In 1995, world output growth slowed slightly to 3½ percent. Economic expansion weakened significantly in many of the industrial countries and among the developing countries of the Western Hemisphere but strengthened in sub-Saharan Africa (particularly the CFA countries) and the Middle East. In the developing countries of Asia, growth moderated somewhat, allaying to some extent concerns about overheating, but was still rapid by most standards. In the countries in transition, the decline in output abated further, with vigorous growth proceeding in a number of cases.

In 1995, world output growth slowed slightly to 3½ percent. Economic expansion weakened significantly in many of the industrial countries and among the developing countries of the Western Hemisphere but strengthened in sub-Saharan Africa (particularly the CFA countries) and the Middle East. In the developing countries of Asia, growth moderated somewhat, allaying to some extent concerns about overheating, but was still rapid by most standards. In the countries in transition, the decline in output abated further, with vigorous growth proceeding in a number of cases.

The near-term outlook is for a slight pickup in global growth to 3¾ percent in 1996 as a whole, and a further modest strengthening to about 4 percent in 1997—projections that are little changed from those presented in the May 1996 World Economic Outlook.2 Among the industrial countries, growth is expected to strengthen slightly to 2¼ percent in 1996, with a markedly stronger expansion in Japan and a pickup in growth in the United States being partly offset by a substantial slowdown in much of Europe, including most notably Germany and France. The easing of monetary conditions already seen in most European countries is expected to lead to a recovery of growth in the latter part of 1996, which should carry forward into 1997. Other factors contributing to the projected strengthening of activity in Europe are the declines in long-term interest rates since late 1994, an end to the drawdown of inventories, and the establishment of a more favorable configuration of exchange rates. In the developing countries of the Western Hemisphere, the recovery from the Mexican crisis and related developments is expected to gain momentum, particularly in Mexico itself and Argentina. In Africa and the Middle East and Europe region, economic conditions are expected to improve further, although growth across countries remains uneven, and in the developing countries of Asia growth is expected to continue to moderate. For the countries in transition, aggregate output is projected to stabilize in 1996 and to grow significantly next year for the first time since the transition process began.

Inflation has remained subdued among the industrial countries and has declined further in many developing countries and countries in transition, even though the prices of oil, cereals, and feedstuff increased quite sharply in late 1995 and early 1996 (Chart 4). Nonfuel commodity prices overall increased slightly during the first eight months of 1996, by about 1 percent in U.S. dollar terms as measured by the IMF’s nonfuel commodity price index.3 In 1997, inflation is expected to remain low in the industrial countries and to decline further in the developing countries and countries in transition.

Chart 4.
Chart 4.

Commodity Price Indices

(1990 = 100)

Economic Activity, Inflation, and Policy Stances in Industrial Countries

In 1995, economic growth slowed in most of the industrial countries, with Japan, Italy, and some of the smaller European countries being the most notable exceptions (Table 2). Since late 1995, the pattern of growth has been more uneven, with stronger expansions in Japan and the United States contrasting with continuing sluggishness in most of continental Europe. The United States stands out as the only major industrial economy operating close to estimated full capacity (Chart 5).

Table 2.

Industrial Countries: Real GDP, Consumer Prices, and Unemployment Rates

(Annual percent change and percent of labor force)

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The projections for unemployment have been adjusted to reflect the new survey techniques adopted by the U.S. Bureau of Labor Statistics in January 1994.

Consumer prices are based on the retail price index excluding mortgage interest.

Consumer prices excluding interest rate components; for Australia also excluding other volatile items.

Chart 5.
Chart 5.

Major Industrial Countries: Output Gaps1

(Actual less potential, as a percent of potential)

1 Shaded areas indicate IMF staff projections. The gap estimates are subject in a significant margin of uncertainty. For a discussion of the approach to calculating potential output, see World Economic Outlook. October 1993, p. 101.2 Data through 1991 apply to west Germany only.

As discussed in the May 1996 World Economic Outlook, a preemptive tightening of monetary conditions and rising bond yields in 1994 slowed growth during 1995 in the United States, the United Kingdom, and Australia, from rates considerably above potential to rates more consistent with sustainable noninflationary growth. Growth slowed more markedly last year in those continental European countries with strong currencies, particularly in Germany, France, other countries closely linked to the deutsche mark, and Switzerland, but was generally well sustained in those countries whose currencies had depreciated in recent years—most notably, Italy, Spain, and Sweden. The slowdown in the former group was of particular concern since there were still considerable margins of slack and high unemployment—remnants from the 1992–93 recession. In Japan, by contrast, the prolonged economic slowdown that began in 1991 gave way to recovery in the course of 1995 with the help of supportive monetary and fiscal policies and a substantial correction of an overvalued yen.

In early 1996, however, signs of renewed growth became evident in the United States, partly reflecting the response to three reductions in short-term interest rates beginning in mid-1995, as well as the decline in bond yields throughout last year (Chart 6). Signs of a pickup in activity also became visible in Canada, where monetary conditions were eased significantly, and in Australia where growth of private consumption and business investment resumed. In Japan, exceptionally strong growth in the first quarter, though partly due to special factors, indicated that the long-awaited recovery was gathering strength.

Chart 6.
Chart 6.

Three Major Industrial Countries: Policy-Related Interest Rates and Ten-Year Government Bond Yields1

(In percent a year)

1 The U.S. federal funds target rate, Japanese overnight call rate, German repurchase rate, and all ten-year government bond yields are monthly averages. All other series are end of month.

In continental Europe, in contrast to 1995—when growth slowed in some countries but was sustained in others—developments in early 1996 showed a more pervasive weakness. Although there were signs of a pickup by midyear in some countries, especially Germany, a more generalized revival of growth was still not apparent. Consumer confidence remained particularly low, especially compared with the recovery of confidence in the United States (Chart 7). And with business confidence deteriorating further, industrial production in early 1996 declined in a number of countries, including Germany (up to February) and Italy. Unemployment also continued to edge up across much of Europe, reaching near record levels in France. In the United Kingdom, Italy, Spain, and many of the smaller European countries, faltering exports to European trading partners contributed to the dampening of growth.

Chart 7.
Chart 7.

European Union and the United States: Indicators of Consumer Confidence1

Sources: For the United States, the Conference Board; and the European Commission.1 Indicators are not comparable across countries.2 Percent of respondents expecting an improvement in their situation minus percent expecting a deterioration.

Since late last year, however, successive cuts in interest rates in Germany and to a greater extent in France and several other European countries, together with the weakening of the deutsche mark and closely related currencies, have eased overall monetary conditions significantly in most countries (Chart 8). Moreover, with committed efforts toward fiscal consolidation the policy mix has generally shifted in a direction that is more conducive to sustainable medium-term growth. In some countries, especially Italy, Spain, and Sweden, progress toward fiscal consolidation has narrowed risk premiums in interest rates and helped to correct the undervaluation of currencies. And signs of a pickup in activity have begun to emerge. The drawdown of inventories has slowed, and industrial orders and consumer confidence have stabilized.

Chart 8.
Chart 8.

Major Industrial Countries: Monetary Conditions Indices1

1 For each country, the index is defined as a weighted average of the percentage point change in the real short-term interest rate and the percentage change in the real effective exchange rate from a base period (January 1990). Relative weights of 3 to 1 are used for France, Italy, and the United Kingdom, 4 to 1 for Germany and Canada, and 10 to 1 for Japan and the United States. The weights are intended to represent the relative impacts of interest rates and exchange rates on aggregate demand; they should be regarded as indicative rather than precise estimates. For instance, a 3-to-1 ratio indicates that a 1 percentage point change in the real short-term interest rate has about the same effect on aggregate demand over time as a 3 percent change in the real effective exchange rate. Movements in the index are thus equivalent to percentage point changes in the real interest rates. The lag with which a change in the index may be expected to affect aggregate demand depends on the extent to which the change stems from a change in the interest rate or the exchange rate, and varies depending on the cyclical position; the lag also differs across countries. No meaning is to be attached to the absolute value of the index; rather, the index is intended to show the degree of tightening or easing in monetary conditions from the (arbitrarily chosen) base period. Small changes in the relative weights may affect the value of the index but not the qualitative picture.

With these signs expected to turn into a moderate recovery of output in the second half of the year, European growth is projected to amount to 1½ percent in 1996 as a whole, and to strengthen further in 1997 in almost all countries. The strength of the expected revival, however, remains uncertain because of underlying risks to the outlook. The recovery in Europe may be weaker than projected because it may be restrained, to a greater extent than assumed, by the short-term contractionary effects of fiscal consolidation efforts being implemented in most EU countries partly to satisfy the Maastricht criteria by 1997, and also by uncertainties about policy implementation and concerns about high levels of unemployment (Table 3). Moreover, notwithstanding considerable progress in reducing inflation and the strong commitment to reduce fiscal imbalances, absence of a convincing recovery in economic activity may renew concerns about the ability of countries to satisfy the convergence criteria, which could result in the reemergence of risk premiums in interest rates in some countries, and again sap confidence and dampen demand.

Table 3.

European Union: Convergence Indicators for 1995, 1996, and 1997

(In percent)

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Sources: National sources; and IMF staff projections.Note: The table shows the convergence indicators mentioned in the Maastricht Treaty, except for the exchange rate. The three relevant convergence criteria are (1) consumer price inflation must not exceed that of the three best-performing countries by more than 1½ percentage points; (2) interest rates on long-term government securities must not be more than 2 percentage points higher than those in the same three member states; and (3) the financial position must be sustainable. In particular, the general government deficit should be at or below the reference value of 3 percent of GDP. If not, it should have declined substantially and continuously and reached a level close to the reference value, or the excess over the reference value should be temporary and exceptional. The gross debt of general government should be at or below 60 percent of GDP or, if not, the debt ratio should be sufficiently diminishing and approaching the 60 percent value at a satisfactory pace. The exchange rate criterion is that the currency must have been held within the normal fluctuation margins of the ERM for two years without a realignment at the initiative of the member state in question.

Official targets or intentions. The IMF staff’s fiscal projections shown in the two preceding columns are in some cases based on different growth, inflation, or interest rate assumptions from those used by national authorities and do not take into account further consolidation measures that are planned by EU governments in accordance with their convergence programs but that have not yet been announced. See Box 1 for the IMF staff’s fiscal assumptions for each EU member.

Debt data refer to end of year. They relate to general government but may not be consistent with the definition agreed at Maastricht.

Ten-year government bond yield or nearest maturity.

Retail price index excluding mortgage interest.

IMF staff estimates for Greece, Portugal, and Spain differ from those of national authorities at least in part because, owing to intercountry differences in budgetary processes, sufficient information on the measures to be proposed in the 1997 budget is not yet available. See Box 1 for details regarding the IMF staff’s fiscal assumptions for each EU member.

Government deposits with the central bank, government holdings of nongovernment bonds, and government debt related to public enterprises amounted to some 20 percent of GDP in 1995.

General government balance includes capitalized interest; long-term interest rate is 12-month treasury bill rate.

Average weighted by GDP shares, based on the purchasing power parity (PPP) valuation of country GDPs for consumer price index, general government balances, and debt.

The Treaty is not specific as to what methodology should be used to calculate reference values for inflation and the interest rate beyond noting that they should be based on the three lowest-inflation countries. For illustrative purposes, a simple average for the three countries is used in calculating the reference values.

Low inflation continues to be a particularly encouraging aspect of economic conditions in almost all the industrial countries. Consumer price inflation on average in these countries is expected to remain below 2½ percent in 1996 and 1997. Success in keeping inflation down generally stems from the commitment of policymakers to a high degree of price stability, but increased global competition may also have been playing a role, by diminishing the scope for excessive price and wage increases. Relatively large output gaps, particularly in Canada, Germany, France, Italy, and Japan among the major countries, have also contributed to subdued inflation. Indeed, across a broad range of indicators, inflationary pressures in these countries seem largely absent (Table 4).

Table 4.

Major Industrial Countries: Questions About Inflationary Pressures1

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This table is intended to provide a broad cross-country survey of inflationary pressures and reflects IMF staff judgments. For individual countries, various indicators will differ in the extent to which they contribute to the inflationary process.

Yield curve has steepened but this appears unlikely to reflect increased inflation expectations.

Turning to country-specific developments and projections, in the United States, following the pickup in growth in the first quarter, the expansion strengthened further in the second quarter, to a rate well in excess of the growth of potential. But the rise in long-term interest rates since January, as well as the further modest increase in short-term interest rates assumed in the projections, are likely to moderate growth in the second half of the year. Growth in 1997 is expected to remain at 2¼ percent. Despite virtually full employment for the last two years, consumer price inflation during 1995 remained below 3 percent. It picked up to about 4 percent in the second quarter of 1996, owing mainly to the weather-related temporary increases in food and energy prices, and there was also some pickup in wage rates. Although inflation is expected to remain under 3 percent in 1996 as a whole and in 1997, the possibility of overheating and the associated need to tighten monetary conditions present some risks to the outlook. With capacity utilization already at a high level, and unemployment reaching a seven-year low of 5.1 percent in August, persistent growth above potential would be likely to rekindle inflation.

Monetary policy, which was eased with reductions in the target federal funds rate from 6 percent to 5¼ percent in three quarter-point steps in July and December 1995 and January 1996, aided the reacceleration of growth after the slowdown during the first half of 1995. The run-up in long-term interest rates since late January 1996 appears to have reflected expectations of monetary tightening in response to the pickup in economic growth, as well as revised expectations about the prospects for a balanced budget. The general government deficit (on a national accounts basis) has declined steadily since 1992 and is expected to reach about 1¼ percent of GDP in 1996—the lowest deficit ratio since 1979 (Table 5). This improvement in the fiscal situation is the result of both the federal budget measures put in place in 1993 and the cyclical recovery. The administration’s fiscal year 1997 budget, released in March 1996, contains proposals that are aimed at achieving a balanced budget by fiscal year 2002, but the prospects for legislative approval are uncertain.

Table 5.

Industrial Countries: General Government Fiscal Balances and Debt1

(In percent of GDP)

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The output gap is actual less potential output, as a percent of potential output. Structural balances arc expressed as a percent of potential output. The structural budget balance is the budgetary position that would be observed if the level of actual output coincided with potential output. Changes in the structural budget balance consequently include effects of temporary fiscal measures, the impact of fluctuations in interest rates and debt-service costs, and other noncyclical fluctuations in the budget balance. The computations of structural budget balances are based on IMF staff estimates of potential GDP and revenue and expenditure elasticities (see the October 1993 World Economic Outlook, Annex I). Net debt is defined as gross debt less financial assets, which include assets held by the social security insurance system. Estimates of the output gap and of the structural budget balance are subject to significant margins of uncertainty.

Data before 1990 refer to west Germany. For net debt, the first column refers to 1986–89. Beginning in 1995. the debt and debt-service obligations of the Treuhandanstalt (and of various other agencies) were taken over by the general government. This debt is equivalent to 8 percent of GDP, and the associated debt service to ½ of ½ percent of GDP.

Figure for 1980–89 is average of 1983–89.

For 1980–89, includes Spain, the Netherlands, Belgium. Sweden. Austria, Denmark, Ireland. Australia, and New Zealand; for years thereafter also includes Finland, Greece, Norway, and Portugal. See Statistical Appendix Table A16 for details.

Economic activity in Canada, which was sluggish through 1995 and early 1996, is expected to pick up following a significant decline in interest rates since late last year and the strengthening of the expansion in the United States. Consumer spending has already rebounded, housing starts have risen considerably, and employment growth has increased. GDP growth is expected to pick up from just 1½ percent in 1996 as a whole to 3¼ percent in 1997. In contrast to the United States, the high level of excess capacity in the Canadian economy leaves considerable room for noninflationary growth. Through substantial cuts in government expenditures, and despite a large margin of slack, Canada has continued to make considerable progress in reducing its fiscal deficit toward the government’s goals of 3 percent of GDP by 1996/97 and 2 percent of GDP in 1997/98. The federal budget for 1996/97, presented to Parliament in March, reaffirmed the government’s commitment to balancing the budget over the medium term, introduced additional spending cuts, and adopted longer-term reforms to the federal system of income support for the elderly.

The long-awaited recovery in Japan finally appears to have become firmly established. Although output in 1995 as a whole expanded by only 1 percent, signs of solid recovery were evident in the fourth quarter, when growth picked up to 3½ percent at an annual rate. In the first quarter of 1996, however, growth widely exceeded expectations, jumping to almost 13 percent at an annual rate. Private consumption, public investment, and residential investment rose sharply. But various special factors, including an increase in public investment that will not be sustained, also contributed, and the underlying pace of recovery appears to remain relatively moderate, as suggested by other indicators of activity, such as industrial production and employment. Taking into account not only the spurt of growth in the first quarter, but also the waning of public investment expected during this year and the expected moderation of growth in private consumption and residential investment, projected real GDP growth for the year as a whole has been revised up, to about 3½ percent. In 1997, the expansion is expected to continue at a more moderate pace of 2½–3 percent.

Last year’s fiscal stimulus measures have played an important role in reviving demand. Much of the fiscal stimulus came from public investment, which is expected to level off in mid-1996 and to decline moderately in 1997. The general government budget deficit (excluding social security) is expected to rise in 1996 to 6¾ percent of GDP, of which 5½ percent is estimated to be structural (the structural deficit including social security is 2½ percent of GDP). The actual deficit (excluding social security) is forecast to decline to 5 percent of GDP in 1997 as public investment falls, temporary cuts in income taxes are reversed, and the consumption tax is raised.

The easing of monetary policy—which brought the official discount rate down to ½ of 1 percent in September of 1995—is also contributing to the recovery. For much of last year the strong exchange rate provided a powerful offsetting influence, but since the middle of 1995 the correction of the exchange rate has implied a further easing of monetary conditions broadly defined to include the effects of interest rates and the exchange rate (see Chart 8). Inflationary pressures are expected to remain negligible, given the high level of excess capacity, but official interest rates will obviously need to be adjusted upward as the recovery gets further under way.

In Europe, the slowdown in economic activity in late 1995 and early 1996 was particularly acute in Germany, but a rebound in activity in the second quarter of 1996 is expected to result in growth of ¼ percent for the year as a whole. Appreciation of the deutsche mark and high wage settlements early in 1995 hampered competitiveness, sapped business confidence, and undermined a recovery that was already weak relative to previous recoveries. Although real GDP increased by almost 2 percent in 1995 as a whole, growth was negative during the second half of the year. Winter-depressed construction activity contributed to a further contraction in the first quarter of 1996, but there is now clear evidence that economic activity has turned around and that business confidence is improving. Activity is expected to continue to strengthen in the second half of 1996 and in 1997, supported by the easing of monetary conditions during the past year, including notably the depreciation of the deutsche mark from its overly strong level of spring last year. Significant labor market slack should contain wage increases and overall inflation at very moderate rates.

In mid-April 1996, the Bundesbank reduced two of its benchmark official interest rates by 50 basis points—the discount rate to 2½ percent, and the Lombard rate to 4½ percent—and in late August lowered the repurchase rate, for the first time since February, by 30 basis points to an historic low of 3 percent. In early September, short-term market rates in Germany were a full percentage point lower than a year earlier. In terms of fiscal policy, the government proposed a fiscal consolidation package in April that includes cuts in social services and a freeze on public sector salaries; if fully implemented, these measures are expected to reduce the general government deficit from 4 percent of GDP in 1996 to 3 percent by 1997.

In 1995, growth slowed to 2¼ percent in France, with activity being particularly weak in the fourth quarter of the year, partly owing to public sector strikes. Although the economy rebounded in the first quarter of 1996, output fell by about ½ of 1 percent in the second quarter and growth is expected to average only 1 ¼ percent in 1996 as a whole. In June and July, unemployment stood at 12½ percent, which is close to the record levels reached in early 1994. Consumer confidence and household consumption remain at low levels. Nevertheless, with the easing of monetary conditions and the improvement in growth prospects for Germany, it appears that the underlying conditions for a strengthening of activity in the second half of 1996 are in place. This should allow growth to firm to 2½ percent in 1997, although as in many other countries of the European Union, there are still downside risks to the projection. Inflation is expected to remain subdued, reflecting moderate wage settlements and the persistence of a sizable output gap.

Over the past year, there has been significant progress with fiscal consolidation in France. In late 1995, the government announced further plans to reduce the budget deficit, including wide-ranging reform of the social security system as well as other expenditure cuts. In early 1996, cuts in spending amounting to about ¼ of 1 percent of GDP were announced to offset the revenue effects of weaker-than-expected economic activity. While the efforts to reduce the fiscal deficit have probably had a contractionary direct impact on domestic demand—the structural deficit is expected to fall by 1¼ percentage points of GDP in 1996—the government’s demonstrated resolve to reduce the deficit has been a key factor boosting market confidence and allowing substantial declines in interest rates in absolute terms and relative to Germany. Thus short-term interest rates have declined by some 4 percentage points from their peaks in March 1995, and long-term rates by 1½ percentage points in the same period.

In Italy, strong exports owing to the lira’s depreciation during 1992–95 and buoyant investment boosted growth in 1995 as a whole to 3 percent. However, growth slowed down in late 1995 as the lira strengthened, European export markets weakened, and temporary tax incentives for investment were phased out. Continued appreciation of the lira in 1996, and the recently enacted corrective fiscal package, have led to a halving of projected GDP growth for 1996 to about 1 percent—the largest downward revision among the industrial countries. After reaching over 5 percent in 1995, annual average inflation is expected to recede to less than 4 percent in 1996, and to 3 percent in 1997. Disinflation has been supported by a firm monetary policy, the appreciation of the lira, and subdued domestic demand.

Considerable progress has been made with fiscal consolidation in Italy in recent years. Combined with the alleviation of political uncertainty following the election earlier this year, this progress has contributed to a significant improvement in market sentiment, with the lira strengthening and interest rate differentials reaching their lowest levels since the early summer of 1994. In June, the new government introduced a package of corrective fiscal measures (in an amount close to 1 percent of GDP) to compensate for lower-than-expected growth, higher interest payments, and other budgetary overruns. The package aims at reducing the 1996 state sector deficit to 6.1 percent of GDP against an original target of 5.8 percent. The government has also updated the privatization calendar and is seeking delegated powers to enact tax and public administration reform. Monetary conditions, broadly defined, have tightened over the past year, with the moderate decline in short-term market interest rates outweighed by the appreciation of the lira. In late July, following indications that inflation had fallen clearly below 4 percent, the Bank of Italy lowered key official interest rates, which had remained unchanged since May 1995, by 75 basis points.

In the United Kingdom, growth moderated in 1995, with both the tightening of monetary conditions in the preceding year and the weakening of export markets playing a role. Both net exports and investment expenditures weakened; steady growth in consumption expenditures continued. The manufacturing sector has been particularly weak since early 1995, and an overhang of stocks is expected to continue to restrain expansion in that sector through 1996. A strengthening of consumer spending, already apparent in mid-1996, is expected to lead to growth above potential in 1997. Unemployment is expected to decline somewhat further from its recent level of 7½ percent. Moderate economic expansion and the continuing output gap have contributed to the containment of inflation that—at its current level of 2¾ percent—is the lowest in thirty years.

The slowdown of growth since 1994 and noncyclical revenue shortfalls have complicated the process of fiscal consolidation. The outturn for fiscal year 1995/96 (ended March 1996) was a public sector borrowing requirement (PSBR) of 5 percent of GDP (excluding privatization receipts), roughly of 1 percent of GDP larger than revised estimates contained in the November 1995 budget. Most of this slippage stemmed from a shortfall of general government revenue, and in particular corporate and value-added tax collections. In 1996/97, the PSBR is projected to decline to ½ percent of GDP. Monetary conditions have eased with the lowering of official interest rates by 1 percentage point, in four steps, between December 1995 and June 1996. Monetary aggregates have been showing rapid growth; in particular, M4 has been growing above its 3–9 percent monitoring range since late last year, partly owing to increased merger and acquisition activity and the development of the gilt repo market.

After increasing by 3 percent in 1995, economic activity has slowed considerably in Sweden, and modest growth of ½ percent is projected for 1996. Inflation has fallen below the Riksbank’s central target of 2 percent, the krona has continued to strengthen, and long-term interest differentials with Germany have narrowed further. Taking advantage of these developments and against the background of a weakening economy and the government’s strong commitment to fiscal consolidation, the Riksbank has eased monetary policy significantly, lowering the repo rate by more than 3 percentage points since the beginning of the year.

In Austria, Belgium, and Switzerland, declines in exports to European trading partners have added to weaknesses in domestic demand. In Austria, growth is expected to fall below 1 percent in 1996 reflecting weaker external demand and lower private consumption and investment. Public finances deteriorated during 1995, bringing the government deficit to more than 6 percent of GDP, and the gross public debt ratio to nearly 70 percent of GDP. A new consolidation package with ambitious fiscal objectives for 1996–97 has been put in place to address these imbalances. In Belgium, a slowdown in growth occurred during 1995, as foreign demand for Belgian exports declined sharply. Subdued domestic demand has also contributed to the slowing of economic activity. Growth in 1996 is projected to be about 1½ percent and the rate of unemployment is expected to remain at about 13 percent. Economic activity in Switzerland contracted in the first quarter of 1996, owing to a continued fall in exports, weak consumer spending and construction investment, and cuts in government spending. Although the lagged effects of the easing of monetary conditions during 1995, and a resumption of growth in other European countries, and particularly in Germany, should contribute to a gradual recovery, year-on-year growth in 1996 is expected to be virtually flat.

In the Netherlands, Denmark, and Finland, strength in various components of domestic demand has offset to some extent declines in exports to major trading partners in Europe, and helped to support activity. In the Netherlands, private consumption remained strong in 1995 owing to substantial gains in employment, and investment accelerated. The outlook for the remainder of 1996 is favorable, with growth slowing only slightly to 2¼ percent for the year as a whole. In Denmark, buoyancy in domestic demand has remained broadly based. Despite the slowdown in Europe, consumer and investment spending have been strong and unemployment has fallen below 10 percent from over 12 percent in 1994. Nevertheless, growth is expected to slow to 2 percent in 1996 before picking up in 1997. In Finland, there are some encouraging signs that growth is strengthening after the lull in economic activity that lasted for most of 1995. Domestic demand appears to have recently picked up and growth is expected at 2½ to 3 percent in 1996 and 4 percent in 1997.

In Spain and Portugal, the pace of economic activity has also slowed since mid-1995, although it remains stronger than in many other European countries. In Spain, despite a recovery in real disposable income, consumer confidence and spending weakened in the middle of 1995 as did private investment. With the export sector in Spain having remained buoyant, a pickup in growth hinges on a revival of consumer spending, the timing and magnitude of which are uncertain. Fiscal consolidation and sound monetary policy brought inflation down to 3½ percent in early 1996—the lowest rate in more than two decades. Growth is projected to fall to between 2 percent and 2½ percent in 1996 before picking up in 1997. In Portugal, weakening exports combined with a slowdown in investment resulted in a deceleration in growth in the second half of 1995, which continued in early 1996. In the remainder of 1996, as recovery takes hold in Europe, growth is expected to rebound, and also to reach some 2 to 2½ percent for the year. A stable exchange rate and robust productivity gains should help to reduce inflation further.

In contrast to much of the rest of Europe, Ireland and Norway have maintained solid growth. In Ireland, financial discipline, outward-looking policies, and considerable foreign direct investment have continued to yield broad-based and robust economic growth, which picked up to over 10 percent in 1995 and is projected to moderate to 7 percent in 1996. Exports have remained remarkably buoyant, and investment and consumer spending have continued to grow at a robust pace. Unemployment fell to about 13 percent in 1995—a significant drop from its peak of about 17 percent in 1993. Growth in Norway has also remained robust with strong consumption and large external surpluses supporting economic activity. These positive developments have caused the krone to appreciate, leading the central bank to lower interest rates despite concerns about overheating.

In Australia and New Zealand, in response to buoyant growth in recent years and signs of overheating, monetary policy was tightened during 1994 in both countries, which helped to slow growth to more sustainable rates in 1995, although the inflationary pressures were not completely preempted. In New Zealand, growth is expected to remain steady in 1996 and increase to 3 percent in 1997. Tightness in the labor market and strong activity in the construction sector have raised inflation, which is likely to remain slightly above the upper end of its target range of zero to 2 percent through the remainder of this year. In Australia, after a strong first quarter, output is expected to slow somewhat, but may nevertheless expand by 3½ to 4 percent in 1996 as a whole, followed by a moderation to 3 percent in 1997.

Economic Situation and Prospects in Developing Countries

In the developing countries, output increased by about 6 percent in 1995, continuing the solid expansion that has been under way since the beginning of the decade, and the average inflation rate slowed significantly to 20 percent (Table 6). In 1996, aggregate growth is projected to continue at about the same pace as in recent years, with some tendency for country growth rates to converge; and inflation is expected to ease further in most countries. Significant further progress is also expected in reducing fiscal imbalances throughout most of the developing world (Table 7).

Table 6.

Selected Developing Countries: Real GDP and Consumer Prices

(Annual percent change)

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African countries that had arrangements, as of the end of 1995, under the IMF’s Structural Adjustment Facility (SAF) or Enhanced Structural Adjustment Facility (ESAF).

Consumer prices” are based on a price index of domestic demand, which is a weighted average of the consumer price index, the wholesale price index, and a price index for construction activity. The year-on-year increase in 1995 in this price index was 59.6 percent, which largely was the result of carryover effects from the high inflation rate prevailing prior to the introduction of the real on July 1. 1994. Consequently, the inflation rate from December 1994 to December 1995, which was 14.8 percent, better reflects the underlying rate during 1995.

Table 7.

Selected Developing Countries: General Government Budget Balance1

(In percent of GDP)

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In calculating the regional and developing country aggregates, central government budget balance is used when general government balance is unavailable. Cambodia is excluded from the Asia and developing country aggregates because data are unavailable. Estimates for Argentina, Brazil, and Peru cover the combined public sector; those for Brazil refer to the operational balance. Projections for Mexico include the inflation adjustment components of indexed government bonds.

Central government balance.

Among the developing countries of the Western Hemisphere, following the disappointing performance in 1995, growth is expected to recover to 3 percent in 1996 and inflation to decline further. In Mexico, tight fiscal and monetary policies helped reduce actual and expected inflation in the first half of the year, contributing to further gains in confidence, declines in interest rates, and the stabilization of the peso. Growth in 1996 could exceed 3½ percent, with an end-of-year inflation rate close to 25 percent. Led by a recovery in consumer confidence and an easing of credit conditions, output in Argentina is expected to increase by about 2½ percent in 1996 following a decline of 4½ percent last year. Continued fiscal tightening aimed at supporting the currency board arrangement is expected to keep inflation subdued, at the lowest rates in more than fifty years. In Brazil, the currency stabilization plan has continued to contain inflation to about 1 percent a month, but growth is projected to slow to 2½ percent in 1996. In Venezuela, a stabilization and reform program has been initiated to correct the deterioration of economic conditions in the early 1990s. Inflation accelerated to 7½ percent a month during the first quarter of 1996, but the measures that have been taken and that are planned are expected to reduce the rate substantially in the second half of the year. In Chile, despite increased inflationary pressures in the early part of the year owing to higher oil and wheat prices, inflation is expected to moderate in the second half following a further tightening of monetary conditions, including increases in the central bank’s target interest rates. Output growth in 1996 is also projected to moderate, to 7½ percent.

Following the marked improvements in Africa’s economic performance in 1994—95, there seem to be reasons for cautious optimism that growth is strengthening more significantly in 1996 and that inflation may decline for the third consecutive year. Although the sharp increases in prices of certain export commodities, especially coffee, witnessed in 1995 have been largely reversed, and activity in the industrial countries—the major trading partners—is likely to recover at a relatively slow pace, many African countries are expected to reap the benefits of fiscal consolidation, reduced inflation rates, greater private sector participation in the economy, liberalization of trade and exchange systems, and more realistic exchange rates. In South Africa, strengthening exports and private investment are contributing to stronger growth, which is projected to reach 4 percent in 1996. Despite a significant depreciation of the rand in early 1996 and a large but gradually declining fiscal deficit, tightened monetary conditions are expected to contain inflation at 7½ percent, although inflationary pressures and the weakness of the exchange rate remain of concern. In Uganda, the credibility of macroeconomic policies has continued to improve, and strong performance in the manufacturing and construction sectors is expected to contribute to a growth rate of around 6 percent in 1996. In Kenya, following a slowdown in the second half of 1995, growth picked up in the first quarter of 1996 and output is projected to rise by about 5 percent again in the year as a whole. Aided by a further reduction in the fiscal deficit and restrained credit policies, inflation is projected to remain below 5 percent. Tight demand management and wage restraint in Algeria are likely to reduce inflation further to about 17 percent in 1996, while output is projected to increase by about 4 percent led by further expansion in the hydrocarbon sector. In Ethiopia, growth should pick up to about 8 percent in 1996 as a result of a favorable agricultural season. The increase in agricultural production along with monetary restraint is expected to bring the rate of inflation down to about 6½ percent in 1996. In Zambia, economic conditions remained difficult in the first half of 1996 as a result of the need to import substantial quantities of maize following the drought in 1995, and also the sharp drop in copper prices. In Nigeria, growth in 1996 is expected to strengthen somewhat despite a stagnant petroleum sector, while inflation is projected to decline.

In many countries of the CFA franc zone, growth has picked up since the 1994 devaluation, and inflation has recently declined. Solid growth is expected to continue through 1996, and inflation should fall further, but these projections are contingent on the continuation of restrained fiscal and credit policies. In Côte d’Ivoire, a projected deterioration in the terms of trade is expected to be offset by a strong increase in oil production, leading to overall growth in output of about 6 percent in 1996. A further reduction in the fiscal deficit along with a restrained credit stance are expected to reduce inflation to about 7 percent. With a favorable crop season and continued expansion of export-oriented activities, growth in Senegal could approach 5 percent in 1996. Demonstrating their strengthened commitment to the liberalization of trade and payments, most of the CFA franc countries recently accepted the obligations of current account convertibility under Article VIII of the IMF’s Articles of Agreement.

Among the developing countries of Asia, policies have been tightened in a number of cases in response to growing concerns about inflationary pressures and deteriorating external positions. Export growth in a number of these economies has decelerated over the past year, and the pace of economic expansion is expected to slow somewhat in the period ahead. Inflation in the region is projected to decline further in 1996, to about 8 percent. In Malaysia and Thailand, the earlier tightening of monetary conditions is expected to be more fully felt in the latter part of 1996 as growth slows somewhat further, reducing the risk of overheating. Inflation in both countries is expected to increase only slightly over the next year. Tighter credit policies during 1996 in Indonesia are also expected to moderate growth, to below 8 percent. In Korea, growth is expected to slow to about 7 percent this year owing to a weakening of exports and equipment investment from the exceptionally rapid rates of expansion in 1995. Consumer spending and construction are expected to remain strong, and inflation to increase slightly as a result of higher food prices. In China, tighter controls on investment approvals and credit have helped to slow growth and alleviate price pressures in 1996, but the authorities will need to follow a tight monetary stance to ensure that inflation remains within the target range.

Growth prospects remain buoyant in a number of other Asian countries as well. In the Philippines, the process of economic adjustment and recovery is now well under way following earlier difficulties, and output expanded by 4½ percent in both 1994 and 1995. Real GDP growth is projected to increase further in 1996 to 6 percent, reflecting the continued strength of both domestic demand and the export sector. Inflation is likely to remain around 8 percent in 1996 as a whole, but should wane significantly by the end of the year. The macroeconomic situation in Vietnam remains strong with robust growth continuing and inflation falling during 1996. In India, the economic expansion is expected to slow from its recent rapid pace, owing to infrastructural bottlenecks and the high real interest rates arising from the policy mix of a large fiscal deficit and the resulting need for a tight monetary stance. Inflationary pressures are likely to become more prominent in the latter part of the year reflecting adjustments in administered prices. In Pakistan, a rebound in agricultural sector activity from depressed levels a year earlier, and better prospects in the mining and construction sectors are expected to contribute to some improvement in overall growth in 1996. Considerable risks to the outlook remain, including the effects of a widening current account deficit, which is linked to a lack of fiscal discipline.

Following a rebound in economic activity in 1995 in the Middle East and Europe region, growth is expected to strengthen somewhat to about 4 percent in 1996. In Kuwait and Saudi Arabia, efforts to eliminate substantial budget deficits through expenditure reductions continue to have a short-term restraining impact, although the increase in oil prices since mid-1995 and particularly in late August has provided an offsetting source of strength. In Egypt, a number of recent economic reforms in the area of privatization and deregulation are expected to help raise output in 1996 by about 4 percent, the strongest growth rate since 1987. In late July, an agreement in principle was reached between Egypt and the IMF on financial support for a package of economic policy reforms. In Jordan, prudent monetary and fiscal policies should continue to promote robust growth with low inflation over the next year. The failure to implement needed economic reforms has contributed to renewed economic difficulties in Turkey, with growth projected to slow from 7½ percent in 1995 to 5 percent in 1996 and inflation likely to remain in the 80 to 90 percent range. In Israel, more moderate growth of domestic demand is expected to slow the growth of output to 5 percent this year. Inflation, however, is expected to pick up—partly as a consequence of the worsening fiscal conditions over the past year and a half.

Developments and Prospects in Countries in Transition

In the countries in transition, economic activity overall is projected to stabilize in 1996 after five years of decline (Table 8). Eight countries are expected to register growth of 5 percent or more. Further gains in reducing inflation are also projected, with four countries registering annual inflation in the single digits.

Table 8.

Countries in Transition: Real GDP and Consumer Prices

(Annual percent change)

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In the countries more advanced in the transition process, sustained growth and further progress toward financial stabilization, and in particular fiscal consolidation, are expected (Table 9). In Poland, strengthening domestic demand is expected to contribute to continued robust growth with inflation slowing further (Chart 9). Strong domestic demand in the Czech Republic should support robust growth, with inflation likely to remain broadly at last year’s level. Steady progress in lowering inflation has been made in other countries, including Estonia, Latvia, and Lithuania, while Croatia has achieved virtual price stability. Continued growth is expected in all these countries, but the short-term prospects of some, including Lithuania, have been adversely affected by banking sector problems that emerged in late 1995. In the Slovak Republic, growth this year is projected to moderate to 6½ percent, down from almost 7½ percent in 1995. Inflation has also continued to moderate and is expected to fall to 6 percent in 1996. Concerns have emerged, however, regarding the sharp deterioration in the current account—from a surplus of 4 percent of GDP in 1995 to a deficit of 5 percent in the first quarter of 1996—which can be traced to a decline in exports and strong domestic demand. In Hungary, growth is projected to slow to about 1 percent in 1996, reflecting the tightening of fiscal policy and the slowdown in western Europe. Recent policy initiatives have helped to restore macroeconomic balance, with the fiscal and current account deficits declining sharply, and have laid the basis for recovery.

Table 9.

Selected Countries in Transition: General Government Budget Balance

(In percent of GDP)

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Central government balance.

Includes privatization revenues.