Latin America in a Global Context - Economic Briefing April 2003

War Over But Concerns Over Global Economy Remain

The risk of war has ceased to loom over the global economic outlook.  However, even though the military conflict has not been protracted as outlined in some worst case scenarios the surge of optimism some analysts had hoped for has not realised.  Yes, the oil price has dropped quickly to a four-month low as anticipated but this is perceived as insufficient to rekindle global growth to full potential.  In fact, the assessment for this year’s global economy has deteriorated further since last month.  With Japan and Germany mired in persistent economic slumps, the global economy continues to depend on the United States to pull it clear from sluggishness.  But even though policy measures could hardly be more stimulating in the U.S. economy is likely to grow at a slower pace than last year, as the pace of private consumption, which buttressed the economy last year, seems unsustainable. 

Eyes turn to economy as war draws to an end
The war in Iraq, which had not even begun at the time of writing last month’s edition of the LatinFocus Consensus Forecast, is virtually over. Occasional resistance may still be flaring up in Iraq but the military campaign has ended. Baghdad has fallen into the hands of the Anglo-US coalition forces without a major protracted battle that some military experts had anticipated. Without the Iraq war looming over the global economic outlook, eyes are again turning to economic fundamentals. However, economists do not appear to like the picture that is emerging. Compared to last month’s edition, the Consensus panel lowered the forecast for global economic growth by 0.2 percentage points. This month’s downgrade continues the series of ever increasing pessimism, which began in June 2002. So far, with the exception of February, the output growth forecast has suffered successive monthly cuts. The global economy is now seen expanding only 2.2% this year, below the 2.5% threshold which some analysts interpret as a recession.

IMF lowers forecast for this year’s global growth close to recession levels
The current International Monetary Fund (IMF) estimate, which was released in the World Economic Outlook on 9 April, sees global economic growth at 3.2% this year. However, the figure refers to global output growth, when calculating individual countries’ weight based on purchasing power parity (PPP) as opposed to the current US$ weights underlying the LatinFocus Consensus Forecast. The IMF’s exchange rate weighted outlook for this year also anticipates global growth at 2.2%. Just as the market consensus, the IMF has applied severe cuts over the past months. Since is latest World Economic Outlook from September 2002, the Fund has sliced half a percentage point from the global outlook. The Fund’s economists lowered their forecasts, as the pace of the recovery, which had seized many economies in mid-2002 and which had fuelled hopes for a sound rebound this year, has slowed, particularly in industrial countries. According to the IMF, the main factors behind the slump were increased uncertainty in the run-up to war in Iraq and the continued adverse effects from the bursting of the equity market bubble. As a result, industrial production has stagnated in the major advanced countries and growth in global trade has slowed. Moreover, labour market conditions remain soft and forward-looking indicators have generally weakened. This could exert additional pressure on private consumption, which had been the main backbone of demand in the current business cycle. If consumption falters, the global economy could face a recession, since global fixed investment does not yet appear strong enough to sustain a recovery. While not yet clear at the time of writing the World Economic Outlook, the IMF’s baseline projections correctly assumes that the uncertainties surrounding the conflict in Iraq will generally be resolved in the near term. Furthermore, the spill-over is likely to be contained to the region, while the global economic impact will be limited. That said, the IMF states that on balance the risks remain distinctly on the downside. The IMF does not discard further declines in financial markets with the corresponding direct downside effects on demand and pressures on financial institutions. Furthermore, the Fund also identifies the dependence of the global recovery on the outlook for the United States as another major risk factor. With Japan and Germany mired in economic slumps, the United States remains as the only growth motor in the industrialised world. This dependence bears the risk of increasing global imbalances, notably a further ballooning in U.S. current account deficit with the corresponding surpluses in Japan and the Euro Area. These imbalances are causing increased concern, especially since the fiscal position in the United States is rapidly deteriorating. Historical experience suggests that an adjustment of the U.S. current account deficit is likely be accompanied by lower U.S. growth and a weakening of the currency, which could send export-dependent countries into a more exacerbated downslide.

Euro Area and Latin America most affected regions by downward revision
The IMF’s cuts have been concentrated in the industrial world, with the brunt taken by the Euro Area forecast for 2003, which was more than halved from 2.3% in March to the current 1.1%. Germany is the main factor behind the downward adjustment. The country accounts for almost one third of the Euro Area’s economy. The IMF has lowered its forecast for Germany a full 1.5 percentage points to just 0.5% growth in 2003, as industrial production, business confidence and retail sales continue to slump. Moreover, with monetary policy no longer a tool for national policy making and fiscal balances strained, the country lacks the means to rekindle growth. In fact, in order to meet the criteria of the European Stability Pact, Germany has to cut fiscal spending, which the government hopes to achieve in part through higher taxes and social security payments. The IMF also lowered the outlook for France, reflecting weak consumer confidence and the soft labour market, whereas subdued consumer and business confidence suggest that economic activity in Italy will pickup slower than previously anticipated by the Fund.