Abstract

The outlook for global growth in 1993 and 1994 is little changed from the projections presented in the May 1993 World Economic Outlook (Table 2). Weaker-than-expected activity in the industrial countries is offset by stronger growth in the developing countries in Asia, the Western Hemisphere, and, in 1994, in the Middle East and Europe. Inflation is expected to slow to 2¾ percent in the industrial countries, and to moderate significantly in the nonindustrial countries as a group. Economic recovery in some of the central European countries in transition provides encouraging evidence of the progress that can be achieved with sustained stabilization and reform efforts.

The outlook for global growth in 1993 and 1994 is little changed from the projections presented in the May 1993 World Economic Outlook (Table 2). Weaker-than-expected activity in the industrial countries is offset by stronger growth in the developing countries in Asia, the Western Hemisphere, and, in 1994, in the Middle East and Europe. Inflation is expected to slow to 2¾ percent in the industrial countries, and to moderate significantly in the nonindustrial countries as a group. Economic recovery in some of the central European countries in transition provides encouraging evidence of the progress that can be achieved with sustained stabilization and reform efforts.

Table 2.

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 August 16-20, 1993, except for the bilateral rates among ERM currencies, which are assumed to remain constant in nominal terms.

Information on 1993 trade may understate trade volumes because of reduced data coverage associated with the opening of the single market in Europe and the abandonment of customs controls on trade within the European Community.

Simple average of the U.S. dollar spot prices of U.K. Brent, Dubai, and Alaska North Slope crude oil; assumptions for 1993 and 1994.

Average based on world commodity export weights.

London interbank offered rate.

Activity and Employment

Economic growth in the industrial countries is projected to weaken in 1993, following an already modest performance in 1992 (Table 3). This disappointing aggregate performance is the outcome of markedly nonsynchronous cyclical developments, with output expected to decline in 1993 in continental Europe and in Japan, and with the recoveries in North America and the United Kingdom gaining strength during the course of the year. The continental European countries are assumed to start to recover in late 1993, although indications of a turnaround are still somewhat tentative (Chart 3). During 1994, recovery is expected gradually to become more firmly established in most industrial countries, but the strength and timing of the pickup in growth remain uncertain.

Table 3.

Industrial Countries: Real GDP and Consumer Prices

(Annual percent change)

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Data for consumer prices based on the retail price index excluding mortgage interest.

Chart 3.
Chart 3.

Major Industrial Countries: Real GDP1

(Percent change from four quarters earlier)

1 Blue shaded areas indicate staff projections; for France and Italy, the second quarter of 1993 is also projected.

Two special factors have altered the character of this business cycle relative to historical experience: the adjustments set in motion by the asset price inflation and subsequent deflation in a number of countries, and the differences in domestic policy requirements across Europe that emerged following German unification. Actual output in Europe is projected to remain significantly below potential through 1994, and measures of excess capacity have reached considerably higher levels than in the recession in the early 1980s (Chart 4). The wealth losses and financial sector repercussions associated with asset price declines have restrained consumption and investment in the affected countries; the severity of these problems is particularly apparent in the large output gap and the very low levels of confidence that have emerged in Japan.4 Reductions of interest rates in several countries have eased the process of balance sheet adjustment and debt management, but the response of demand to the interest rate reductions has remained muted. Although the downturn in the United States was milder than the 1981-82 recession, activity has remained below potential for a much longer period.5

Chart 4.
Chart 4.

Major Industrial Countries: Output Gaps1

(Actual less potential output, as a percent of potential)

1 Blue shaded areas indicate staff projections.2 Data through 1990 apply to west Germany only.

It is not yet clear whether the risk of a more prolonged delay in the recovery—highlighted in the May 1993 World Economic Outlook—has receded, especially in Japan and in continental Europe. A related uncertainty is whether the recoveries in North America and the United Kingdom will add impetus to growth in the other industrial economies or will themselves be dampened by weak export demand. The strength of exports forestalled—temporarily—the downturn in France and, more recently, has contributed significantly to the turnaround in the United Kingdom and Canada. In contrast, weaker-than-expected export markets account for part of the downward adjustments to the projections for a number of European countries, and for part of the unexpectedly subdued first quarter in the United States. An additional source of uncertainty arises from the low levels and apparent fragility of business and consumer confidence, particularly in Japan and in those countries where unemployment has recently increased. Although prospects for a successful early completion of the Uruguay Round may have improved, and needed fiscal consolidation programs have been announced in some countries, confidence remains weak. A failure by governments to uphold their repeated commitments to complete the Uruguay Round and to reduce excessive government deficits, and a failure to address the problem of persistently high unemployment, would further weaken confidence and increase uncertainty about future economic policies.

The recovery in the United States slowed in early 1993 as severe weather, weaker-than-projected net exports, and cuts in defense spending more than counterbalanced stronger-than-expected business fixed investment. Despite this weakness, growth is projected to average 2¾ percent in 1993, mainly on the strength of private consumption and investment. Slow employment growth and relatively high unemployment have weakened consumer confidence and personal consumption growth. In view of the assumed adoption of the proposed government spending cuts and tax increases, growth is projected to moderate slightly to 2½ percent in 1994; activity is expected to be supported mainly by the favorable market response to announced deficit-reduction plans, the effects of relatively low interest rates, and continued progress in reducing debt burdens in the private sector.

The increase in output projected for Canada in 1993 has been scaled back slightly, to 2½ percent, because of weakness in other industrial countries; slower-than-expected employment growth, housing starts, and retail sales in early 1993; and some fiscal tightening by provincial governments. However, the continuing U.S. recovery, easier monetary conditions, and improved competitiveness suggest that activity will strengthen as the year proceeds, and output is expected to grow at a robust 3¾ percent in 1994. Unemployment is projected to remain at 11¼ percent in 1993, but it should begin to decline during 1994 with the strengthening of activity. The substantial amount of slack should help to contain inflationary pressure.

The United Kingdom provides the sole exception among the major industrial countries to the pattern of downward revisions to the 1993 projections. Domestic demand strengthened significantly in early 1993 as lower interest rates and signs of recovery in the housing market had a positive impact on consumer and business confidence. Moreover, external competitiveness has improved with the depreciation of the pound and the recent moderation of wage increases. The unemployment rate fell slightly during the first half of 1993, although it remains high at 10½ percent. As the recovery gains momentum, growth is projected to rise to 2¾ percent in 1994.

Japan is the most recent country to suffer the restraining effects of asset price deflation. Despite a recovery of equity prices during 1993—albeit to levels well below earlier peaks—balance sheet adjustments continue to be significant. In addition, investment has declined from the very high levels maintained through the late 1980s, and the recent appreciation of the yen has curtailed business profits and weakened exports. Indicators of economic activity in the first quarter of 1993 were somewhat favorable, including gains in industrial production, shipments, and sales. These were reversed, however, in the second quarter, when output declined by ½ of 1 percent, with an increase in inventories and greater-than-expected declines in private consumption and business fixed investment. In keeping with these developments, the index of business confidence in August reached its lowest level since 1975. In response to signs of prolonged recession, the Japanese authorities announced on September 16 an additional economic stimulus package aimed at easing regulatory constraints and supporting public spending. The appreciation of the yen may also stimulate private consumption through lower import prices. Nevertheless, the temporary contractionary effects of the stronger yen, larger-than-expected consequences of the asset price deflation, and unusually poor weather during the summer have contributed to substantial downward revisions to the projections. Output is expected to be stagnant in 1993 and to rise by 2 percent in 1994.

Economic conditions in Germany continue to be shaped by the problems of economic unification and by policy responses to the adjustment process. Projections for 1993 have been revised downward, and output is now expected to contract by 1½ percent for all of Germany, and by 2¼ percent in western Germany. The contractionary effects of tight monetary policy, adopted to offset the inflationary consequences of the fiscal expansion associated with unification, have been particularly pronounced in the industrial sector. More recently, these problems have been compounded by weakness in the export sector, which has lost competitiveness and suffered from the lower growth in Germany’s partner countries attributable to high interest rates across Europe. Recently announced spending cuts and a likely significant reduction of inflation in the second half of 1993 should pave the way for further interest rate reductions, which should help to generate a moderate turnaround in economic activity toward the end of 1993. With likely further losses of export market shares, however, growth in 1994 is expected to average only about 1¼ percent.

The projections for France have been revised down substantially: output is expected to decline 1 percent in 1993 and to expand a modest 1 percent in 1994. Although the widening of ERM bands has created room for further interest rate reduction, in line with domestic policy needs, weaker-thanexpected activity in partner countries in 1993 has contributed to a net downward revisions in projections. Foreign demand, which had sustained economic activity through much of 1992, tapered off late in the year and remained weak in early 1993. Although interest rates have declined significantly since the beginning of the year, they remain high in real terms. Fixed investment is projected to decline by 6½ percent in 1993, following already significant declines in 1991-92. Unemployment reached 11½ percent in mid-1993, despite temporary jobcreation measures. With business and consumer confidence severely depressed, the outlook depends critically on the course of European interest rates and on developments in external markets.

Economic activity in Italy continues to be very subdued, with growth projected at only ¼ of 1 percent in 1993 and 1 ¾ percent in 1994. Domestic demand has been restrained by tax increases and fiscal reform efforts, by high and rising unemployment—between January and April 1993, unemployment rose by 1 percentage point—and by generally depressed consumer and business sentiment. The effects of weak external demand have, however, been partially offset by improved competitiveness following the depreciation of the lira and the continued moderation of wage increases. The new agreement on wage bargaining signed in July by the social partners, which definitively ended wage indexation (the “scala mobile”), enhances the prospects for continued wage moderation over the medium term.

Weak growth of export markets and difficulties in those countries recovering from the effects of asset price deflation have further weakened the outlook for the smaller industrial countries. Economic activity in 1993 is projected to remain flat for this group as a whole, with further significant declines in output expected in Sweden and Finland because of ongoing balance sheet adjustments, financial fragility, and severe economic imbalances. Output is also expected to decline in Spain, the Netherlands, Belgium, Switzerland, and Austria, reflecting weak foreign demand and high European interest rates. Only in Australia, Ireland, and New Zealand is growth expected to be maintained above 2 percent in 1993-94.

In contrast to the downward revisions and pervasive weakness of activity in much of the industrial world, growth in the developing countries as a group is projected to remain relatively strong in 1993-94. Sustained stabilization efforts, together with low interest rates on dollar-denominated debt and increased capital inflows, have helped many developing countries, particularly in the Western Hemisphere and Asia, to maintain growth (Chart 5). Economic activity in Asia is also benefiting considerably from the continued buoyancy of intraregional trade.

Chart 5.
Chart 5.

Developing Countries: Real GDP1

(Annual percent change)

1Blue shaded area indicates staff projections.

The 1993 projection for growth in Asia has been increased substantially, to 8¾ percent, primarily because of stronger-than-expected output in China, which more than offsets weaker-than-expected activity in Korea and the Philippines (Table 4). Although the very rapid economic expansion in China in 1992 is expected to be maintained in 1993, the Chinese authorities have recently taken policy actions aimed at slowing the growth of aggregate demand, which should slow growth to a more sustainable pace in 1994. After the moderation of growth in Korea in 1992-93, which reflects measures taken to reduce excess demand pressures, activity is expected to strengthen in 1994. Economic activity in India is projected to remain robust in 1993-94, reflecting successful stabilization and reform efforts (Box 1). Growth strengthened in Pakistan in 1993 despite political uncertainties and foreign exchange constraints; as these factors abate, activity is expected to improve even further. Strong growth is expected to continue in 1993-94 in Indonesia, Taiwan Province of China, Thailand, and a number of other economies in the region, although at a more moderate pace than in the early 1990s.

Table 4.

Selected Developing Countries and Countries in Transition: Real GDP and Consumer Prices

(Annual percent change)

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In the developing countries of the Middle East and Europe, growth is projected to moderate to 3 ½ percent in 1993 and to rise to 4½ percent in 1994. Movements in the regional average continue to be significantly affected by the aftermath of the 1991 regional conflict. In Saudi Arabia, growth is anticipated to decline further in 1993 as a result of weakness in the oil market, and to remain subdued in 1994.6 Growth in the Islamic Republic of Iran is expected to be relatively strong in 1993 as recent economic reforms begin to take effect, although activity may be constrained by the high level of shortterm external debt. Economic activity was weak in Egypt in 1992 and is expected to strengthen only moderately in 1993-94.

Increases in output in the developing countries of the Western Hemisphere are expected to average 3½ percent in 1993-94. In Brazil, uncertainty regarding the direction of economic policy and high inflation resulted in a decline in output in 1992; however, output is expected to expand 4 percent in 1993. Economic growth in Chile in 1993-94 is projected to slow to sustainable rates, following the very strong performance in 1992 based mainly on increases in private investment and exports. In Argentina, following the rapid expansion of activity in the early 1990s as the economy recovered from earlier policy imbalances, growth is expected to slow to a more moderate but still satisfactory pace in 1993-94. In Venezuela, economic activity weakened in 1993 as the fiscal situation deteriorated and political uncertainties increased, but growth is projected to strengthen in 1994. Growth in Mexico in 1993 continues to be somewhat restrained because of efforts to reduce the current account deficit, but activity is expected to strengthen in 1994.

Adverse weather, weak export demand from industrial countries, and the effects of policy imbalances in several countries have weakened the nearterm outlook for Africa, where growth is now expected to average only 1½ percent in 1993 and 2½ percent in 1994. Among the larger economies, activity in Algeria is expected to contract in 1993 and 1994 because of growing imbalances and political uncertainties. Despite problems in implementing liberalization measures in Kenya—which have led to downward revision of expected growth in 1993—domestic activity is projected to be significantly stronger in 1993 than in 1992. Fiscal expansion and strong harvests in Sudan in 1992 raised output sharply, but rapid inflation and severe fiscal imbalances have weakened the outlook for 199394. Growth in Tunisia is projected to return to more normal rates following a particularly abundant harvest and unusually rapid growth in 1992. Economic activity in Morocco is expected to remain subdued in 1993, owing to the continued severe drought and to weak export markets in Europe, but activity is expected to recover in 1994. For the sub-Saharan African countries that had arrangements, as of end-1992, under the IMF’s structural adjustment facility (SAF) and enhanced structural adjustment facility (ESAF), growth is projected to average 4 ½ percent in 1993 and 1994; for the countries in sub-Saharan Africa without such arrangements, output is expected to increase 1½ percent in 1993 and 2½ percent in 1994.

India’s Economic Rebound

Only two years ago, India was in the midst of a balance of payments crisis with foreign exchange reserves nearly depleted; inflation—traditionally low was rising steadily; and output was starting to fall because of a severe import squeeze and sharply declining exports to the former Soviet Union. That situation has now been dramatically reversed, as a result of a major stabilization effort centered on fiscal consolidation and a reorientation of economic policies away from four decades of heavy state intervention (see table). The turnaround is testimony to the efficacy of strong adjustment policies and timely international financial support.

As in many other countries, the roots of the crisis in India lay in the interaction of long-standing structural rigidities and rising demand pressures stemming from excessive fiscal expansion. Since the 1950s, the economy had been shackled by a vast regulatory apparatus designed to support a large public sector that encompassed heavy industry, power, mining, banking, and transportation. The production of consumer goods (which were subject to numerous restrictions, including a ban on imports) and agricultural production were left to the private sector. The government not only controlled the allocation of investment but also restricted firms’ ability to reduce employment. Notwithstanding some very gradual reforms in the early and mid-1980s, interventionist policies retarded India’s growth and export potential.

High and rising fiscal deficits in the 1980s created pressures that led to a steady drawdown of foreign exchange reserves and to increased use of external borrowing on commercial terms. Overtime, questions were raised about India’s ability to service its growing external debt burden, and this increased vulnerability became apparent as a result of two major adverse shocks in the latter half of 1990. One was the Middle East conflict, which temporarily raised the oil import bill and lowered remittances from overseas workers. The other, and perhaps more important, development was the sharp deterioration in domestic political stability and the ensuing fall of two governments in quick succession, which precluded strong policy action. The crisis deepened after the assassination of former Prime Minister Rajiv Gandhi in May 1991—by which point capital flight had depleted foreign exchange holdings to a level equivalent to just a few weeks of imports.

Although quantitative import controls were intensified in the early stages of the crisis, the new government that assumed office in June 1991 recognized that, quite apart from the damaging consequences for output, such measures failed to address the underlying causes of the crisis. To restore confidence in economic policies and to halt capital flight, the government acted decisively in three key areas. First, the authorities quickly implemented a credible set of measures to lower the fiscal deficit by over 2 percent of GDP during the eight remaining months of the fiscal year; the fiscal package included several politically difficult decisions, such as cuts in fertilizer subsidies and reduced transfers to state governments and public enterprises. Monetary policy was also tightened, including through a series of upward adjustments in the structure of interest rates. Second, the rupee was devalued by about 19 percent, and a de facto dual exchange rate system was introduced through a special license for tradable imports. Third, a major shift away from economic interventionism and gradualist reform policies was set in motion. The most far-reaching step was the virtual abolition of the complex system of industrial licensing that had for decades governed the entry, expansion, and diversification of industries. In addition, the government sought to enhance domestic competition by sharply reducing the number of industries reserved exclusively for the public sector, and to encourage foreign direct investment through automatic approval of foreign investment in a wide range of industries.

India: Key Economic Indicators

(In percent unless otherwise noted)

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Projections.

Growth of exports measured in dollars. In 1991/92 and 1992/93, exports to the former Soviet Union declined by about 60 percent and 50 percent, respectively.

With credible adjustment well under way, a substantial amount of quick-disbursing support became available to India from bilateral donors and multilateral financial institutions, including total IMF commitments since the start of the crisis of SDR 3.6 billion. Decisive policy action coupled with international financial support proved effective in restoring confidence, and capital began to flow back into India. Within four months of the start of the IMF program, foreign exchange reserves had been rebuilt to well over three months of imports, above the level that existed before the onset of the crisis. Annual inflation also fell back to single digits, albeit more slowly than had been hoped, while real GDP growth declined temporarily but remained positive.

The breathing space afforded by the rebuilding of reserves allowed the authorities to initiate a second round of reforms. The focus of short-term policy shifted to a further reduction in inflation, which had remained high by historical standards. Accordingly, a further reduction in the central government deficit was planned for 1992/93. Despite some slippages because of revenue shortfalls associated with social disturbances late in the year, the deficit was reduced by a further 1 percentage point to 5¾ percent of GDP. Monetary restraint, together with the effect on food prices of favorable monsoon rains, helped to push down inflation, thereby permitting a gradual lowering of nominal interest rates.

On the structural side, the second round of reforms emphasized the liberalization of the trade and payments system and the beginnings of financial sector reform. All the temporary import restrictions imposed during the crisis were withdrawn; the complex system of import licensing was simplified; and tariff rates were cut substantially in early 1992, and again in 1993, although consumer goods imports continued to be banned. A formal dual exchange rate system was introduced in early 1992, and the exchange rate system was unified a year later. Measures were taken to deregulate the rigid financial system and to move toward a more market-determined allocation of credit. The cash reserve ratio and the statutory liquidity requirement were reduced significantly. At the same time, controls on deposit interest rates were relaxed and, on the lending side, cross-subsidies to preferred sectors were lowered. A modest start was also made in restructuring public enterprises; the most serious loss makers were referred to a special agency empowered to draw up restructuring plans, and partial disinvestment of a few selected enterprises was begun. A social safety net was also created to support these initiatives.

By early 1993, the reform package had helped to lower inflation further, to about 6 percent, and economic growth began to revive; the recovery appears to have been quicker in services than in manufacturing. Buoyant capital inflows helped to raise foreign exchange reserves further, even as the painful contraction of trade and the current account deficit from the earlier import compression was reversed. Although total exports rose only modestly, this was mainly due to the collapse of a substantial volume of trade with the former Soviet Union. Exports to the rest of the world were growing at an annual rate of over 11 percent in dollar terms in early 1993.

India’s reforms have firmly re-established macroeconomic stability and public confidence, as evidenced by the lack of capital flight even during the severe civil disturbances in late 1992 and again in early 1993. Nevertheless, although the immediate crisis has passed, it is clear that the reforms still have far to go if the desired increases in investment and efficiency are to be realized. In addition to continued fiscal consolidation, the government has identified three areas as central to its reform agenda. First, given the imperative to scale back a large number of highly distortionary taxes, especially on foreign trade, a major tax reform aimed at broadening the tax base will be needed to offset revenue losses. Second, with consumer goods imports and major agricultural exports still rigidly controlled, it is clear that much remains to be done to lower trade barriers, which are still among the highest in the world. Finally, public enterprise restructuring will have to be accompanied by policies to ensure a dynamic response by the private sector, including a relaxation of labor and landuse regulations, in order to facilitate long-term employment growth.

Among the central European countries in transition, early indications of recovery in the Czech Republic, Hungary, and Poland—mainly reflecting increased output in the expanding private sectorhave solidified, despite a less favorable external environment than was earlier anticipated. As supply conditions improve further, the stage should be set for further improvements in 1994. There are preliminary signs of a turnaround in Albania and Slovenia, but real output is estimated to have continued to fall during 1993 in the Slovak Republic—in part because of the termination of fiscal transfers from the Czech Republic—and in Romania and Bulgaria. For the year as a whole, average output in the region is expected to decline again in 1993, although by much less than recently, and to increase in 1994 for the first time since 1988.

Activity remains extremely weak in the Russian Federation, following a large decline in 1992. Output in most other countries of the former Soviet Union also continued to decline in the first half of 1993, mainly because of disruptions in energy imports, rapid inflation, continued deterioration in the terms of trade, and regional or civil conflicts. Steady progress in implementing reforms in Estonia and Latvia is expected to result in significantly positive growth in 1994. For the former Soviet Union as a whole, output is projected to decline by 13¾ percent in 1993 and to begin to stabilize next year; these projections are based on the crucial assumption that increased commitments to stabilization and reform are translated into credible policy actions.

Inflation and Commodity Prices

For most of the industrial countries, moderate inflation remains one of the most positive features of the current situation. The weakening of economic activity has contributed to an easing of inflationary pressures, and in some countries rates of price increase are at their lowest levels since the 1960s. In the United States, indications in early 1993 of increasing inflation were not confirmed in subsequent months; underlying factors, especially the moderate trend in wage increases, suggest that inflation is likely to remain below 3 percent in the near term, although the floods in the farm belt in mid-year may temporarily raise food prices. Most continental European countries and Japan have made further progress in reducing inflation, coming in some cases within, or close to, long-term objectives. In Italy and the United Kingdom, currency depreciations will put some upward pressure on prices, but recent indicators have been encouraging, and inflation is projected to rise only slightly in 1994. In Germany, there are now clear indications that price increases are beginning to moderate in response to tight monetary conditions and restrained wage increases.7 Among the smaller industrial countries, the inflation outlook for Spain has deteriorated relative to earlier projections, primarily because of the devaluations of the peseta in the ERM. The severity of the downturn in Sweden has reduced inflationary pressures, but the significant depreciation of the krona will prevent inflation from falling much below 5 percent in 1993. Inflation performance in New Zealand continues to be very encouraging.

Average inflation in developing countries is projected to rise in 1993 to 43¾ percent, and then to fall to 34¾ percent in 1994. The relatively high average inflation rate reflects extremely rapid inflation in a small number of countries; median inflation is much lower and is expected to decline further, from 7 percent in 1993 to 5½ percent in 1994. In Africa, inflation is expected to decline in both 1993 and 1994 on the assumption that policy reform programs are implemented in a number of countries. Inflation is, however, projected to rise in 1993 in Kenya, and to remain high in Algeria, Nigeria, and Sudan, mainly as a result of policy slippages. Continued very rapid inflation in Zaïre in 1993 reflects rapid monetary expansion to finance very high government spending. Inflation in Asia is expected to rise slightly to 8¼ percent in 1993, although this projection depends critically on macroeconomic developments in China, where inflation has accelerated sharply since the beginning of the year. In the Western Hemisphere, inflation has been brought down in several countries, substantially so in Argentina, Peru, and Nicaragua. Chronic high inflation in Brazil, however, implies that average inflation in the region will remain high, just above 220 percent in 1993; excluding Brazil, inflation in the region is expected to moderate from 23 percent in 1992 to 16 percent in 1993, and to 11½ percent in 1994. Inflation is expected to decline only slightly in the Middle East and Europe region, to 22¾ percent in 1993 and 21¼ percent in 1994. Inflation remains high in Turkey because of continued large fiscal deficits.

Although average inflation in the countries in transition is still high, the inflation outlook varies markedly across countries, reflecting different degrees of progress with macroeconomic stabilization (see Chapter VI). Excluding the former Yugoslavia, inflation in central European countries in transition is projected to be 56 percent in 1993 and 32 percent in 1994. Prices in Slovakia and the Czech Republic jumped in January upon introduction of the value-added tax (VAT) but stabilized thereafter. Following the loosening of fiscal and monetary policies in the second half of 1992, inflation in Russia remained high early in 1993, but declined slightly—to about 20 percent a month—by mid-year. Recent indicators, however, suggest that these gains are being reversed, and that inflation has increased again. Monthly inflation is still high in most of the other countries of the former Soviet Union, but it has fallen to very low levels in Estonia and Latvia because of cautious financial policies and effective income policies (see Box 7 in Chapter VI).

Average petroleum prices fell from $18.27 a barrel in the fourth quarter of 1992 to $17.37 in the second quarter of 1993 (Chart 6). The price drop reflected increased supply pressures, which intensified following Kuwait’s decision at the OPEC meeting in June to produce above its quota. Progress in mid-July on an agreement between the United Nations and Iraq to allow the sale of $1.6 billion of oil by Iraq brought prices to their lowest level since the regional conflict in 1991. For the year as a whole, oil prices are projected to average $16.68 a barrel and then to increase slightly to $17.23 a barrel in 1994.

Chart 6.
Chart 6.

Consumer Prices and Commodity Prices

1Three-month centered moving average of twelve-month inflation rates. Consumer prices are measured in local currencies and are averaged using PPP weights. The nonfuel commodity price index is an export-weighted average of 36 prices denominated in SDRs, including gold. The oil price is a simple average of the U.S. dollar spot prices of U.K. Brent, Dubai, and Alaska North Slope crude oil, equally weighted.2 Nonfuel commodity prices deflated by the export price of manufactures of industrial countries.

Average nonfuel commodity prices continued to decline in the first half of 1993, reflecting weak overall demand from industrial countries, mounting stocks, and, in the case of beverages, problems with international price support agreements. Prices of metals have been pushed lower by weak demand and by continued exports from the former Soviet Union. The balance of these pressures over the year points to further price drops. Nonfuel commodity prices are projected to decline by 2½ percent in 1993 as a whole, and then to increase by 4 percent in 1994 with the pickup in world growth (see the Statistical Appendix, Table A21).

Foreign Exchange and Financial Markets

Other than the realignments of the peseta and escudo in mid-May, visible tensions in the ERM receded during the first half of 1993, especially following the positive vote on the Maastricht Treaty in Denmark on May 18. These reduced tensions were reflected in diminished interest rate spreads with respect to Germany and in the appreciation of several European currencies vis-à-vis the deutsche mark. By the end of June, French, Belgian, Dutch, and Irish short-term interest rates had fallen below comparable rates in Germany (see Chart 18 in Chapter III).

Chart 18.
Chart 18.

European Monetary System: Interest Rate Differentials vis-à-vis Germany

1 The interest rate refers to the before-tax yield on twelve-month treasury bills.

However, during the course of July, mainly as a result of unfavorable economic indicators and doubts about the pace of interest rate reductions in Germany, the French franc, Danish krone, Belgian franc, Spanish peseta, and Portuguese escudo again came under considerable pressure within the ERM. Exchange market pressures were countered by renewed significant increases in short-term interest rates and by substantial foreign exchange market intervention. Speculative pressures nevertheless increased further at the end of the month, and intensified following the modest cuts in German official interest rates announced on July 28-29. These developments culminated with the widening of the ERM band of exchange rate fluctuations to 15 percent (from central parities), except for the bilateral exchange rate between the deutsche mark and the Dutch guilder, where on the basis of a bilateral agreement the narrow band of 2¼ percent was maintained.8

The U.S. dollar appreciated significantly against the European currencies between mid-April and end-July, reflecting relative cyclical positions and expectations that interest rate differentials gradually would move in favor of dollar-denominated assets. Subsequently the dollar moved lower, as favorable news on inflation and evidence of lower-thanexpected real economic growth reduced expectations of an increase in U.S. short-term interest rates. An enlarged U.S. trade deficit and unfulfilled market expectations of cuts in the Bundesbank’s official rates probably also weakened the dollar. On balance from mid-April to early September, the U.S. dollar rose by 5½ percent against the French franc and by 1 to 1½ percent against the deutsche mark, Italian lira, and pound sterling. The Japanese yen during this period appreciated by 7 to 12 percent against these currencies, and also appreciated further against the dollar (by about 6½ percent). Thus, the yen strengthened from 125 yen per dollar at the start of 1993 to 105 yen per dollar in early September, after approaching 100 yen per dollar in mid-August.

In nominal effective terms, the U.S. currency has depreciated by 1 percent compared with the assumptions underlying the May 1993 World Economic Outlook, but it has appreciated by 9½ percent since August 1992 (Chart 7). The Japanese yen has appreciated in nominal effective terms by 24½ percent since the beginning of the year, reflecting recent and prospective current account surpluses in Japan, and expectations of reduced interest rate differentials in favor of assets denominated in European currencies. Accompanying these movements, the nominal effective exchange rate of the deutsche mark declined during the first seven months of 1993; in real effective terms, however, it is still significantly above its 1987-92 average.

Chart 7.
Chart 7.

Major Industrial Countries: Nominal and Real Effective Exchange Rates

(Logarithmic scale; 1980 = 100; an increase indicates an appreciation of the currency)

1 Defined in terms of relative normalized unit labor costs in manufacturing, as estimated by the IMF’s Competitiveness Indicators System, using 1980 trade weights.2 Constructed using 1980 trade weights.

Since mid-April, short-term official and market interest rates in the United Kingdom and the United States have changed little, whereas in Japan market interest rates have declined by about 50 basis points (Chart 8). In Canada, the bank rate declined by about 30 basis points on balance, despite some increases in August in response to pressures on the Canadian currency. In Europe, short-term official and market interest rates have fluctuated considerably in recent months, rising in response to the pressures preceding the widening of the ERM intervention bands, and subsequently falling in most countries (see Chart 17 in Chapter III). The Bundesbank has gradually reduced official interest rates since end-March, cutting the discount rate by 1¼ percentage points and the Lombard rate by 1¾ percentage points—including cuts in both official rates of ½ of 1 percentage point, effective September 10. The most recent interest rate cuts announced by the Bundesbank were followed immediately by reductions in official interest rates in France, Belgium, Italy, Spain, and Austria. In France, short-term market interest rates have declined by over 2 percentage points since mid-April. Long-term interest rates have continued their downward trend, reflecting the adoption of significant budgetary consolidation measures in the United States and Germany, in particular; generally encouraging inflation prospects; and the scaling back of official and private growth forecasts (Chart 9).

Chart 8.
Chart 8.

Major Industrial Countries: Short-Term Interest Rates1

(In percent a year)

1 For the United States and Japan, three-month certificate of deposit rates; for Italy, three-month treasury bill rate; for Canada, three-month prime corporate paper rate; and for other countries, three-month interbank deposit rates. Monthly averages of daily observations are plotted for all countries other than Italy and Canada. For Italy, averages of results of fortnightly treasury bill auctions are shown. For Canada, monthly averages of weekly observations are plotted.
Chart 17.
Chart 17.

Selected European Countries: Short-Term Interest Rates1

(In percent)

1Weekly averages for Belgium, France, Germany, Netherlands, United Kingdom, and Sweden; monthly averages for others.
Chart 9.
Chart 9.

Major Industrial Countries: Long-Term Interest Rates1

(In percent a year)

1 Yields on government bonds with residual maturities of ten years or nearest. Monthly averages of daily data.

Many developing countries made further efforts to liberalize their foreign exchange systems in 1992 and the first half of 1993. Exchange rates were unified in the Islamic Republic of Iran in March 1993, resulting in a marked devaluation of the official rate. In Nigeria, earlier efforts to bring the official and parallel market rates together were partially reversed in February 1993, leading to a sizable increase in the spread between the two rates. High domestic price inflation led to large currency depreciations in Brazil, Sudan, and Zaïre during 1992 and early 1993, and smaller but significant depreciations in Ecuador, Peru, Turkey, Uruguay, and Venezuela. In Taiwan Province of China and in Malaysia, strong export performance and, in Malaysia, large capital inflows, contributed to significant exchange rate appreciations relative to the dollar during 1992, which were subsequently partially reversed. The Philippines eliminated virtually all foreign exchange restrictions during 1992, and in 1993 strong capital inflows were reflected in an appreciation of the exchange rate. In Argentina, the real exchange rate appreciated somewhat in 1992 and the first half of 1993.

Equity markets in the major industrial countries have shown considerable resilience since the beginning of 1993, with price indices up by 6 to 10 percent by early September in the United States and the United Kingdom and, in the remaining five countries, posting gains of 20 percent or more. Equity prices in Europe moved up sharply following the widening of the ERM bands, reflecting the anticipation of lower interest rates in Europe and the prospects for monetary policies to become more attuned to domestic needs. More generally, the relative strength in equity markets since the beginning of 1993 contrasts with the weakening of activity in continental Europe and Japan and the risk this poses for activity in other industrial countries. The equity price increases reflect in part the lowering of interest rates during 1993, but may also indicate that the beneficial effects of reforms and business restructuring in a number of countries are expected to increase activity and raise business profits in the period ahead.

The emerging stock markets in developing countries displayed considerably greater variability than equity markets in industrial countries.9 The largest gains in the first half of 1993, in dollar terms, were in Turkey, where the stock market index rose by 29 percent in the first quarter and a further 64 percent in the second quarter, and in Brazil, where the stock market index increased by 23 percent in the first quarter and by 31 percent in the second quarter. In both countries, the increases reflected increased foreign portfolio investment, favorable market expectations, and, in Turkey, lower interest rates. A large first-quarter increase in stock prices in Taiwan Province of China, partly in response to the outcome of parliamentary elections in February, was partially reversed in the second quarter. In Nigeria, fluctuations in the exchange rate during the first half of the year led to large stock price swings in dollar terms, with only a small net change over the period. Political uncertainties in Venezuela contributed to a 26 percent decline in stock prices in the first quarter, but this decline was reversed in the second quarter as the political situation improved.

External Payments, Financing, and Debt

Projections for world trade growth in 1993 have been lowered to 3 percent, mainly because of lower demand growth in European countries, but trade, like output, is expected to expand at a more rapid pace in 1994.10 Continued expansion of trade among the developing countries has helped to sustain world trade despite the weakness of activity in industrial countries. Intraregional exports as a share of total exports have risen particularly rapidly in Asia and have recovered in the Western Hemisphere to levels comparable to those prevailing before the debt crisis (Chart 10).

Chart 10.
Chart 10.

Developing Countries: Shares of Intraregional Trade in Total Trade1

1 Exports to other countries within the region as a percentage of total exports.

The current account deficit of the United States widened to 1 percent of GDP in 1992, reflecting in part the end of transfers from other countries associated with financing the regional conflict in the Middle East (Chart 11). The U.S. current account deficit is expected to widen to 1¾ percent of GDP in 1993-94, owing to growing cyclical disparities among industrial countries and on the assumption of unchanged real effective exchange rates. Japan’s current account surplus is projected to remain high in 1993 mainly as a result of weak import demand associated with the recession, lower oil prices, and the initial J-curve effects from the strong appreciation of the yen (Box 2); stronger domestic demand and the volume effects of the recent appreciation of the yen, however, should reduce the surplus slightly in 1994. Germany’s current account deficit is projected to increase to about 1½ percent of GDP in 1993 and 1994, mainly because of weak export performance. The current account deficits in Italy and Canada are expected to narrow in 1993 and 1994—in Italy because of slow growth in domestic demand and the depreciation of the lira, and in Canada because of strength in the U.S. export market and improved competitiveness. The U.K. current account deficit is projected to widen further, despite the depreciation of the pound sterling, as import growth remains high with the recovery of demand. Among the smaller industrial countries, large current account deficits are projected to persist in 1993 in Finland, to increase in Australia, and to decline somewhat but remain high relative to GDP in Greece, Iceland, and Spain.

Chart 11.
Chart 11.

Major Industrial Countries: Current Account Positions

(In percent of GDP)

1 Before 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. Blue shaded areas indicate staff projections.

The developing countries’ aggregate current account deficit is projected to increase in 1993 to $80 billion, about 1½ percent of aggregate GDP in the developing countries. A large component of the change in the aggregate current account reflects the fall in surpluses or increase in deficits in several countries in Asia, where the late 1980s pattern of large net outflows of capital has been reversed. China’s current account is projected to move into deficit in 1993 as high growth in output and in demand for imported capital goods continues. External surpluses are expected to decline in 1993 in Hong Kong and Taiwan Province of China, and the deficit in Thailand is projected to widen, due to the continuing strength of domestic activity and relatively weak export demand. Efforts to restrain excessive demand growth in Korea are expected to narrow the current account deficit in 1993. In the Western Hemisphere, large current account deficits, associated with capital inflows, are projected to persist in 1993 in Argentina and Mexico. Current account balances are expected to deteriorate somewhat in Africa in 1993, owing to stagnant exports and adverse movement in the terms of trade in some countries; they are projected to improve slightly in the Middle East and Europe region, mainly as the result of efforts to reduce imbalances in Saudi Arabia.

Foreign reserves are expected to increase in all developing country regions in 1993, but this will occur at a slower pace than earlier in Asia and the Western Hemisphere. Net financial flows to developing countries—comprising official transfers, direct investment, and external borrowing—are projected to increase slightly in 1993 to $115 billion. This small increase largely reflects offsetting movements in the Western Hemisphere—where net external borrowing declined, particularly in Brazil—and in Asia—where borrowing, primarily short-term trade credit, increased, particularly in China and Taiwan Province of China (Chart 12). For 1994, net financial flows to developing countries are expected to increase somewhat as net external borrowing remains high in Asia and rises above its 1992 level in the Western Hemisphere. Direct investment as a share of non-debt-creating flows has recovered in the Western Hemisphere to the level prevailing before the debt crisis, around 90 percent; in Asia it has increased from 50 percent in 1979 to an expected 85 percent in 1993. In Africa direct investment is projected to account for only 17½ percent of the total in 1993 (see Chapter V).

Chart 12.
Chart 12.

Developing Countries and Countries in Transition: Net External Financing Flows

(In billions of U.S. dollars)

1The sum (with opposite sign) of balance on current account, excluding official transfers, change in reserves, asset transactions, and errors and omissions, net. See the Statistical Appendix, Table A32.2The sum of official transfers and direct investment.

The aggregate current account deficit of the countries in transition increased on net in 1992 to $4 billion, because the increase in the aggregate deficit in the countries of the former Soviet Union was partially offset by the reduction in the aggregate deficit in central European countries in transition. For 1993, the aggregate deficit is projected to increase significantly to $15 billion, in part as a result of the projected financial flows to Russia. The worsening of the trade balances of the central European countries in transition reflects weakness in European export markets, stronger domestic demand in some cases, and significant capital inflows. Prospects for future export growth have improved following the European Council decision at the June 1993 Copenhagen Summit to accelerate trade liberalization with the central European countries in transition. Net financial flows to the countries in transition reached $22 billion in 1992 and are projected to grow further to $30 billion in 1993 because of increased financial assistance (including rescheduling of official debt).

Total debt (excluding IMF credit) of the developing countries as a percent of exports of goods and services is projected to continue the declining trend apparent since 1986, falling to just above 107 percent by 1994 (Chart 13; see also Box 5 in Chapter V). Contrary to the significant declines in debtexport and debt-service-to-export ratios in other regions, the situation for African countries is projected to show only a slight improvement. The debt export ratio for sub-Saharan countries is projected to increase further in 1993, to almost 400 percent. The debt-export ratio of countries in transition is expected to increase to over 147 percent in 1993 before declining to 142 percent in 1994; the decline in the debt-service-to-export ratio in 1992-93 reflects partly the temporary effects of debt reschedulings, but the ratio is expected to rise substantially in 1994.

Chart 13.
Chart 13.

Developing Countries and Countries in Transition: External Debt and Debt Service1

(In percent of exports of goods and services)

1Debt service refers to actual payments of interest on total debt plus actual amortization payments on long-term debt. The projections (blue shaded areas) incorporate the impact of exceptional financing items.

Japan’s Trade Surplus

There are widespread concerns that Japan’s international economic policies and institutions differ fundamentally from those of other industrial countries and that these differences hamper international competition. At the macroeconomic level, Japan’s persistent trade and current account surpluses are viewed as a destabilizing influence on Japan’s trading partners. At the microeconomic level, it is frequently alleged that Japan’s markets are much more difficult to penetrate than those of other developed countries.

From a macroeconomic perspective, there is nothing surprising about Japan’s surpluses, which reflect international differences in saving and investment (see Table 11 in Chapter IV). High national saving in Japan naturally entails a net flow of capital from Japan to the rest of the world, which has its counterpart in Japanese current account surpluses. Rising international capital mobility in the 1980s also contributed to the widening of current account balances by increasing the scope for transferring savings from Japan to other countries.

Real exchange rates are a key link in current account adjustment. In Japan, as in the United States, the current account typically responds to exchange rate changes with about a two-year lag (see chart). Some of the controversy over the effects of the exchange rate changes that occurred in the late 1980s seems to have arisen from these long lags. The striking extent of the adjustment in Japan since the yen’s sustained appreciation beginning in mid-1985 is evidenced by the growth of trade volumes. Between 1986 and 1991, Japan’s export volume growth was only 2 ¾ percent a year, compared with the industrial country average of 5 percent and U.S. export growth of 10 percent. Similarly, Japan’s import volume growth during this period averaged 8½ percent a year, compared with the industrial country average of 6¼ percent and the U.S. average of 4 percent. More generally, there is strong evidence that the evolution of the Japanese current account can be explained by macroeconomic factors such as the business cycle, the determinants of national saving and investment, and exchange rates.1

uch02fig01

Japan: Real Effective Exchange Rate and Current Account Balance1

1 Blue shaded area indicates staff projections.

A key issue in the debate is the nature of Japan’s trade policy and its possible effects on trade patterns—although trade policy would not be expected to significantly affect the trade balance, which is primarily determined by macroeconomic factors. Japan’s level of tariffs and quotas is lower than that of most other industrial countries, except in agriculture. The importance of intangible barriers to the Japanese market is more controversial because, by their nature, such barriers are difficult to assess directly. There are numerous anecdotes and case studies reporting substantial intangible barriers to the Japanese market, but there is also evidence that at least some foreign firms have not found such barriers difficult to cross. A 1991 survey conducted by the American Chamber of Commerce in Japan, for example, revealed that 52 percent of U.S. firms in Japan viewed the environment in Japan as favorable or somewhat favorable for their business, and only 18 percent viewed it as unfavorable. Several recent studies find that the existence of informal industrial groups (keiretsu) have a negative effect on imports. It is difficult to determine whether this reflects efficient organization of activities among firms in the group or restraint of trade. The empirical evidence on the role of the keiretsu and their impact on international trade is mixed.2

Major Industrial Countries: Imports and Exports of Goods and Nonfactor Services

(In percent of GDP)

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It is clear, however, that Japan’s exports and imports are lower in relation to GDP than those of other large industrial countries, except for the United States (see table). Moreover, intra-industry trade and the level of inward foreign direct investment in Japan are much smaller than those in other industrial countries. A number of studies have attempted to determine whether Japan’s level and pattern of trade can be explained by country characteristics such as size, location, and natural resource endowment. These studies have arrived at conflicting conclusions: most find that Japan’s imports of manufactures are unusually small, but others conclude that Japan’s total trade is normal and that Japanese trading patterns are consistent with Japan’s factor endowments.3

Another approach to the issue of invisible barriers is to examine differences in prices of similar goods in Japan and elsewhere, since these might indicate implicit protection. There is a widespread belief, for example, that Japanese-produced goods are cheaper in the United States than in Japan—the so-called “47th Street Photo phenomenon”—although Saxonhouse argues that this is not the case.4 It is true, however, that imported goods in Japan are more expensive than in their home markets, but this pattern need not imply protection if the pricing practices of foreign firms in Japan are responsible. In any case, international price divergences are widespread in all countries.

In summary, the evidence suggests that macroeconomic forces—saving, investment, and exchange rates—can adequately account for most of the movements in the Japanese current account. The pattern of Japanese trade, however, differs in important respects from that of other countries. The differences are likely to reflect mainly the workings of comparative advantage, given Japan’s relative lack of natural resources and distance from major markets. The role of subtle or hidden trade barriers has been difficult to establish. Trade-opening measures are important in Japan—as in other countries—to increase efficiency and enhance welfare. But they cannot be expected to alter substantially the pattern of external balances among countries in the absence of changes in national saving rates relative to domestic investment opportunities.

1See Guy Meredith, “Revisiting Japan’s External Adjustment Since 1985,” IMF Working Paper 93/52 (June 1993); and Paul R. Krugman, “Has the Adjustment Process Worked?” in International Adjustment and Financing: The Lessons of 1985-1991, edited by C. Fred Bergsten (Washington: Institute for International Economics, 1991).2See Robert Z. Lawrence, “Efficient or Exclusionist? The Import Behavior of Japanese Corporate Groups,” Brookings Papers on Economic Activity: 1 (1991), pp. 311-41, who finds that the keiretsu restrict trade; Gary R. Saxonhouse, “What Does Japanese Trade Structure Tell Us About Japanese Trade Policy?” Journal of Economic Perspectives, Vol. 7 (Summer 1993), pp. 21-43, who argues that Lawrence’s methodology is flawed and that the keiretsu do not distort trade; and Daniel A. Citrin, “Japanese Corporate Groups and Imports,” IMF Paper on Policy Analysis and Assessment 92/2 (August 1992), who also concludes that Lawrence’s methodology is flawed, and that the data do not indicate a clear intra-keiretsu bias.3For a survey, see C. Fred Bergsten and Marcus Noland, Reconcilable Differences? United States-Japan Economic Conflict (Washington: Institute for International Economics, 1993), Chapter 5; and Luca Barbone, “Is Japan an Underimporter? Some Contrasting Results,” OECD Economic Studies, No. 11 (Autumn 1988), pp. 155-68.4See Saxonhouse, “What Does Japanese Trade Structure Tell Us About Trade Policy?”

Several debt-restructuring agreements have been concluded so far in 1993 by official bilateral creditors. Paris Club creditors granted debt relief to four middle-income countries (Costa Rica, Guatemala, Jamaica, and Peru) and to five low-income countries (Benin, Burkina Faso, Guyana, Mauritania, and Mozambique). Official bilateral creditors also concluded a rescheduling agreement with Russia, covering some $15 billion of arrears and debt-service payments falling due through end-1993 on debt of the former Soviet Union. Commercial bank creditors have reached an agreement on terms with Brazil on a $35 billion debt-relief package, as well as with the Dominican Republic and Jordan, and negotiations continue with several other countries.

The major industrial countries are placing new emphasis on the debt problems of the poorest highly indebted countries. Authorities in the United Kingdom and France, in particular, have called for a significant increase in official debt relief for these countries, to two-thirds or three-quarters of existing debt. At the July Summit in Tokyo, the major industrial countries confirmed the validity of the international debt strategy and encouraged further review by the Paris Club of debt relief for the poorest highly indebted countries. The earlier announcement by the United States of an initiative to write off half the debts owed to it by 18 of the poorest countries in Africa was welcomed at the Summit as an important step.

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    Major Industrial Countries: Real GDP1

    (Percent change from four quarters earlier)

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    Major Industrial Countries: Output Gaps1

    (Actual less potential output, as a percent of potential)

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    Developing Countries: Real GDP1

    (Annual percent change)

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    Consumer Prices and Commodity Prices

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    European Monetary System: Interest Rate Differentials vis-à-vis Germany

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    Major Industrial Countries: Nominal and Real Effective Exchange Rates

    (Logarithmic scale; 1980 = 100; an increase indicates an appreciation of the currency)

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    Major Industrial Countries: Short-Term Interest Rates1

    (In percent a year)

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    Selected European Countries: Short-Term Interest Rates1

    (In percent)

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    Major Industrial Countries: Long-Term Interest Rates1

    (In percent a year)

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    Developing Countries: Shares of Intraregional Trade in Total Trade1

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    Major Industrial Countries: Current Account Positions

    (In percent of GDP)

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    Developing Countries and Countries in Transition: Net External Financing Flows

    (In billions of U.S. dollars)

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    Developing Countries and Countries in Transition: External Debt and Debt Service1

    (In percent of exports of goods and services)

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    Japan: Real Effective Exchange Rate and Current Account Balance1