Abstract
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World Economic Outlook
Global economic growth in 2004, at 5.1 percent, was the highest in decades, announced Raghuram Rajan, IMF Economic Counsellor and Director of the Research Department, at an April 13 press conference releasing the April 2005 World Economic Outlook (WEO). The WEO projects 4.3 percent growth in 2005, which is close to the trend rate, but higher and volatile oil prices, rising interest rates, and widening current account imbalances mean the risk to that projection is tilted to the downside. And there has been increasing divergence in growth across regions: the expansion is still overly dependent on growth in the United States and emerging Asia, while sustained recovery is yet to be seen in the euro area and Japan.
Regional prospects
The U.S. economy “continues to hum,” noted Rajan: annual GDP growth of 3.6 percent is projected for both 2005 and 2006. The WEO projects a moderation in private consumption, reflecting a withdrawal of fiscal and monetary stimulus, offset by continued strength in investment.
In the euro area, the modest expansion that seemed to be under way during the first half of 2004 hit the rails in the second half of the year, Rajan said. Weak domestic demand was compounded by weak export growth. The WEO now projects 1.6 percent growth in 2005, down from 2.2 percent projected in September.
The Japanese economy continues to be moody, Rajan remarked. In 2004, ebullience in the first quarter gave way to despondency in the rest of the year. However, underlying fundamentals have improved, and the WEO expects the economy will record growth of 0.8 percent in 2005, rising to 1.9 percent in 2006.
The two fast-growing emerging giants—India and China—have contrasting problems related to investment, Rajan noted. Investment in China accounted for an extraordinary 45 percent of GDP in 2004, and the government is concerned about the quality of this investment. In this regard, reforms in the financial sector and in public enterprises will be critical, while greater exchange rate flexibility could also help. By contrast, India needs more investment, especially in infrastructure, said Rajan. To create room in the already overstretched government budget, the authorities will have to rationalize expenditures and expand revenues. They will also have to strengthen policy frameworks to raise investment by the private sector.
Other regions of the world have also been growing robustly. One of the brightest spots in the current global recovery, Rajan said, has been sub-Saharan Africa, where growth accelerated to over 5 percent in 2004—the highest in almost a decade. The WEO expects growth prospects in Africa to remain favorable in 2005 and 2006.
In Latin America, Brazil performed notably well in 2004, with growth of 5.2 percent—partly thanks to the fiscal and structural reforms the government has implemented. The monetary authorities have appropriately responded to higher inflation by raising interest rates, and the balance between fiscal and monetary policy seems reasonable. High interest rates, Rajan said, signal the need for a greater focus on structural reforms to improve the functioning of the financial sector.
On the rise
Global real long-term interest rates are incteasing.
(percent1)
Citation: IMF Survey 34, 007; 10.5089/9781451938456.023.A006
Note: Shaded area indicates IMF staff projections.1GDP-weighted average on long-term government bond yields minus inflation rates for the United States, Japan, Germany, France, Italy, the United Kingdom, and Canada.Data: IMF, World Economic Outlook, April 2005.On the rise
Global real long-term interest rates are incteasing.
(percent1)
Citation: IMF Survey 34, 007; 10.5089/9781451938456.023.A006
Note: Shaded area indicates IMF staff projections.1GDP-weighted average on long-term government bond yields minus inflation rates for the United States, Japan, Germany, France, Italy, the United Kingdom, and Canada.Data: IMF, World Economic Outlook, April 2005.On the rise
Global real long-term interest rates are incteasing.
(percent1)
Citation: IMF Survey 34, 007; 10.5089/9781451938456.023.A006
Note: Shaded area indicates IMF staff projections.1GDP-weighted average on long-term government bond yields minus inflation rates for the United States, Japan, Germany, France, Italy, the United Kingdom, and Canada.Data: IMF, World Economic Outlook, April 2005.Risky business: interest rates, oil, and imbalances
The projection of robust growth in the world economy is framed by significant risks, however. Rajan cited higher interest rates, high and volatile oil prices, and increasing current account imbalances, adding that these risks must be viewed in the context of two important medium-term transitions now taking place: the increasing economic importance of developing countries and the aging of industrial country populations. Too little is being done to adjust to these transitions, and current risks reflect this.
Developing and emerging market countries will account for an increasingly important share of world GDP, noted Rajan. Not only is GDP in these countries more volatile, but it will also be more commodity-intensive. Even by conservative estimates, China should see car ownership multiply 15 times over the next quarter-century, and India will not be far behind. While the spectacular growth of these countries will benefit all, it will also strain existing resources.
The second major transition is the aging of populations in the rich industrial countries. Not only should these countries be restructuring their own work environment to make better use of the changing labor force, Rajan observed, but also many of them should be sending capital to younger, poorer developing countries. “This will enable Adrian and Becky to draw on their foreign investments in their old age,” Rajan remarked, “even while the younger, increasingly skilled Abebe or Nafisa receive the capital to remain productive today.” Rich countries should be saving more and running current account surpluses, and poor countries should be investing more, and running larger current account deficits.
Instead, capital is flowing in the wrong direction nowadays; emerging markets are financing the rich (see table). The problem with global imbalances is not just the small but costly risk that financial markets will become wary of financing the U.S. current account deficit but also the fact that the direction of capital flows does not match what is needed given demographic trends. Markets will eventually deal with both the resource crunch and the global real-location of capital, but governments have to help markets work better by removing impediments.
All regions have a part to play
Turning to global payments imbalances, Rajan stressed that all regions have a role in correcting them. Everyone seems to agree on that, he noted, but their attitudes toward the attendant policy changes seem much like St. Augustine’s “Lord, give me chastity, but not just yet.” A mutually agreed, credible, multilateral framework for policy action, with specifics on measures and timing, would help keep markets calm.
The United States needs to save more, Rajan said. The worthy intent of halving the fiscal deficit by 2009 needs to be backed by credible measures to achieve it. The U.S. consumer who has bought the world out of recession needs to rest a bit now and save more. Monetary policy could help if higher interest rates lead to greater household saving.
A number of emerging markets, especially in Asia, have built up enough reserves to protect against everything short of the Apocalypse, joked Rajan. The reserve buildup is now undermining monetary control. These countries, he said, need to introduce greater exchange rate flexibility, which would slow reserve buildup and allow countries to regain monetary control. Financial sector reforms to allocate capital more transparently and profitably would also increase the returns to investment. This should not only lead to higher investment but also reduce the need to save, allowing imported capital to fill the gap. Capital could then flow again in the desired direction.
Europe and Japan will have to help out too, Rajan said, by growing faster. Europe simply cannot afford its welfare state, while Japan will have difficulty dealing with its fiscal problems. Structural reforms to increase competition and flexibility are essential. When call centers are helping firms around the world squeeze 24 hours into a working day, Europe should not still be debating stretching 35 hours into a working week.
Politicians typically deal only with the painfully immediate, Rajan observed. Thus far, the periods of foreign exchange or oil price volatility have been relatively brief and the resulting pain muted, so politicians have not been forced to focus on those issues. But the world economy is running out of time; markets may not be willing to wait until after the next election. Rajan emphasized that action is needed now.
Widening current account imbalances
Emerging markets are financing the rich countries.
(percent of GDP)
Projections.
Includes Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States.
Corrected for reporting discrepancies in intra-area transactions.
Data: IMF, World Economic Outlook, April 2005.
Emerging markets are financing the rich countries.
(percent of GDP)
| 2003 | 2004 | 20051 | 20061 | |||
|---|---|---|---|---|---|---|
| Major advanced economies2 | -1.6 | -1.7 | -1.9 | -1.8 | ||
| United States | -4.8 | -5.7 | -5.8 | -5.7 | ||
| Euro area3 | 0.3 | 0.6 | 0.4 | 0.4 | ||
| Japan | 3.2 | 3.7 | 3.3 | 3.5 | ||
| United Kingdom | -1.7 | -2.2 | -2.3 | -2.4 | ||
| Canada | 2.0 | 2.6 | 2.6 | 2.5 | ||
| Newly industrialized | ||||||
| Asian economies | 7.4 | 7.1 | 6.8 | 6.2 | ||
| Korea | 2.0 | 3.9 | 3.6 | 2.9 | ||
| Taiwan Province of China | 10.2 | 6.2 | 6.6 | 5.9 | ||
| Hong Kong SAR | 10.3 | 9.6 | 9.4 | 9.3 | ||
| Singapore | 29.2 | 26.1 | 23.4 | 22.9 | ||
Projections.
Includes Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States.
Corrected for reporting discrepancies in intra-area transactions.
Data: IMF, World Economic Outlook, April 2005.
Emerging markets are financing the rich countries.
(percent of GDP)
| 2003 | 2004 | 20051 | 20061 | |||
|---|---|---|---|---|---|---|
| Major advanced economies2 | -1.6 | -1.7 | -1.9 | -1.8 | ||
| United States | -4.8 | -5.7 | -5.8 | -5.7 | ||
| Euro area3 | 0.3 | 0.6 | 0.4 | 0.4 | ||
| Japan | 3.2 | 3.7 | 3.3 | 3.5 | ||
| United Kingdom | -1.7 | -2.2 | -2.3 | -2.4 | ||
| Canada | 2.0 | 2.6 | 2.6 | 2.5 | ||
| Newly industrialized | ||||||
| Asian economies | 7.4 | 7.1 | 6.8 | 6.2 | ||
| Korea | 2.0 | 3.9 | 3.6 | 2.9 | ||
| Taiwan Province of China | 10.2 | 6.2 | 6.6 | 5.9 | ||
| Hong Kong SAR | 10.3 | 9.6 | 9.4 | 9.3 | ||
| Singapore | 29.2 | 26.1 | 23.4 | 22.9 | ||
Projections.
Includes Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States.
Corrected for reporting discrepancies in intra-area transactions.
Data: IMF, World Economic Outlook, April 2005.
Copies of the April 2005 World Economic Outlook are available for $49.00 each ($46.00 academic price) from IMF Publications Services. The full text of the latest issue of the World Economic Outlook is available on the IMF’s website (http://www.imf.org).
