Latin America in a Global Context - Economic Briefing January 2003

Outlook for Global Growth Continues to Deteriorate

Economists remain sceptical about the potential for recovery in 2003. With the exception of non-Japan Asia, all regions seem to lack the necessary impetus to rekindle economic growth. The Japanese economy continues to ail along, as the government fails to address the fundamental misalignments. With fiscal deficits running high and persistent inflationary pressures, Europe lacks the ability to rekindle growth with classic policy tools. Meanwhile, the U.S. economy benefits from policies that could hardly be more stimulating, as the Bush administration has announced yet another economic stimulus package.

Global outlook weakens amid wide-spread pessimism
The sentiment over the global economy continues to deteriorate. Compared to last month, the average forecast for global economic output growth this year dropped one tenth of a percentage point to 2.5% from 2.6% in December. The downward revision in global economic growth followed on lower growth forecasts for virtually all economic regions. With the exception of the United States, where the 2003 growth projection is unchanged from last month, all regions suffered from an increasingly negative outlook. Europe once again led the pack, with the average forecast for economic growth this year slashed another 0.14 percentage points over last month. This month’s cut continues a series of downward revisions, which was only halted briefly last month, when projections remained stable. Japan is also seen a notch more pessimistically, as Consensus Forecast panellists lowered their outlook to the current 0.8%, with non-Japan Asia suffering a downward revision of the same magnitude. Finally, Latin America mirrors the global forecast, with the projection for economic recovery in 2003 lowered from 2.6% in December to the current 2.5%.

United States presents mixed bag of news
In the United States, current economic indicators present a mixed image of the country’s economic state of play. Revised estimates released by the Bureau of Economic Analysis confirmed that the U.S. economy expanded at a healthy annual 4.0% clip in the third quarter, following on 1.3% growth in the second quarter. However, the third quarter pace of economic growth seems unsustainable and most analysts expect a significant slowdown in the final quarter of 2002. The latest indicators support this view. According to December unemployment data, the already troubled labour market took a turn for the worse. While the unemployment rate remained stable at 6.0% (an eight-year high), the economy lost 101,000 jobs - the largest drop since February 2002 and in contrast to expectations that companies would add to their workforces. The jobless data indicate a weak retail season, which should translate into a notable slowdown of consumption in the final quarter.

Expansive fiscal and monetary policies underpin U.S. economy but …
Even with a slowdown, the U.S. economy is still set to grow by 2.6% in 2003, a pace that would represent a notable recovery in most other regions. Key behind the resilient growth is the economic policy setting that could hardly be more encouraging. In December, the Federal Reserve Bank left its key interest rate unchanged at a 41-year low and the Bush administration has presented yet another giant economic stimulus package. On 7 January, President Bush unveiled a number of measures, which aim to invigorate the economy by encouraging consumer spending, promoting investment and helping the unemployed. Key measures eliminate the taxation of most stock dividends for individual taxpayers, increase the child tax credit from US$ 600 to US$ 1,000 and accelerate tax rate cuts scheduled for 2004 and 2006 to this year, with the reductions retroactive to 1 January. According to the government, the package represents US$ 98 billion in tax relief over the next 16 months and US$ 674 billion over the next ten years. If sanctioned by Congress, the plan - in combination with last year’s tax reductions - would bring total tax cuts to more than US$ 2 trillion over a decade. Democrats have criticized the measures for disproportionately benefiting the wealthy. With strong support for the President in both houses, the package is likely to be passed without substantial changes from the opposition.

… Weak spots in U.S. economy may jeopardise recovery
Despite this overall positive picture, some weak spots in the U.S. economy remain present. Massive tax reductions of the Bush administration have reversed the trend of an ever sounder fiscal policy. Amid the US$ 2 trillion tax reductions over the decade, perceptions of the public finances are deteriorating rapidly. Analysts see the fiscal deficit rising from a 1.4% of GDP surplus in 2001 to a 1.5% deficit in 2002, rising further to a 2.0% of GDP deficit this year. Moreover, some observers also claim that real estate prices are unsustainably high. If real estate prices were to come under significant pressure this would add to the already sizeable loss of wealth resulting from the financial asset price erosion in the past years and may finally break the American consumer, who has been the unrelenting backbone of the economy during the weak periods of the current business cycle. Finally, the external balances have repeatedly drawn attention, particularly when looking at the economy over the longer term. Currently, the Consensus sees the U.S. current account deficit at 4.6% of GDP in 2003, following on a 4.7% deficit in 2002. Certainly, the special function of the US$ in the world economy renders a current account deficit of this magnitude less menacing than for a “normal” economy. Moreover, in the past, the enormous capital inflow were virtually always sufficient to cover current account shortfalls. Nevertheless, the persistent imbalance could eventually trigger a substantial weakening of the exchange rate, with notable consequences for the European and Japanese economies, which depend largely on the U.S. demand to rekindle their sluggish economies.