Neither a return to stability in the buffeted Asian economies, nor the apparent containment of the Brazilian crisis can hide the downside risks facing the global economy in 1999. This is the conclusion of a 43-page report on Global Economic Conditions and Prospects (UNCTAD/GDS/MDPB/4) presented by UNCTAD to ASEAN last month. Another round of financial instability could push an already fragile world economy into recession. According to the report, avoiding such an outcome requires "vigilance on the part of policy makers in the industrial countries where there remains considerable scope and freedom for expansionary policy actions".
Difficult Policy Challenges Ahead
The key to a healthy world economy lies with policy makers in the North. But, the report suggests, past practice may not be the best guide if downside risks become a reality.
Efforts to redesign the global financial architecture in the light of recent experiences have been hostage to disagreements among the G7. Just when developing countries are becoming increasingly vulnerable to international pressures originating in the North, there remains a general reluctance to accommodate their concerns and interests. The report welcomes the greater willingness shown by some developing countries to use capital controls in managing short-term capital flows and currencies.
According to the report, falling inflation rates and increased risk premia limit the effectiveness of more expansionary monetary policy. However, the room for fiscal expansion remains large in the North. The United States is well placed to use fiscal policy should stronger contractionary forces emerge. In Japan, monetization of debt financing of the budget deficit could accommodate further stimulus. The EU - - currently debating the possibility of amending the Stability Pact to allow room for increased government investment expenditures -- looks set to return to more pragmatic policy-making.
But, given the considerable downside risks, even further fiscal expansion in the North may prove insufficient if the current financial crisis deepens. "Given the limited scope in developing countries to pursue counter-cyclical monetary and fiscal policies, and the relative ineffectiveness of monetary policy in industrial countries in arresting slowdown, a possible policy response could be the direct injection of liquidity into developing countries through official channels to raise demand, imports and growth".
A more imaginative approach could thus include following elements:
- Debt relief through a rapid write-off of unpayable official and multilateral debt, along the lines already being suggested by some G7 finance ministers.
- Regional aid plans. The report endorses the initiative of the Japanese government under the Miyazawa Plan but suggests that a much larger package is likely to be needed.
- A direct injection of liquidity through a substantial SDR allocation to developing countries and transition economies.
The Global Economy in 1999 -- Uncertain Times
The dramatic slowdown in developing countries and the persistent volatility in international financial markets which combined to knock off more than one percentage point from world growth in 1998 continue to influence global economic prospects in 1999. Hopes of repeating even last years modest 2 per cent global growth hinge on the performance of the industrial countries where forecasts are generally below 1998 figures (see table).
Western European economies, which have been enjoying an export-led recovery over the past two years will falter in 1999. Although changes of government have brought a greater emphasis on growth and employment, the report sees little likelihood that a fiscal stimulus will offset the slowdown in exports.
Japan was the only G7 country in outright recession in 1998. Recent efforts to revitalize the Japanese economy have so far been ineffective. The yen=s appreciationand a sharp increase in bond yields at the end of the year weaken prospects of a Japanese recovery. The report concurs with other forecasts in seeing further contraction in 1999.
Considerable uncertainty surrounds the speed of recovery in Asia and the size of the slowdown in Latin America. Exchange rates have stabilised in Asia; and in some countries, notably the Republic of Korea and Thailand, there have been modest appreciations. However, with exports still weak and a further decline in capital flows expected, domestic macroeconomic policies will be the decisive factor. China has so far weathered the storm that devastated neighbouring economies, although it failed to meet its official growth target in 1998. However, trade and capital inflows are likely to remain weak in 1999, leaving the onus on domestic market conditions. The report expects growth to fall below 7 per cent.
Prospects in Latin America are among the hardest to gauge. The breakdown of the currency peg in Brazil, and the country’s ensuing financial crisis, ensures that the economy will experience full blown recession this year. The impact of depreciation, high interest rates and fiscal contraction is difficult to predict. But the report does not rule out a drop in output of as much as 5%. The fallout from Brazil will be felt across the region, where growth rates in 1998 had already fallen sharply. The greatest impact will be felt in Argentina, but the report does not exclude a regional recession, particularly if increased competition from Asian exports proves significant.
The optimism which had returned to East and Central Europe in the first half of 1998 evaporated with the subsequent financial crisis in Russia. The report=s examination of that crisis provides familiar reading, although the trigger was different from the earlier crises in Asia. Prospects, particularly in the group of leading reformers, depend more than ever on trends in Western Europe. Overall the region looks set to contract again this year.
The growth of world trade fell sharply in 1998, led by the contraction in imports in Asia which, to a significant extent, offset strong growth in US imports. The extent of the expected export recovery this year is difficult to estimate given the recent strengthening of some currencies and uncertainty about growth elsewhere in the world economy. Globally, the report does not expect trade growth to exceed last year=s performance.
The picture with commodity trade is more disturbing. The steep price falls which began for many non-oil commodities in 1997 and for oil during 1998, are expected to continue. The Brazilian crisis is likely to impact adversely on oil and coffee prices. A significant slowdown in the United States could add to the difficulties facing many producers. The major victims of declining commodity prices have been in Africa where growth fell back sharply in 1998 after three years of encouraging performance. Growth is unlikely to pick up much this year.
Downside Risks - A Year of Living Dangerously
According to the report, "Global economic performance in 1999 will depend, to a large extent, on the willingness of capital markets to place funds at risk in emerging markets as well as on the extent of risk aversion and instability in capital markets within developed economies, in particular the United States and Japan".
On both counts the potential for the world economy to undershoot projections is a real one. Downside scenarios by the World Bank and the OECD describe a stagnant world economy this year; and, even the IMF´s World Economic Outlook does not rule out a significant further slowdown.
Financial flows to "emerging markets" will remain depressed in 1999. These flows, which are very vulnerable to downside risk, fell by more than US$130 billion in 1998, to around US$120 billion and are unlikely to recover much this year. A continuing decline in commercial bank lending is expected this year, with Latin America hit hardest. On various independent estimates, net FDI inflows to developing countries is likely to remain unchanged, at around US$100 billion. But, increased risk aversion to emerging markets could see greater outflows of short-term funds, and would have significant knock-on effects through trade.
A sharp correction in stock markets, a stalled recovery in Japan and failure to restructure its banking sector, or increased currency volatility linked to perceptions of current account sustainability could trigger slower than expected growth in the North, thereby further damaging prospects of recovery in the South.
