Latin America in a Global Context - Economic Briefing October 2003

Year-end Rebound Fuelling Optimism for Global Economy

Recent evidence suggests that some economic areas are developing at a more robust pace in the second half of the year than anticipated earlier. As a result, optimism for the global economy continues to rise. However, even with a year-end rebound, total output growth this year will remain moderate and just a notch above last year’s level. The US economy, which is developing along a more favourable trajectory than expected earlier, will grow below potential despite unprecedented stimulus from monetary and fiscal policy. Moreover, the contribution from fiscal policy comes at the price of a significant deterioration in public sector accounts, which adds to the sizeable current account deficit. The Japanese economy, which had been ailing along for a decade, is showing signs of an unexpected pickup. While it is too early to call the recent developments a trend change and severe imbalances continue to loom over a full rebound, the increase in optimism over the Japanese economy contributed to the improved global outlook. The positive developments in the United States and Japan are mirrored by more sombre picture in Europe and in Latin America. Europe is suffering from structural imbalances, which preclude a quicker adjustment to economic realities and translate into a slower growth. In Latin America, the prospects differ largely among the countries, with some economies experiencing notable growth, while others remain mired in recession.

Global growth forecast lifted again
The outlook for global economic growth has improved significantly. Since last month, the average forecast for global output growth this year rose 0.2 percentage points from 2.1% expected last month to the current 2.3%. The improvement represents the second consecutive upward adjustment to the global growth outlook and ends the series of downward revisions, which has characterised most of the year. As was the case last month, the upward revisions were concentrated in the United States, non-Japan Asia and Japan. Upward adjustments were rather incremental in the U.S. (+0.2 percentage points) and non-Japan Asia (+0.1 percentage point) but the outlook for Japan mushroomed almost a full percentage point, virtually doubling the already large 0.5 percentage point upward adjustment observed in last month’s forecast. In contrast, Europe and Latin America are seen more pessimistically than last month. While the Consensus lowered the growth forecast for this year only a notch in both regions, the downward revisions continue the string of ever more negative assessments of the two economic areas.

IMF maintains April global outlook but significant shifts in assessment of economic regions
The more upbeat global outlook is also reflected in the September edition of the World Economic Outlook (WEO) of the International Monetary Fund (IMF). While the IMF maintained the outlook for the global growth for this year unchanged compared to the April edition of the WEO, the April outlook was based on the assumption that the war in Iraq would be short and contained whereas Consensus analysts had factored in the risks of a protracted military conflict. Moreover, markets were also concerned about the potential impact of Severe Acute Respiratory Syndrome (SARS) on global economic activity, particularly declines in Asian economies. Fortunately, the spreading of the disease was contained at an early stage and thus SARS-related disruptions have faded relatively quickly. Despite the unchanged growth rate anticipated for this year’s global aggregate, the Fund changed its assessment of the economic regions. In accordance with the Consensus, the IMF has hiked the forecasts for economic growth in the United States, Japan and Developing Asia but lowered the outlook for Europe and Latin America.

IMF estimate for 2003 in line with market
The current IMF estimate 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. This gives countries such as China and India a much higher weight in the global aggregate. Since both countries continue to expand at a much quicker pace than industrialised economies, applying the PPP methodology leads to higher growth rates than an exchange rate weighted global average. The IMF’s exchange rate weighted outlook for this year also anticipates global growth at 2.3%, in line with the latest Consensus. For next year, the IMF anticipates global growth to accelerate to 3.2% (4.1% based on PPP weights), which is 0.3 percentage points below the current Consensus. The more sombre outlook of the Fund is probably due to its concerns over the implications of the rising imbalances in the global economy, mostly concentrated in the United States but also mirrored in other regions around the globe.

Fund concerned about global imbalances
In the past, the IMF has repeatedly pointed out the risks associated to the current account deficit in the United States. The Fund again states that the record U.S. current account deficit is still an important vulnerability. Historical experience suggests that an adjustment of the U.S. current account deficit is likely be accompanied by lower growth and a weakening of the currency. Despite the depreciation of the US$ over the last year, the currency still appears overvalued from a medium-term standpoint and the risk that its adjustment may become disorderly or prompt overshooting cannot be ruled out. Moreover, the current account deficit is now matched by an equally large fiscal deficit. The IMF claims that the general government deficit (covering both the federal government and the states) is projected at over 6.0% of GDP in 2003, compared with a surplus of over 1% in 2000 - the largest swing in the fiscal position over three years in at least three decades. While this has provided short-term support to the recovery, it has come at the cost of a substantial deterioration in the medium-term fiscal position. Adjusting these imbalances without choking off economic growth will prove a difficult task for U.S. policymakers, in particular given the weakness of demand in the rest of the world.