Latin America in a Global Context - Economic Briefing November 2004

Global Economic Growth to Slow in 2005 from Buoyant Expansion This Year

The global economy remains on track for rock-solid growth this year.  However, while the prospects for next year are also positive the growth pace will be notably less buoyant than in 2004 since the stimulating policies that have boosted the economic expansion in early this year are drawing to an end and the higher oil price will erode purchasing power.  This year, all major economic regions are recovering, with the upturn being most pronounced in emerging Asia, particularly China.  Among the industrial countries, Japan is now projected to grow a notch slower than the United States, following a slight downgrade to the Japanese outlook this month.  While the two economies lead in the growth tables, higher energy prices are casting a shadow over their short-term outlook.  In addition, both economies remain hampered with fundamental imbalances.  In Japan, misalignments in the financial sector persist and the country remains mired in deflation.  Therefore, growth is seen to reach half of this year’s level.  The U. S. economy is burdened with sizeable current account and public sector deficits, which are sending the US$ tumbling to new lows against the Euro.  This is not welcome news for the Euro Area, which precariously depends on its external sector to revive the ailing economy.  Consequently, the prospects for the Euro Area remains subdued.  In contrast, Latin America continues to be seen increasingly optimistic, as higher growth in the export sector spurred by higher commodity prices is feeding through to increased domestic demand.

Outlook for global growth stagnates at high level
The outlook for global economic growth this year is stabilising a notch above last month’s forecast and with 4.3% has returned to its peak reached in July, following on three consecutive months of no change to the global outlook.  However, the 0.1 percentage point upward revision over last month for the 2004 growth estimate comes at the cost of a downward revision of the same magnitude for 2005.  As a result, global output growth next year is seen to be almost a full percentage point below this year, as the global economy is expected to expand by 3.4%.  The anticipated slowdown should seize all economic regions except Europe, which will grow slightly faster than this year albeit at a dismal 2.0% pace.  Japan will experience the most notable slowdown, as growth drops to barley half the 4.1% presaged for this year.  All other economic regions will experience a sizeable but less dramatic slowdown in 2005. 

Reductions in Federal spending unlikely amid ambitious plans
With president Bush re-elected, the attention is now focused on his agenda, parts of which were outlined the day after the election victory.  The pledge to cut the deficit in half by 2009 constitutes the key pillar in the economic agenda.  Simultaneously, the Bush administration will strive to make the 2001 “temporary” tax cuts permanent.  Keeping both promises will be difficult, in particular since the political agenda contains a number of projects that will further fuel spending, following on the biggest four-year federal spending increase in forty years.  While the planned changes in the tax code are to be "revenue neutral", the plan to overhaul the existing social security system - one of the biggest objectives of Bush’s second term - is likely to have a sizeable fiscal impact.  An important campaign proposal suggests adding voluntary personal investment accounts to social security, letting workers divert part of their payroll taxes to be invested as they see fit.  However, it remains unclear how the government intends to fund full benefits for current retirees if payroll taxes from current workers are partially diverted to private accounts.  Moreover, demographic developments will require significant additional provisions to fund rising outlays for Medicare and social security, once the baby-boomer generation starts retiring.  Whatever the fiscal impact of the reform measures may be, in the short-term the fiscal accounts remain burdened with huge deficits.  According to the Consensus, the fiscal deficit will reach 3.8% of GDP this year and 3.1% of GDP next, which leaves the administration with little room to fund additional projects on the political agenda.  Moreover, with GDP projected to grow by 4.4% this year and 3.5% next year, the materialisation of downside risks could postpone the process of returning to fiscal soundness.

U.S. economy recovers from soft patch as consumption rebounds in third quarter
According to advance estimates released by the Bureau of Economic Analysis (BEA) on 29 October, GDP increased at an annual rate of 3.7% in the third quarter over the same quarter last year, which was up from the 3.3% reading for the prior quarter.  The actual reading was well below expectations, which had seen the economy advancing by 4.3%.  The acceleration in real GDP growth in the third quarter compared to the second primarily reflected a sharp acceleration in consumption, which rebounded from the “soft patch” in the second quarter, when consumption increased by a paltry 1.6% over the same period last year.  In the third quarter, consumption growth rebounded to a robust 4.6%. Durable consumer goods, in particular, recovered strongly, emerging from negative territory (-0.3% year-on-year) to rebound at a strong 16.8% growth pace.  Non-durable consumer goods consumption also recovered from barely positive growth in the second quarter (+0.1% yoy) to 3.9% growth in the third.  On the downside, the slower build-up of inventories and lower net exports partly offset the surge in domestic demand.