of the year, but further measures are likely to be necessary to reduce inflation to an acceptable rate.

Financial and Exchange Market Developments

In the first eight months of 1992, movements in short-term interest rates in the major industrial countries were predominantly downward (Chart 7; see also Chapter III). In the United States, Canada, Japan, and the United Kingdom, the authorities acted to ease monetary conditions further. Only in Germany and Italy were monetary conditions tightened.

Chart 7.
Chart 7.

Major Industrial Countries: Interest Rates

(In percent a year)

1Three-month certificate of deposit rates for the United States and Japan; three-month treasury bill rate for Italy; rate on three-month prime corporate paper for Canada; and three-month interbank deposit rates for other countries.21987 GDP weights.3Yields on government bonds with residual maturities of ten years or nearest.

In the United States, additional easing by the Federal Reserve, in early April, early July, and early September, lowered short-term market rates by a further 1 percentage point. On the second occasion, the Federal Reserve lowered the discount rate from 3½ percent to 3 percent, its lowest level since 1963. In Canada, the authorities allowed short-term rates to decline during January through August by about 2½ percentage points, more than in any of the other major industrial countries. In Japan, the official discount rate was lowered in two steps, in early April and in late July, from 4½ percent to 3¼ percent, and short-term market rates fell by almost 2 percentage points during the first eight months of the year. In the United Kingdom, banks’ base rates were lowered from 10½ percent to 10 percent in early May—the first such reduction in eight months—and short-term market rates declined by somewhat less over the period.

In Germany, by contrast, where inflationary pressures remained a concern, short-term market rates rose by about 30 basis points in the first eight months of 1992. The Bundesbank raised its discount rate from 8 percent to 8¾ percent in mid-July, but subsequently market rates rose only modestly. Although monetary conditions thus remained firm in Germany, a weakening of the deutsche mark in the exchange rate mechanism (ERM) of the European Monetary System (EMS) through much of the first half of the year helped to limit upward pressure on interest rates in other member countries. Thus, short-term rates were lowered in the United Kingdom over this period, and were broadly unchanged in France during the first half of the year.

In the course of the summer, however, conditions within the ERM changed sharply and significant upward pressures on the deutsche mark during June through August were accompanied by increases in short-term market rates in the United Kingdom and France of some 60-70 basis points. In Italy, short-term interest rates rose even more sharply in June through August as the lira came under downward pressure in the ERM. These developments were related to uncertainty about the ratification of the Maastricht treaty following the Danish referendum in early June, which raised doubts about the prospects for convergence of inflation and interest rates among the EMS countries (including associated countries); with regard to Italy, concern about the fiscal deficit also increased. In July, the Bank of Italy raised its discount rate in two steps, from 12 percent to 13¾ percent, but in early August these increases were partially reversed by a cut of ½ of 1 percentage point. Lira market interest rates in late August were as much as 3½ percentage points higher than they were eight months earlier.

The marked downward trend in government bond yields in the major industrial countries was halted around the end of 1991 (Chart 7). In the United States, long-term interest rates increased by up to a full percentage point through mid-March as optimism grew about the economic recovery and as projections of the budget deficit were raised. Subsequently, however, this increase in rates was largely reversed as growth expectations became less sanguine and as the Federal Reserve lowered short-term rates. During the first eight months of 1992 the yield curve in the United States became more steeply upward-sloping than at any time in the preceding post-war period. In the other countries where monetary conditions were eased, long-term rates declined during this period, although generally by less than short-term rates. The largest increase in bond yields—more than a full percentage point—occurred in Italy. In Germany, where bond yields were unchanged on balance through July, the yield curve became more steeply inverted in August as bond yields declined by about 25 basis points.

The most notable development in equity markets in the industrial countries in the first eight months of 1992 was a further steep decline in stock prices in Japan. On August 18, the Nikkei index reached its lowest level since April 1986, 63 percent below its end-1989 peak and 38 percent lower than at the end of 1991. This further substantial drop can be attributed to several factors, including the slowing of the economy and low business confidence, but it may also be viewed as a continued correction of the excessive increase that took place during 1986-89. The index began to rise, however, immediately following the announcement by the Japanese authorities on August 18 of measures to support the stock market. By end-August the index had risen by 25 percent from its trough. In Italy, stock prices declined by 23 percent in the first eight months of 1992, almost entirely in June through August. In the other major industrial countries, movements in equity prices were more moderate over the period as a whole; they declined by about 7 percent in the United Kingdom, by 5 percent in Germany, and by 2-3 percent in Canada and France, but they increased by around 2 percent in the United States.

In developing country equity markets, the largest increase in stock prices during the first quarter of 1992 was in India, although these gains were partially reversed during the second quarter because of a stock market scandal. Stock prices in Nigeria declined because of the elimination of controlled exchange rates, and stock markets were generally weak in Africa and the Middle East through the first quarter of 1992. Equity prices in Argentina, Chile, and Mexico posted substantial gains in the first quarter because of improved economic prospects and capital inflows; these gains were largely reversed during the second quarter of 1992 in Argentina and Mexico. The major developments in Asian equity markets were the decline in stock prices in Korea and the surge in stock prices in Hong Kong through the second quarter, attributable to lower interest rates, improved corporate earnings, and, more generally, increased confidence in Hong Kong’s economic prospects.

In foreign exchange markets, the U.S. dollar appreciated sharply in terms of all other major currencies between early January and mid-March, as current indicators suggested a strengthening of the economic recovery and as longer-term interest differentials shifted in favor of dollar-denominated assets (Chart 8). During the period from mid-March to late August, however, this rise was fully reversed as interest rates fell in the United States. By late August, the U.S. dollar’s nominal effective value was 3 percent below its level eight months earlier, and close to the all-time low reached in February 1991. Over the eight months, the U.S. dollar depreciated by 7½ percent against the deutsche mark and French franc, 6½ percent against the Italian lira, 5½ percent against pound sterling, and 1½ percent against the yen. Against the Canadian dollar, in contrast, the U.S. dollar appreciated by 3¼ percent, In real effective terms, the value of the U.S. dollar in August 1992 was at an all-time low, almost 50 percent below its peak of February 1985 and 20 percent below its average level in 1980 (Chart 9). In the EMS, the deutsche mark weakened through much of the first half of 1992, and this contributed to a reduction of tension in the ERM narrow band. In June through August, however, tension progressively increased as the deutsche mark strengthened and the lira came under downward pressure. At the same time, a weakening of sterling contributed to increased tension in the wide band (Chart 10). These pressures within the EMS were absorbed in part by the movements in interest rates referred to earlier as well as by official intervention.

Chart 8.
Chart 8.

Bilateral Exchange Rates and Interest Differentials in Relation to the U.S. Dollar1

1Interest differentials shown are U.S. interest rates minus domestic interest rates in percent a year. Exchange rates are drawn on logarithmic scales and are defined in terms of national currency units per U.S. dollar.
Chart 9.
Chart 9.

Major Industrial Countries: Monthly Average Real Effective Exchange Rates1

(1980 = 100; logarithmic scale)

1Defined in terms of relative normalized unit labor costs in manufacturing and constructed using trade weights based on 1980 trade data. Data for October 1991 through 1992 are estimated on the basis of preliminary information.
Chart 10.
Chart 10.

European Monetary System: Positions of Selected Currencies in the Wide Band1

1Weekly averages of daily data. For any pair of currencies shown in the chart, the vertical distance between them measures the percent deviation of their bilateral exchange rate from their bilateral central rate.

Currency movements in the first eight months of 1992 reflected several influences. The effects of changes in relative interest rates seem particularly clear in the declines of the U.S. dollar, Canadian dollar, and the yen in relation to the European currencies. But other factors also appear to have been important. Thus in the ERM, short-term interest differentials in favor of assets denominated in French francs and sterling, relative to assets denominated in deutsche mark, narrowed significantly during the first half of 1992, while the deutsche mark recorded comparatively little in the way of appreciation against these currencies. Increased concern about inflation in Germany may have been one factor offsetting the narrowing of interest differentials. More recent concerns about the prospects for convergence subsequently put upward pressure on French and U.K. interest rates, reversing part of the earlier narrowing of short-term interest differentials among EMS currencies. Finally, the relative stability of the Japanese yen against the U.S. dollar in the face of relatively large interest rate declines in Japan may have reflected the further widening of Japan’s current account surplus, official statements indicating that a stronger yen would be welcome for the adjustment process, and official intervention.4 In addition, there may have been market expectations of further monetary easing in the United States because of the slow recovery.

In the developing countries, real effective exchange rates appreciated significantly in 1991 in the Middle East and the Western Hemisphere, mainly because of large capital inflows (Chart 11).

Chart 11.
Chart 11.

Developing Countries: Real Effective Exchange Rates1

(1980= 100)

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

In the Middle East, capital inflows reflected the cessation of the recent conflict, the normalization of economic activity, and the restoration of public confidence in the region. In the Western Hemisphere, capital inflows were attracted by the improved medium-term outlook in the region and by a return of confidence. In Asia, higher increases in labor costs, among other factors, have caused real exchange rates to appreciate somewhat.

Commodity Markets

Since early 1991, the monthly average petroleum spot price has fluctuated between $16 and $22 a barrel (Chart 12).5 Oil prices dropped to $16.53 a barrel in the first quarter of 1992 before rising to $19.47 a barrel in July. The recent strengthening of oil prices has been influenced by the relatively cool spring weather, a stronger-than-expected recovery in the underlying demand for oil, and the decision by the Organization of Petroleum Exporting Countries (OPEC) in May 1992 to maintain current production levels through the third quarter of 1992 for all members other than Kuwait.

Chart 12.
Chart 12.

World Crude Oil Price1

(In U.S. dollars a barrel)

Sources: Petroleum Market Intelligence (New York), other oil industry sources, and staff estimates.1Data from 1984 are the unweighted average spot market price of U.K. Brent, Dubai, and Alaska North Slope crude oils representing light, medium, and heavier crude oils, respectively, in three different regions. Estimated average prices for earlier years are intended to be comparable with these data.2The deflator used is the index of the export price of manufactures of industrial countries.3The OPEC reference price is based on the unweighted average prices of seven crude oils. It was raised from $18 a barrel to $21 a barrel on July 27, 1990.

Although world oil consumption is projected to increase by 1 percent in 1992, total non-OPEC supplies are expected to continue to decline, in part because of a resumption of the downward trend in U.S. oil production. As a result, world demand for OPEC oil is expected to show a larger increase in 1992 than in 1991. These projections are based on the assumption—consistent with futures prices in early August 1992—that the annual average price of oil will be unchanged at $18.32 a barrel in 1992 and will fall to $18.21 a barrel in 1993.

Nonfuel commodity prices continued to decline in 1991, influenced by the slowdown in the world economy and abundant supplies of certain agricultural commodities. Nonfuel commodity prices fell by 4½ percent in dollar terms in 1991; prices in all major commodity groups were lower, but especially those for metals and minerals (down 11 percent), which are particularly sensitive to cyclical conditions, and tropical beverages (down 6¾ percent). The weakness of prices for nonfuel commodities contributed to the recent decline in inflation worldwide (Chart 13).

Chart 13.
Chart 13.

Consumer Prices and Commodity Prices

1Three-month centered moving average of 12-month inflation rates. Consumer prices are measured in local currencies and are averaged using GDP weights. The commodity price index is an export-weighted average of 36 prices denominated in SDRs, including prices of oil and gold.2Nonfuel commodity prices deflated by the export price of manufactures of industrial countries.

Nonfuel commodity prices are projected to increase in dollar terms by 1½ percent in 1992 and by 2¾ percent in 1993, reflecting the expected moderate recovery of world growth and the likely evolution of supply conditions. Metals prices should increase only moderately because the recovery in Europe and North America is likely to be balanced by weak demand for metals in Japan. Prices of food commodities are also projected to recover slightly, in part because of increased demand for wheat from the states of the former Soviet Union and low world grain stocks. In contrast, prices for beverages are expected to weaken because supplies, including large stocks and high levels of exportable production, are abundant.

External Trade and Payments

After an unusually strong expansion during 1987-89, the volume of world trade grew by 4 percent in 1990 and by 2¼ percent in 1991.6 This development reflected the cyclical slowdown in import demand in the industrial countries and the collapse of trade between the countries of Eastern Europe and the former Soviet Union. In contrast, imports rose in 1991 by 12½ percent in Asia and by 17 percent in the Western Hemisphere. Stronger world economic activity is expected to boost world trade growth to 4½ percent in I992 and to 6¾ percent in 1993.

The current account deficit of the United States declined sharply in 1991, mainly because of war-related transfers, but also as a result of the recession. As the influence of these temporary factors abates, the deficit is expected to widen in 1992, notwithstanding continued strong exports (Chart 14). Japan’s current account surplus doubled to 2¼ percent of GDP in 1991 and is expected to rise somewhat further to 3 percent of GDP in 1992. The widening of the surplus from 1990 to 1992 reflects mainly a sharp decline in purchases of gold investment certificates and large terms of trade gains.

Chart 14.
Chart 14.

Three Major Industrial Countries: Current Account Imbalances

(In percent of GDP)

1Before July 1990, the current account balance of west Germany excluding the bilateral balance with east Germany; from July 1990, the current account balance of unified Germany. The shaded area indicates staff projections. Data are GNP.

In Germany, the current account surplus shifted into deficit in the wake of unification as imports increased and as production switched away from exports to meet domestic demand. The recent moderation of growth in west Germany, however, should slow the rise in imports, which should gradually reduce the deficit over the next two years. The current account deficit of France is expected to remain very small in 1992-93, whereas those of Italy and the United Kingdom are projected to widen. Canada’s large deficit will probably narrow somewhat in 1992-93. Among the smaller industrial countries, current account deficits are projected to remain fairly large (over 2 percent of GDP) on average in 1992-93 in Australia, Austria, Finland, Greece, New Zealand, and Spain.

The aggregate current account deficit of the developing countries increased sharply, from $14 billion in 1990 to $78 billion in 1991. Although influenced by cyclical developments in the industrial countries and by a worsening of the terms of trade, this widening was caused primarily by the effects of the crisis in the Middle East. There was also a significant increase in current account deficits in the Western Hemisphere and Asia in 1991. The current account deficit of the developing countries is projected to decline to $52 billion in 1992, followed by a slight increase to $53 billion in 1993. Although the external position of the Middle Eastern region is expected to improve as a result of the normalization of oil production, the external deficits of many other developing countries are projected to increase, partly in response to strong capital inflows.

The aggregate current account deficit of the countries of Eastern Europe is projected to decline from $6½ billion in 1991 to $3 billion this year. In 1991, a lower-than-expected deficit was mainly due to a lack of foreign financing and to depressed domestic demand. In 1992, the deficit is expected to be contained because of relatively strong exports to the West from Poland, Czechoslovakia, and Hungary. In Bulgaria and Romania, financing constraints are expected to continue to restrain imports.

Only scattered information is available on the external performance of the countries of the former Soviet Union. Exports from Russia to countries outside the territory of the former Union are reported to have fallen some 30 percent in the first five months of 1992 from a year earlier; the actual decline could be less, since a growing number of export activities may not be reflected in official statistics. Imports are estimated to have fallen by 18 percent. Preliminary projections point to a combined current account deficit for the 15 countries of the former Soviet Union of about $15 billion in 1992 and $20 billion in 1993; these figures are conditional on sizable external financial support.

External Financing and Debt

Net financial flows (official transfers, direct investment, and external borrowing) to the developing countries fell slightly to $101 billion in 1991 and are projected to average $133 billion during 1992-93. A significant fraction of these funds is expected to strengthen official foreign exchange holdings because central banks are likely to continue to sterilize the effect on domestic liquidity of capital inflows. Except for Africa, financial inflows are projected to increase significantly in all regions (Chart 15).

Chart 15.
Chart 15.

Developing Countries and Former Centrally Planned Economies: Net Flow of Financial Resources1

(In billions of U.S. dollars)

1Official transfers, foreign direct investment, and net external borrowing.

In Eastern Europe, net financial flows are expected to increase from $2½ billion in 1991 to $3½ billion in 1992 and to increase further, to $6 billion, in 1993. Direct foreign investment, although still modest, surged in 1991 and the first half of 1992 in Hungary and Czechoslovakia, but it remained subdued in most other countries. Official creditors still account for the largest part of the capital inflows, although improvements in underlying performance and creditworthiness as well as stronger reserve positions have allowed some countries to gain access to private sources of capital. Foreign currency holdings have remained exceptionally low, however, in Romania and Bulgaria.

Net financial flows to the countries of the former Soviet Union are projected to rise to almost $21 billion in 1992 compared with about $9 billion in 1991. Contributing to the increase are transfers by Germany, related to the repatriation of former Soviet military personnel, and substantial borrowing by Russia from official creditors under the assistance package committed by the international community. The increase also assumes a moderate buildup of foreign currency holdings after the depletion that occurred in 1990.

During the first half of 1992, debt-restructuring agreements were successfully completed for several developing countries. In June, Argentina and representatives of creditor banks announced agreement on final terms for reducing medium- and long-term foreign bank debt and past-due interest. The Philippines also signed an agreement with commercial banks involving a combination of new financing, a restructuring of existing debt, and debt buy-backs. Nigeria completed a debt-restructuring agreement during the first half of 1992, which reduced medium-term foreign debt by $3.5 billion. Reflows to Mexico that followed the debt-restructuring agreement in 1991 provided Mexico with the funds to buy back at a discount $7 billion of its foreign debt during the spring of 1992. For Brazil, an agreement in principle has been reached to restructure the country’s $44 billion commercial foreign debt; the agreement must now be approved by Brazil’s Senate and by individual creditor banks. In addition, 12 developing countries concluded bilateral debt-restructuring agreements with official creditors, consolidating more than $17 billion of debt-service obligations.

The total external debt of the developing countries increased by 6¼ percent during 1991, to $1,362 billion (Chart 16). The Middle Eastern countries have used mainly their own resources for reconstruction, and debt in this region increased by only 5 percent in 1991. Total external debt relative to exports rose slightly (to 127 percent) in 1991, and it is expected to decline in 1992 and 1993 (to 123 percent and 113 percent, respectively) because of improved economic performance, reduced borrowing, and the impact of debt-reduction operations. The total external debt of Eastern Europe remained broadly unchanged, at $109 billion, in 1991 because the impact of the debt-restructuring agreement between Poland and the Paris Club offset increased borrowing from official sources by other countries in the region (Chart 17). The total external debt of the former Soviet Union increased in 1991 to some $66 billion, but the debt-export ratio jumped from 53 percent to 85 percent as trade collapsed.

Chart 16.
Chart 16.

Developing Countries: External Debt and Debt Service1

1Debt service refers to actual payments of interest on total debt plus actual amortization payments on long-term debt. The projections incorporate the impact of exceptional financing items. Shaded areas indicate staff projections.
Chart 17.
Chart 17.

Former Centrally Planned Economies: External Debt and Debt Service1

1Debt service refers to actual payments of interest on total debt plus actual amortization payments on long-term debt. The projections incorporate the impact of exceptional financing items. Shaded areas indicate staff projections.

Within Same Series

Other IMF Content

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Cover World Economic Outlook, October 1992
World Economic Outlook, October 1992
Author: International Monetary Fund. Research Dept.
ISBN:
9781451944563
ISSN:
0256-6877
Publication Date:
01 Jan 1992
Publisher:
International Monetary Fund
DOI:
https://doi.org/10.5089/9781451944563.081
Pages:
189
  • View in gallery

    Industrial Countries: Real GDP1

    (Percent change from four quarters earlier)

  • View in gallery

    Six Major Industrial Countries: Indicators of Consumer Confidence

  • View in gallery

    Industrial Countries: Unemployment Rates1

    (In percent of labor force)

  • View in gallery

    Major Industrial Countries: Output Gaps1

    (In percent)

  • View in gallery

    Developing Countries: Consumer Prices1

    (Percent change)

  • View in gallery

    Major Industrial Countries: Interest Rates

    (In percent a year)

  • View in gallery

    Bilateral Exchange Rates and Interest Differentials in Relation to the U.S. Dollar1

  • View in gallery

    Major Industrial Countries: Monthly Average Real Effective Exchange Rates1

    (1980 = 100; logarithmic scale)

  • View in gallery

    European Monetary System: Positions of Selected Currencies in the Wide Band1

  • View in gallery

    Developing Countries: Real Effective Exchange Rates1

    (1980= 100)

  • View in gallery

    World Crude Oil Price1

    (In U.S. dollars a barrel)

  • View in gallery

    Consumer Prices and Commodity Prices

  • View in gallery

    Three Major Industrial Countries: Current Account Imbalances

    (In percent of GDP)

  • View in gallery

    Developing Countries and Former Centrally Planned Economies: Net Flow of Financial Resources1

    (In billions of U.S. dollars)

  • View in gallery

    Developing Countries: External Debt and Debt Service1

  • View in gallery

    Former Centrally Planned Economies: External Debt and Debt Service1

Industrial Countries: Real GDP1

(Percent change from four quarters earlier)

Six Major Industrial Countries: Indicators of Consumer Confidence

Industrial Countries: Unemployment Rates1

(In percent of labor force)

Major Industrial Countries: Output Gaps1

(In percent)

Developing Countries: Consumer Prices1

(Percent change)

Major Industrial Countries: Interest Rates

(In percent a year)

Bilateral Exchange Rates and Interest Differentials in Relation to the U.S. Dollar1

Major Industrial Countries: Monthly Average Real Effective Exchange Rates1

(1980 = 100; logarithmic scale)

European Monetary System: Positions of Selected Currencies in the Wide Band1

Developing Countries: Real Effective Exchange Rates1

(1980= 100)

World Crude Oil Price1

(In U.S. dollars a barrel)

Consumer Prices and Commodity Prices

Three Major Industrial Countries: Current Account Imbalances

(In percent of GDP)

Developing Countries and Former Centrally Planned Economies: Net Flow of Financial Resources1

(In billions of U.S. dollars)

Developing Countries: External Debt and Debt Service1

Former Centrally Planned Economies: External Debt and Debt Service1