Latin America in a Global Context - Economic Briefing October 2003

Year-end Rebound Fuelling Optimism for Global Economy (continued)

European economy continues to ail along
Economic weakness is particularly pronounced in Europe. The IMF states that the slowdown in the Euro Area has been deeper and more prolonged than expected in April. As a result, the Fund has lowered its 2003 forecast by 0.6 percentage points to just 0.5%. Moreover, while the Fund acknowledges that recent indicators may suggest economic improvement, officials highlight the absence of signs of a broader pickup in the Euro Area economy and underlines that recovery prospects are mainly dependent on a pickup in external demand, low interest rates and a winding down of corporate balance sheet adjustments. Therefore, the IMF also cut its forecast for next year by 0.4 percentage points compared to April to 1.9%. With these adjusted forecasts, the IMF is in line with the Consensus, which has the Euro Area economy growing 0.5% this year and is even more pessimistic than the Fund for 2004, estimating output growth at just 1.7%.

Japan outlook lifted sharply
In contrast, Japan is developing much better than expected. The initial estimate of second quarter growth in Japan significantly exceeded the IMF’s expectations. This and a further upward revision to first quarter growth, an improved external environment, and the pickup in equity markets, has prompted the IMF to revise its growth projections for 2003 and 2004 upward sharply. Officials raised the forecast for this year by 1.2 percentage points compared to an April forecast to 2.0%. However, the outlook remains clouded by entrenched deflation and persistent weaknesses in the balance sheets of the financial and public sectors. Given the limited progress with bank restructuring, potential declines in equity or bond prices could weaken financial balance sheets, triggering a rapid drop in bank lending and choking off investment. In addition, the country faces the risk of currency appreciation. So far, the authorities managed to stem the appreciation of the yen with massive foreign exchange market intervention. If the yen experiences a sustained appreciation, the beneficial contribution from the external sector to the current rebound would be severely curtailed. Reflecting this and other risks, the IMF raised the 2004 projection by only 0.4 percentage points and sees growth at a moderate 1.7%.

More sombre assessment of Latin America
Since April, the IMF has reduced its forecast for GDP growth in Latin America by 0.4 percentage points for 2003 to 1.1% (Consensus: 1.3%). Nevertheless, the Fund sees a tentative recovery emerging in Latin America, although growth is highly differentiated across the region and political uncertainty continues to weigh heavily in some cases. The recovery reflects a pickup in exports, helped by stronger global growth and substantial real exchange rate depreciations. In addition, the region has profited from an improvement in international investor’s risk appetite, which has prompted a rally in emerging market bonds and pushed spreads to near all-time lows in some countries. However, the IMF sees the recovery as fragile, even if global growth should gradually improve. In particular, the officials make out the risk that the rally in emerging bond markets is not sustained if risk appetite drops again or interest rates in industrial countries should rise. Taking these risks into account, the IMF also lowered its outlook for 2004 by 0.6 percentage points over April to 3.6%, which falls a notch short of the current Consensus Forecast of 3.7%.