Latin America in a Global Context - Economic Briefing September 2003

Increasing Optimism for Global Economy

Optimism for the global economy is rising again. However, output growth will barely be above last year’s level, with the forecasts for global economic growth this year are hovering around levels considered by many as a recession. The United States will grow at subdued rates despite unprecedented policy stimulus, which sent interest rates to decade-lows and a fiscal deficit that would raise concerns if observed in a Latin American economy. The major European economies are hanging at the brink of recession but with inflation hovering around monetary authorities’ ceiling, further interest rate cuts are unlikely to stimulate the ailing Euro Area economy. On a positive note, the outlook for Japan, is seen much more optimistically, as the economy is propelled by robust external demand. Finally, the prospects for economic growth in the Latin American region are disappointing, as the regional behemoth, Brazil will grow less than expected.

Changing trend in global growth forecast
The series of downward revisions to the global outlook, which has characterised most of the year is drawing to an end. In fact, the average forecast for global output growth this year rose for the first time in more than a year, moving from 2.0% growth expected last month to the current 2.1%. Compared to last month, both the United States and non-Japan Asia are seen a notch more optimistically. The positive surprise came from Japan, where the growth outlook for this year was lifted half a percentage point from 0.8% expected last month to the current 1.3%, as recent data suggest a more resilient economy in the second half of the year. On the downside, the projection for Europe was lowered yet again and according to this month’s forecast, as the Euro Area economy is seen expanding a dismal 0.6% in 2003. Finally, despite positive signs in some Latin American countries, the average outlook has worsened yet again, as the outlook for the regional behemoth, Brazil, deteriorated significantly over last month.

U.S. second quarter growth revised upwards
In the United States, evidence is accumulating that the tentative and erratic recovery of the first half is taking a firmer hold over the economy in the second half, as indicators released in the last month mostly paint a more positive image than expected earlier. The Bureau of Economic Analysis reported that gross domestic product (GDP) increased at an even higher rate than the advance estimate of 2.4% released last month. According to the preliminary estimates, the economy expanded at an annual rate of 3.1% in the second quarter. The reading came in ahead of market expectations, which had been raised to 2.9% after the advance estimate, and is more than twice the 1.4% growth rate observed in the first quarter. The adjustment primarily reflected an upward revision to personal consumption and business investment but also in defence spending. Strong increases in military spending had constituted the key driver behind the second quarter growth. Military spending posted its biggest three-month increase since the Korean War (1951), adding a whopping 45.9% in seasonally adjusted annual terms (previously reported: 44.1%). Without the contribution from national defence, GDP growth would have been just 1.4% in the second quarter and actually below the defence-adjusted 1.6% growth in the first quarter.

Outlook for economic growth this year revised upwards but at the cost of a rising fiscal deficit
Apart from consumer confidence, which dropped slightly in August, most recent economic data releases point upwards, prompting the economists surveyed to raise their GDP outlook for this year a notch over last month to 2.3%. The seasonally adjusted unemployment rate fell from 6.2% in July to 6.1% in August, even though payrolls declined for the seventh consecutive month by another 93,000. Furthermore, in July, consumer spending rose by 0.8%, up from 0.6% in June, the largest increase in four months and personal disposable income increased US$ 120.3 billion (+1.5%), which is up from a US$ 30.6 billion (0.4%) increase in the previous month. Consumers are benefiting from funds freed up by mortgage refinancing and the massive tax cuts implemented by the Bush administration. However, the extra stimulus is not without a cost. Analysts are becoming increasingly concerned about the ballooning fiscal deficit. Since May last year, when the Consensus had expected the U.S. public sector to incur a slight surplus in 2003, the outlook has continuously deteriorated. According to this month’s Consensus, the fiscal deficit will reach 4.1% of GDP, down yet another 0.1 percentage point over last month. And the fiscal deficit is likely to increase even further, amid the growing financial burden in Iraq.

Japanese economy develops better than expected in the second quarter
In the second quarter, the Japanese GDP rose at an annual rate of 2.3%. The 0.6% quarter-on-quarter reading came in well above market expectations of 0.2 % and represented the sixth straight quarter of economic growth. However, the bout of strength observed in the second quarter was fuelled mainly by the external sector, which was propelled by a rebound in Asian demand attributable to the retreat of the SARS outbreak and by strong external demand for Japanese equipment machinery destined overseas. In part, the improvement is inflated by the government’s attempts to keep the Japanese currency from rising by selling international reserves. Nevertheless, the domestic economy is also improving. The government stated that non-performing loan ratios are declining and that corporate profitability is jumping, as reflected by a strong rise in the stock market.

Stronger recovery this year unlikely to carry over to 2004
In the past decade, Japan has repeatedly experienced short bouts of economic growth. However, amid the government's inability to fix long-term structural problems, particularly the failure to tackle the long-due overhaul of the banking system, these growth spurts have remained short-lived and failed to bring the economy back on a more durable growth track. The economists surveyed for the Consensus seem to expect a repetition of this pattern. Even though the GDP forecast for this year has been raised a noteworthy half percentage point from 0.8% expected last month to the current 1.3%, panellists do not see the higher growth prospects carrying over into next year. In fact, the Consensus Forecast for GDP growth for next year dropped a notch compared to last month’s forecast to 1.0%.