IV Implications for the World Economy: Revisions and Risks to the Projections
Author: International Monetary Fund
Language:
English
Keywords:
WEFS; market; emerging market; interest rate; U.S. dollar; current account; credit crunch; consumer confidence; export market growth; stimulus package; nonfuel commodity; Exports; Trade balance; Consumer prices; Emerging and frontier financial markets; Private capital flows; Africa; Western Hemisphere; Asia and Pacific; Global; Middle East
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Abstract

Global growth in 1999 seems likely to be in the range of 2–2¼ percent for the second consecutive year, well below the historical average of nearly 4 percent. This underscores the continuing costs of the Asian crisis, its repercussions, and the crises that have afflicted financial markets more broadly in 1998. However, the most serious downside risks to the global economy that emerged as a result of the turbulence in global financial markets in the wake of the Russian crisis in August now seem to have subsided, and the relatively modest scale of the further downward revisions to the global growth outlook since early September suggests that the situation may have begun to stabilize. At the same time, the balance of risks still seems to be predominantly on the downside. The consequences of some of these risks materializing are explored in an alternative scenario below.

Global growth in 1999 seems likely to be in the range of 2–2¼ percent for the second consecutive year, well below the historical average of nearly 4 percent. This underscores the continuing costs of the Asian crisis, its repercussions, and the crises that have afflicted financial markets more broadly in 1998. However, the most serious downside risks to the global economy that emerged as a result of the turbulence in global financial markets in the wake of the Russian crisis in August now seem to have subsided, and the relatively modest scale of the further downward revisions to the global growth outlook since early September suggests that the situation may have begun to stabilize. At the same time, the balance of risks still seems to be predominantly on the downside. The consequences of some of these risks materializing are explored in an alternative scenario below.

Key Revisions to the Projections

Projected growth in the world economy in 1999 has been lowered only modestly from the October 1998 World Economic Outlook to 2.2 percent, about the same growth rate as estimated for 1998 (Table 4.1). Nevertheless, there are significant downward revisions to projected growth in particular countries and regions, notably in Japan, where the recession now appears deeper and longer than previously projected, and in other countries reflecting the crisis in Russia and the subsequent contagion to other emerging markets, including Brazil. Recent changes in exchange rates, interest rates, and commodity prices, which affect assumptions underlying the projections, have also contributed to forecast revisions. Chief among these are a stronger yen (which, in real effective terms, is now assumed to be 12½ percent more appreciated in 1999 compared to the October 1998 World Economic Outlook), lower short-term interest rates in the United States and Europe, and lower real oil and nonfuel commodity prices (see Table 4.1 and Figure 4.1). Net private capital flows into emerging market economies are projected to increase by about one-third in 1999 to about $90 billion, but this represents a downward revision of about $40 billion compared with the October projection, and it would still be well below the levels seen in 1990–97. The timing and strength of the recovery in capital flows to emerging markets is one of the key uncertainties in the outlook.

Table 4.1.

Overview of the World Economic Outlook 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 October 19–November 4, 1998 except for the bi lateral rates among ERM currencies, which are assumed to remain constant in nominal terms.

Indonesia, Malaysia, Philippines, and Thailand.

Simple average of spot prices of U.K. Brent, Dubai, and West Texas Intermediate crude oil. The average price of oil in U.S. dollars a barrel was $19.27 in 1997; the assumed price is $13.39 in 1998 and $14.51 in 1999.

Average, based on world commodity export weights.

London interbank offered rate.

Figure 4.1
Figure 4.1

Prices of Crude Petroleum and Nonfuel Commodities1

(Quarterly averages, 1990 = 100)

Prices of oil and nonfuel commodities have declined further in 1998, in both nominal (U.S. dollar) and real terms. Petroleum prices are assumed to recover somewhat in 1999.

1Shaded areas indicate IMF staff projections.

Apart from Japan, the largest downward revisions to projected growth in 1999 are for various emerging market countries across all regions. These downward revisions are slightly offset by an upward revision for China. The major industrial countries, excluding Japan, have been affected relatively little so far by the crisis, in part because of the limited importance, relative to overall activity, of trade with emerging market economies, and also because of generally robust domestic demand, especially in the United States. In 1999, output growth is expected to slow somewhat in the euro area and to a greater extent in the United States, but the risk of more pronounced slowdowns has been reduced by recent monetary policy actions.

Japan and Emerging Market Economies in Asia: When Will the Recessions End?

The outlook for Japan has deteriorated further since the October assessment, with output now expected to fall by 2¾ percent in 1998 and by ½ of 1 percent in 1999 (Table 4.2). The downward revisions reflect the continued stagnation of private domestic demand, which is linked to difficulties in the financial sector, as well as implications for net exports of the appreciation of the yen since September. These factors are expected to be only partially offset by additional countercyclical policy measures. The appreciation of the yen, in particular, represents a tightening of monetary conditions that could, on its own, reduce GDP by about 1 percent over a one- to two-year period (Figure 4.2).

Table 4.2.

Advanced Economies: Real GDP, Consumer Prices, and Unemployment Rates

(Annual percent change and percent of labor force)

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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.

Figure 4.2
Figure 4.2

Major Industrial Countries: Indices of Monetary Conditions1

Monetary conditions—reflecting changes in both real interest rates and real exchange rates—have recently eased in North America and the United Kingdom but have tightened in Japan.

1For each country and the euro area, 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 relative to a base period (Janaury 1990 to December 1997). Relative weights of 3 to 1 are used for Canada and the United Kingdom; 6.25 to 1 for the euro area; and 10 to 1 for Japan and the United States. The weights are intended to represent the relative impact 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. For more details, see the October 1998 World Economic Outlook, Figure 2.7. For the euro area, a synthetic euro is constructed. For details, see the October 1998 World Economic Outlook, Box 5.5.

Recent data point to a continued deepening of the recession. Retail sales have continued to decline, while employment contracted again in the third quarter, and unemployment rose to 4¼ percent, contributing to consumer apprehension. GDP fell in the third quarter, by 2.6 percent at an annual rate, owing to declines in private consumption and investment that were partially offset by a boost from net exports and marginal increases in public spending. Industrial production shows no sign of sustained improvement; machine orders are low, signaling further declines in investment, as does the accelerating decline of bank lending; land price declines have picked up again; and business sector confidence remains depressed (Figure 4.3). The external sector contributed to growth in 1998 entirely through import compression. Looking ahead, it is unlikely that exports will contribute much to Japan’s recovery in the near term, owing to the weakness of activity among many of Japan’s trading partners, especially in Asia, and the recent yen appreciation. Indeed, uncertainties about the strength and timing of recoveries in the Asian crisis economies are an important risk factor for Japan, just as recovery in Japan will be critical for recovery in the rest of Asia (Tables 4.3 and 4.4).

Figure 4.3
Figure 4.3

Selected European Countries, Japan, and the United States: Indicators of Consumer and Business Confidence1

Consumer confidence has continued to improve in France and Germany but has declined in the United Kingdom and the United States. Falling business confidence has been widespread.

Sources: Consumer confidence—for the United States, the Conference Board; for European countries, the European Commission. Business confidence—for the United States, the U.S. Department of Commerce, Purchasing Managers Composite Diffusion Index; for European countries, the European Commission; for Japan, Bank of Japan.1Indicators are not comparable across countries.2Percent of respondents expecting an improvement in their situation minus percent expecting a deterioration.
Table 4.3.

Selected Advanced Economies and Regions: Importance of Merchandise Export Markets in 1996

(Exports to partner countries as a percent of exporter’s GDP)

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Sources: IMF, Direction of Trade Statistics, and World Economic Outlook database.

Excludes Japan, Australia, and New Zealand.

Developing countries.

Total exports as a ratio to total GDP. For the European Union, intraregional trade is included. Excluding this reduces the export share in GDP by about one-half.

Table 4.4.

Selected Regions: Importance of Merchandise Export Markets in 1996

(Exports to partner countries as a percent of exporter’s GDP)

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Sources: IMF, Direction of Trade Statistics, and World Economic Outlook database.

Total exports as a ratio to total GDP.

Excludes Japan, Australia, and New Zealand.

Developing countries.

The government announced a new fiscal stimulus package in mid-November, which will begin to be felt in the current fiscal year, although most of the impact is expected by IMF staff to be concentrated in FY 1999, which starts next April. The stimulus to be provided by fiscal policy as a whole in FY 1999, as measured by the change in the structural deficit from FY 1998, is now projected to be 1 percent of GDP. This is about ½ of 1 percent of GDP more than assumed in the October 1998 World Economic Outlook, where part of the stimulus in the November package was anticipated in the staff’s projection.1 Also in November, the Bank of Japan announced new measures to alleviate corporate funding difficulties, broadening the scope of its repurchase operations by raising the maturity ceiling of eligible commercial paper to one year. These and other related measures are intended to alleviate the effects of the credit crunch caused by large volumes of nonperforming or substandard loans in banks’ portfolios, but their impact on the economy is difficult to judge given the uncertainties about banks’ ability and willingness to lend and about the demand for new loans. There has been some progress in establishing a framework to resolve Japan’s banking problems, but there is a need for strong implementation.

The crisis-afflicted economies in east Asia—Indonesia, Korea, Malaysia, and Thailand—have suffered deep recessions in 1998, with output declines through the first half of the year, and probably also in the second half, in all countries (Table 4.5). Prospects for 1999 are better, with small declines in output or modest recoveries in prospect for all countries except Indonesia, where the reform process is less advanced and political uncertainties have complicated the economic difficulties (Table 4.6). The Philippines has fared better, with only a negligible decline in output in the year to the third quarter of 1998, in part reflecting the benefits of past stabilization and reform policies, but also the country’s stronger export ties to North America, where import demand has remained robust.

Table 4.5.

Selected Asian Economies: Macroeconomic Indicators

(Percent change from four quarters earlier unless otherwise noted)

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Sources: Country authorities; IMF, International Financial Statistics (IFS), and IMF staff estimates.

On national accounts basis calculated as exports (f.o.b.) less imports (c.i.f), except balance of payments basis for the Philippines, Singapore, and Thailand. 1998:Q3 trade data for Indonesia exclude oil and gas.

In U.S. dollar terms, on a national accounts basis, except balance of payments basis for the Philippines, Singapore, and Thailand.

Table 4.6.

Selected Developing Countries: Real GDP and Consumer Prices

(Annual percent change)

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The inflation figures published in the May 1998 World Economic Outlook were end-of-period data.

African countries that had arrangements, as of the end of 1997, under the IMF’s Structural Adjustment Facility (SAF) or Enhanced Structural Adjustment Facility (ESAF).

In Korea and Thailand, financial markets have already recovered significantly: the exchange rate collapses of late 1997 and early 1998 have been partly reversed, international reserves have been substantially replenished, and stock markets have rebounded. Key factors behind the return of confidence in financial markets are the significant progress with policy programs in both countries and the emergence of large external current account surpluses, which provide assurance that external obligations can be met. The depreciation of the U.S. dollar since September and reductions in short-term interest rates throughout the industrial countries in recent months have also alleviated financial market pressures. Beyond the financial markets, however, there are few signs of incipient recovery, although there are some signs of bottoming out. The rate of decline in industrial production has begun to moderate in recent months; the unemployment rate in Korea has declined slightly after reaching over 7½ percent in July; and sales of new vehicles in Thailand, which have been an indicator of consumer confidence and of the strength of the nonbank financial sector, which extends the loans to buyers, rose in October on a 12-month basis for the first time since the beginning of the crisis. However, these signals are tenuous, and activity may well remain quite weak in 1999. In Malaysia, signs of an end to the recession, which has been as deep as that in Korea, also remain tentative. However, financial markets appear to have stabilized, and there are some indications of a turnaround in demand.

The return of financial market confidence has allowed monetary and fiscal policies to become quite supportive of activity in all the affected countries. Short-term market interest rates in Korea, Thailand, and the Philippines have fallen below precrisis levels, although lending rate spreads remain high owing to problems in the financial sectors. In Malaysia, capital and exchange controls introduced in September may have facilitated the easing of interest rates, but controls could be an impediment to recovery. Interest rates have also come down somewhat in Indonesia. Fiscal policy has helped to dampen the recession and lessen its impact on the poor in these countries in 1998, and some additional stimulus is assumed for 1999.2 Recovery will also be aided by further easing of monetary policy to the extent that exchange market conditions permit; however, a sustainable rebound will also require financial sector reforms and corporate sector restructuring. Export market growth, which declined sharply in 1998, is expected to recover somewhat in 1999 but to remain well below trend, underscoring the external constraints on the pace of recovery.

Real GDP in China in the third quarter of 1998 is estimated to have been 7.6 percent higher than in the corresponding period of 1997, suggesting that growth has been better sustained than appeared likely at the time the October 1998 World Economic Outlook projections were prepared. As a result, the 1998 growth estimate has been revised up, to 7.2 percent. The stronger than expected growth in 1998 partly reflects policy measures—including a fiscal stimulus package equivalent to 2½ percent of GDP, consisting primarily of infrastructure projects, as well as reductions in domestic interest rates—that will continue to support growth in 1999. These measures appear to have more than offset the significant drags on the economy originating from the impact of the Asian crisis on exports, and severe flooding, but evidence of overbuilding and inventory accumulation, as well as financial sector fragilities, raise questions about the sustainability of growth at its recent pace. For these reasons, the staff projects some further slowdown in 1999, to 6½ percent. It should also be noted that the various signs of weakness in domestic demand may not be fully captured in the official GDP statistics (Box 4.1, page 78).

In Hong Kong SAR output is estimated to have contracted by 5 percent in 1998, reflecting the impact of the regional crisis and sharp falls in property and stock market prices; there have also been clear indications of declines in consumer prices and labor earnings. The authorities have responded to the weakening in activity with a fiscal stimulus of about 3 percent of GDP and measures to support the property market, including a suspension of government land sales. In addition, the authorities intervened in the stock market in August, purchasing about $15 billion of shares and significantly reducing the free float for many issues. Over the past few months the authorities have also adopted several measures to discourage speculation in the futures market, strengthen the regulatory framework for securities, and modify the discount window facility to buffer the effects of temporary market pressures on interest rates. Interest rates have come down as pressure on the currency has subsided. While activity is expected to remain weak in the first half of 1999, partly reflecting the impact of high real interest rates associated with falling prices, growth may pick up in the second half of the year. Considerable downside risks remain, however, given the economy’s openness and exposure to developments in Japan and mainland China.

Effects of the Russian Crisis on the Domestic Economy and Other Countries in Transition

Economic and social conditions in Russia have deteriorated dramatically since the August crisis. The decline in output in 1998 is estimated at almost 6 percent, and projections for 1999 have been revised down further since the October World Economic Outlook, to show an 8 percent output decline (Table 4.7). There is clearly a risk of an even larger decline, however, given the continuing fiscal imbalances, banking sector problems, and signs of reversals in the reform process. Monthly inflation, which had accelerated to 38 percent in September, receded to 4½ percent in October, as new foreign exchange controls contributed to a stabilization of the exchange rate and as price controls limited open inflation. Inflation is projected to accelerate in 1999, however, because support to the banking system and the continuing large budget shortfall are expected to be financed largely through monetary expansion.

Table 4.7.

Countries in Transition: Real GDP and Consumer Prices

(Annual percent change)

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Russia’s external current account is likely to have swung into surplus in the second half of 1998, owing to a sharp compression of imports that reflects import financing problems and the collapse of the ruble. Indications are that capital flight is also on the rise and, together with the collapse of private and official capital inflows, is putting pressure on the overall external position. In 1999 the current account surplus is expected to reach 6½ percent of GDP.

The financial crisis in Russia has significantly affected developments and prospects in many other transition countries, especially those that are dependent on external private financing or have maintained strong trade and financial ties with Russia. Ukraine, in addition to facing reduced trade with Russia, has been confronted with the consequences of persistent budgetary imbalances and inadequate reform efforts, which have contributed to a drying up of new financing and the need to repay some of its maturing external debt. The country has, however, managed to avert a complete cutoff from private financing by obtaining agreement to a voluntary conversion of a substantial part of its treasury bills held by nonresidents into Eurobonds and to a rescheduling of some loans from international banks. Following the adoption of a new exchange rate band in early September, the hryvnia depreciated by around 35 percent (against the U.S. dollar) before stabilizing at the limit of the band in mid-October, as administrative controls on the foreign exchange market were tightened. The depreciation has put upward pressure on inflation, which accelerated to 6½ percent on a monthly basis in October. Ukraine has not experienced positive growth in any year since transition began, and output is projected to continue to contract in 1999 (see Table 4.7).

In Kazakhstan, sharply reduced access to international financial markets has exacerbated the impact of the slowdown in trade with Russia, and output is estimated to have declined by 1½ percent in 1998. In Belarus and Moldova, which both rely on Russian markets for 60–70 percent of their exports, the main impact of the Russian crisis is occurring through trade. The effects of the decline in exports to Russia are expected to be more limited, but still significant, in the Caucasian and Central Asian states that have made progress in reorienting their trade toward new markets.

The three Baltic countries, in addition to being affected by reduced access to private external financing, are expected also to face significant direct effects from the Russian crisis through banking sector and trade links. Estonia and Lithuania, with current account deficits of around 10 percent of GDP in 1998, are particularly vulnerable to changes in sentiment in global financial markets. Latvia, whose commercial banks have around 10 percent of their assets loaned to Russia, with the two banks with the largest exposure already being restructured, is also substantially affected by spillovers from the Russian crisis.

The least affected transition countries are those in central and eastern Europe, where fundamentals are relatively strong. In these cases, financial market pressures in the wake of the Russian crisis have been mostly short-lived. Nevertheless, there are downward revisions of the growth projections for some countries. For the Czech Republic, continued weakness in domestic demand and economic activity in recent months, following the tightening of macroeconomic policies in 1997, suggests that real GDP is likely to have contracted by 1 ½ percent in 1998, and activity is expected to remain subdued in 1999. In Hungary and Poland, less favorable prospects for exports are projected to lead to some slowdown in growth in 1999, but not to much less than 5 percent in either case.

Brazil and Other Emerging Market Economies: Effects of the Global Crisis

Among the regional groups of developing countries, near-term growth prospects have weakened the most for the Western Hemisphere, reflecting the particularly severe impact of the emerging market crisis on Brazil, the largest economy in the region (see Tables 4.6 and 4.8). Growth projections for Brazil have been revised down sharply, with a small decline in output now projected for 1999. The policy program adopted by the authorities to reduce the fiscal deficit, address structural weaknesses, and restore investor confidence is discussed in Chapter I (Box 1.1). Effects of the reduced availability and increased cost of external finance, and tight domestic credit, have begun to show in the real economy, as indicated by a sharp fall in industrial production in September. The economy has also been adversely affected by a recent contraction of export earnings, reflecting lower commodity prices—notably for soya, sugar, and coffee—and a drop in demand for manufactured goods from trading partners (Figure 4.4). Even after the downward revisions, considerable downside risks to the outlook remain, including in relation to conditions in international financial markets and the possibility of steeper-than-projected slowdowns in export demand from partner countries. The projections assume that the policy program will be fully implemented and that investor confidence and willingness to roll over public debt will be maintained.

Table 4.8.

Selected Latin American Economies: Macroeconomic Indicators

(Percent change from four quarters earlier unless otherwise noted)

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Sources: Country authorities; and IMF, staff estimates (for GDP) and IFS (for inflation, trade balance, import value, export value, and export volume, except where noted).

On a national accounts basis.

In U.S. dollars terms on a national accounts basis.