GLOBAL RECOVERY UNDER WAY, BUT WITH TROUBLED OUTLOOK

After two years of slow growth, the world economy registered a 2.6% expansion in 2003, which is expected to accelerate to 3.8% this year. The recovery has been driven largely by the US economy and continued fast expansion in East and South Asia. Some believe that this recovery will be the start of an extended period of growth, lifting the boats in both developed and developing countries. But such optimism is dampened by imbalances in the world economy and uncertainties about oil prices, exchange rates, and the relative health of the US economy, UNCTAD finds. The big question is whether the US will continue to provide the same growth stimulus to the rest of the world as it did in 2003 and the first half of this year.

An exceptionally strong fiscal stimulus and a reduction of interest rates to their lowest level in 50 years helped the US economy overcome the recent weakness. Asia´s two largest economies -- China and India -- continued their rapid pace of expansion in 2003, with growth rates of 9.1% and 7.4%, respectively, and considerable international and especially regional spillover effects from China in particular. Europe benefited from the recent US recovery despite the appreciation of the euro against the dollar. Domestic demand in the euro area remained flat, however, as the European Central Bank has been reluctant to follow a more aggressive expansionary policy and the space for expansionary fiscal policies is restricted by the Stability and Growth Pact.

The dependence of the global economy on US economic performance is not new, but that country´s deficits are much larger today than they were in the late 1990s. This, according to UNCTAD, raises doubts about the sustainability of the pattern of world growth. US´s deficits have contributed significantly to exports from East Asia, including Japan and to the growing current-account surpluses of these countries. The East Asian countries have been following a policy of keeping their exchange rates at a competitive level following the currency depreciations of the late 1990s. This was possible only through heavy intervention in the foreign exchange market and has led to the accumulation of reserves on an unprecedented scale. By investing these reserves in US Treasury securities, the East Asian countries have been recycling their current-account surpluses to finance the US deficits. In 2003, East Asian developing countries, including China, bought more than $210 billion in foreign currency, as against the US budget deficit of $455 billion and the US trade deficit of $490 billion. This pattern is unlikely to be sustainable in the long run, UNCTAD says, especially if pressure on the dollar to depreciate mounts as a result of further rising US deficits. Asian central banks may then be induced to minimize risks by diversifying their foreign exchange holdings into assets denominated in other currencies, in particular the euro.

Expansion last year in the developing countries (4.5%) and transition economies (5.9%) outpaced growth in the developed world (2.0%). Income growth, however, continues to be very unequally distributed among the developing countries. In East and South Asia it reached 6.0% in 2003 and is set to accelerate further this year. Since the second half of 2003 output growth has also picked up in Latin America after two years of falling per capita incomes. This is mainly due to a sharp recovery in Argentina (8.8%), where GDP had declined by almost 18% since 1998. Africa benefited from the world economic recovery less than other developing regions, although growth in North Africa increased substantially, mainly as a result of higher oil prices and a revival of tourism. Per capita income, by contrast, is stagnating in most of sub-Saharan Africa, where poverty and social deprivation continue to take their greatest toll.

Changing geography of trade

World trade grew substantially in 2003 and the first half of this year, but unlike the rapid expansion of the 1990s, this was largely the result of a surge in the dollar unit value of exports. Expressed in current dollar prices, merchandise exports grew by 15.5% last year, whereas export volume increased by only 4.9%. Trade expansion was driven by the recovery in the US, but the Trade and Development Report notes that developing and transition countries play an even more important role: in 2002 and 2003, they accounted for around three quarters of the increase in export volume and for 60% of the increase in import volume. This reflects both the increasing relocation of manufacturing production and the international pattern of demand growth. A number of developing countries, especially in East and South Asia, are not only expanding their own manufacturing industries at a very rapid pace but also becoming important markets for a wide range of manufactures and commodities. Their growth is more energy-intensive and requires more inputs of metals and agricultural raw materials than growth based on expansion of the services sector. Moreover, given the large populations of these countries, their demand for food products has been expanding vigorously.

Inflow of private capital to developing and transition economies rose from $47 billion in 2002 to $131 billion in 2003, the highest level since 1997. However, this increase was due almost entirely to a sharp rise in credits and short-term capital flows attracted by high interest rates or the expectation of currency appreciation in a small number of emerging-market economies. Net private capital flows were thus directed to economies with often sizeable current- account surpluses, where they added to the accumulation of foreign exchange reserves. By contrast, the developing countries with the most pressing external financing needs, or with low investment rates, hardly benefited. The UNCTAD report emphasizes that as a result of the rapid reserve accumulation, last year saw an overall net capital outflow of some $230 billion from developing and transition economies to the developed countries. The fear of many developing countries of floating their currencies in the presence of sharply fluctuating expectations on international financial markets should be taken seriously and give rise to increased efforts to establish a rule-based and truly multilateral international monetary system, one that is coherent with the international trading system. (See Part Two of the Report, and UNCTAD/PRESS/PR/2004/020, for more on this issue.)

Stronger recovery in 2004…

While forecasting a stronger global recovery this year, the UNCTAD report is also warning about a number of factors that make the outlook increasingly uncertain. Risks are resulting not only from oil prices but also from persistently large disparities in the strength of domestic demand among the major industrial countries and increasing trade imbalances between the major economic blocs. These factors could lead to new protectionist pressures and greater instability in currency and financial markets, with particularly adverse implications for developing countries.

Output growth in the developed countries is expected to accelerate further in 2004, to 3.2%, with attendant effects on the developing and transition economies. While growth in the latter is likely to remain stable, at slightly below 6%, the 5.8% forecast for the developing countries (5.2% if China is excluded) is the highest in many years. While this is largely on account of East and South Asia, where a 6.6% expansion is expected despite a moderate slowdown in China and India, a strengthening of the recovery is also forecast for Latin America and, to a lesser extent, Africa.

In Latin America growth may accelerate to 4.3% this year, mainly as a result of further improvements in Argentina´s economic situation and a recovery in Brazil, Mexico and Venezuela. But the region´s recovery is still very fragile, especially in light of the high external debt burden and weak domestic demand; in particular, the fixed capital formation has fallen in several countries has fallen to its lowest level in decades. Growth on the African continent is also expected to strengthen but will vary considerably among countries, depending largely on how much they benefit from rising primary commodity prices. Given the severe financing constraints of most sub-Saharan economies, debt relief and the additional provision of official development assistance in the form of grants remain indispensable to achieving the required rise in investment and diversification of production. The report warns that in light of the persistent weakness of growth and investment it now appears increasingly unlikely that sub-Saharan Africa can attain the Millennium Development Goals, in particular that of halving poverty by 2015. In most countries, growth would need to be doubled and sustained over a decade in order to meet those goals.

…but outlook overshadowed by uncertainties about oil prices and exchange rates

Nonetheless, the Trade and Development Report notes that the overall positive forecasts, and the expectation that the recovery will lead to an extended phase of growth beyond 2004, may turn out to be overly optimistic in light of the uncertainty about oil prices and their impact on growth. Higher oil prices are boosting the incomes of oil exporters but tend to compromise growth in oil-importing countries, especially the developing countries among them. This effect will also depend on the extent to which the oil-exporting countries translate higher oil revenues into higher demand for goods produced in the oil-importing countries. Moreover, should prices remain at their third quarter 2004 levels or even rise further, they could have a considerable impact on inflationary expectations in the industrialized countries. This in turn might lead to increases in interest rates, which would dampen growth even more.

Bringing the US budget deficit to below 3% by 2005 will require a shift towards more restrictive fiscal policies, UNCTAD believes. The unusually expansionary monetary policy stance might also need to be revised in light of inflationary pressures stemming from the surge in import prices, particularly oil prices. And the increasing US trade deficit is likely to create additional downward pressure on the dollar.

Fiscal and monetary policies matter

As the surplus countries of East and South Asia are fiercely defending their exchange rates vis-à-vis the dollar, adjustments to the global imbalances are likely to require more pronounced exchange-rate changes in the rest of the world, particularly Europe. In order to maintain the growth momentum in the world economy without ever-growing US deficits and mounting pressure on the dollar, domestic demand would need to be massively strengthened in the euro area and Japan, UNCTAD says. If the euro area is not reoriented away from fiscal and monetary orthodoxy, the rising imbalances in world trade will force further and even more dramatic changes in real exchange rates, and continental Western Europe could be trapped in a low-growth, high-unemployment scenario.

Processes that led to the global economic recovery and to the regional growth patterns of 2003 and the first half of this year confirm the importance of proactive fiscal and monetary policies. The economies that provided growth stimuli to the rest of the world were those whose monetary and fiscal policies supported domestic demand growth. This is true for both developed and developing countries. A competitive exchange rate can play a decisive role in forestalling external constraints and creating policy space for improving competitiveness, asserts the UNCTAD report.