Latin America in a Global Context - Economic Briefing August 2004

Strong Growth Seizes Virtually All Economic Regions

The global economy remains poised for robust growth this year, following on two years of anaemic growth.  Moreover, the prospects for next year are also positive.  With the exception of Europe, all regions are recovering, with the upturn being most pronounced in emerging Asia, particularly China.  Among the industrial countries, the United States led growth, followed by Japan, for which forecasts have been ratcheted up rapidly in the past months, as the economy seems rebounding strongly from several sluggish years.  However, both economies are hampered with fundamental imbalances.  The United States economy is burdened with sizeable deficits in the current account and public sector balances, which could trigger a sudden adjustment in the foreign exchanging markets.  In Japan, misalignments in the financial sector persist and the country remains mired in deflation.  More recently, higher oil prices are also beginning to cast a shadow over each country’s outlook.  The prospects for the major European economies, on the other hand, remain sombre.  The Euro Area will recover from last year’s slump but economic growth will remain moderate.  Finally, Latin America remains poised for a robust recovery, as all economies are profiting from increased global and increasingly domestic demand. 

U.S. second quarter growth disappoints
According to advance estimates released by the Bureau of Economic Analysis (BEA) on 30 July, gross domestic product (GDP) increased at an annual rate of 3.0% in the second quarter of 2004.  The actual reading was well below expectations, which had expected the economy to advance by 3.7% in the second quarter.  With the publication of the second quarter figures, the BEA also revised past national accounting data back to 2001, which included an upward revision of first quarter GDP growth from the 3.9% previously reported to 4.5%.

U.S economy cools off in second quarter amid consumption slowdown
The deceleration in real GDP growth in the second quarter compared to the first quarter primarily reflected a sharp deceleration in consumption, which dropped from an annual 4.1% growth in Q1 to a paltry 1.0% expansion in the second quarter. In particular, durable consumer goods slumped and actually entered the red territory (-2.5 year-on-year), following 2.2% growth in the first quarter.  However, growth dropped on the back of the very robust expansion observed in the same period last year, when durable consumer goods swelled by 20.6%.  The slowdown in durable goods was thus to be expected.  In the second quarter, non-durable consumer goods consumption dropped by 0.1% over the same period last year, following on 6.7% growth in the first quarter.  In addition, the slower build-up of inventories also contributed to the overall slowdown in the second quarter.  These detrimental impacts were partly offset by accelerations in exports and in residential fixed investment.

Outlook for U.S. economy remains solid despite recent oil price increase
With the weaker than expected second quarter compensated for by the upward revision to first quarter growth, the Consensus Forecast for this year’s growth prospects did not change over last month’s 4.5% forecast.  In fact, the Consensus has remained virtually unchanged since February, despite some important changes in the fundamentals underlying the development of the global economy.  In particular, the recent sharp increase of the oil price is beginning to raise doubts about the previous optimistic assessment of global economic growth prospects.  Past price increases have ebbed off at high but insufficient levels to derail the U.S. economy from its upswing. However, the latest jitters have raised concerns that the oil price might move into the US$ 50 to US$ 60 range and could dent the current growth spurt.  The recent surge in oil prices is fuelled by concerns that the increase in demand prompted by the buoyant global economy cannot be met by sufficient supply from the main oil producing countries.  According to recent estimates, the steaming Chinese economy accounts for one third of this year’s demand increase.  The Organization of Petroleum Exporting Countries (OPEC) has indicated that it is on standby to increase oil supplies by up to 1.5 million barrels per day (bpd) to help to cool prices, pending a formal decision on its next meeting on 14 September in Vienna.  However, even so, OPEC has difficulties reassuring markets about the cartel's ability to quickly boost output to provide additional supply.  Consequently, on 5 August, the price for West Texas Intermediate (WTI) increased to an all-time high of US$ 44.41 per barrel.  However, if inflation is taken into account, oil prices would have to climb to about US$ 57 per barrel to exceed the value leading up to the first Gulf War and above US$ 80 to be comparable to the levels reached in the early 1980s.

Japanese government raises outlook for economic growth
In Japan, the economy is recovering at a solid pace, as improvements in the corporate sector are extending into households, according to the government’s monthly economic report, published on 5 August.  This upbeat judgment followed on a doubling of the government’s growth forecast in July.  On 21 July, the Cabinet Office revised upwards its January assessment and almost doubled its economic growth forecast for the current fiscal year (ending in March 2005) from 1.8% to 3.5%, as strong business investment and a rebound in consumer spending could lift growth to its fastest pace in eight years.  Brisk exports to China and a pick-up in capital spending and personal consumption have helped pull Japan's economy out of its decade-long slump in recent months. The economy grew at an annualised pace of 6.1% in the first quarter of this year compared to the same quarter in 2003, its best showing in more than a decade.  The government is also optimistic that the country could advance on edging out persistent deflation and stated that it now expected the consumer price index to decline only 0.1% this year, compared with its previous forecast of a 0.2% drop.  However, at the same time, the government warned that rising oil prices and higher interest rates could dampen activity.  A private sector study has recently shown that Japan's economy may be vulnerable to higher oil prices because companies, the main driver of the current recovery, have only limited ability to pass on higher input costs to consumers.  The report by Nikko Citigroup stated that for every US$ 10 rise in the oil price, Japan's GDP growth rate would be reduced by 0.2 to 0.3 percentage points.  Nevertheless, Consensus Forecast panellists remain optimistic and have even hiked their projection for economic growth in 2004 a notch over last month’s forecast to 4.3%.