| When the twins meet
The World Economic Outlook, released last month, is the International Monetary Fund's report on the global economic scenario. It is usually issued at the time of the semi-annual meet of the Bretton Woods twins. This year, finance ministers of the world met in Washington to deliberate on the problems of developed and developing countries. Such meetings are important occasions for finance ministers and central bank chiefs to exchange ideas and seek advice from experts. It is thus appropriate that the IMF issues its WEO on such an occasion. It provides food for thought, a necessary diversion from the festivities that accompany the gatherings of the world's treasurers and bankers.
The WEO 2004 is the second of a series to be prepared under Raghuram Rajan, a product of the Indian Institute of Management, Ahmedabad and the University of Chicago, who was handpicked for the job of counsellor and director (research) of the IMF. This latest report lives up to the high reputation of its predecessors, which have all been looked up to as representing the collective wisdom of the IMF's experts on the global economic scenario.
The WEO notes that the global economic recovery has become increasingly well-established. World economies are now expected to grow at 5 per cent in 2004, the highest in nearly three decades. For 2005, the IMF experts put their growth estimates at 4.3 per cent. As for India, the WEO predicts a growth rate of 6.4 per cent for 2004 and 6.7 per cent for 2005. China is set to establish higher rates of growth of 9 per cent and 7.5 per cent respectively for 2004 and 2005.
The United States of America is estimated to grow at 3.6 per cent in 2004 and 2.9 per cent in 2005, and Japan at 4.4 per cent and 2.3 per cent respectively. Evidently, the stimulative policies of the Japanese government and central bank have had a beneficial impact, and deflation is no longer evident. The area under the euro is slowly recovering and is estimated to grow at 2.2 per cent in 2004 and 2005.
But, the grim prospects on the energy front ' a reflection of the scorching pace of growth of China, and Asia in general ' may spoil the rosy picture. While crude prices have reached a high of $50 per barrel, the WEO makes a forecast of around $29 a barrel for 2004. However, it admits that the low levels of spare global capacity are leading to concern that global oil production may not be able to cope with the unanticipated short-term supply stock.
The imbalances in the global economy continue to be dominated by America's twin deficits ' on the current account and in the budget. The US is likely to have a current account deficit of nearly 5.3-5.4 per cent in 2004 and 2005. This is compensated for by the current account surpluses of Japan, the newly industrializing economies of Asia and the regional surplus of the areas under the euro. In financial terms thus, the Asian countries' surplus is sustaining the deficit of the US in terms of fund flows ' loans to the US and investment in US securities. The size of the US's current account deficit ' standing at 5 per cent ' is a cause for alarm and would have led to decisive action to bring about adjustments if encountered in developing countries. There is a separate law for the rich and for the poor of the world.
Short of devaluation, a credible solution to the US's current account imbalance seems unlikely. This requires action at both the global and national levels. WEO 2004 does not indicate any specific approach but stresses that all countries and regions should play a part in addressing global imbalances. The key policy requirements include medium-term fiscal consolidation in the US to boost savings, structural reforms to boost growth prospects outside the US and greater exchange-rate flexibility in Asia, consistent with an orderly reduction in the current account surplus. WEO 2004 notes that while progress is being made, in varying degrees, on the first two heads, little progress has been made with the third.
While at the Dubai meet of the IMF and World Bank, the former had stressed on the need for a revaluation of China's currency in order to remedy the US's current account imbalance, the latest WEO is more circumspect. It discusses possible options for exchange-rate management ' pegged, intermediate or floating. It is biased in favour of a floating regime, although individual countries may find the move to pure floating difficult.
The report specially cites India as a successful case of a transition from a currency pegged to the dollar to a managed float in March 1993. It notes that while India initiated greater exchange-rate flexibility when economic policy reforms were still in progress, the managed float has been maintained without much distress, even during times of international market turbulence. A well-deserved pat on the back from the bastion of international financial prudence!
Turning to India's macroeconomic situation, here is the WEO's summary of its prospects. 'India's GDP growth is projected at 6.4% in 2004... Large budget deficits and high and rising levels of public debt remain the Achilles' heel of the economy. Beyond long-run sustainability concerns, high public borrowing may choke off the nascent recovery in private investment needed to sustain the expansion. The newly-elected ruling coalition intends to effect ambitious fiscal adjustment to balance the current budget by 2009...while increasing expenditure in priority areas...While this target path appears broadly appropriate, the supporting measures that were recently proposed will take time to be implemented and yield results. In view of this uncertainly, expenditure increases should be contingent on progress on the revenue front. Accelerating structural reforms...remains key to step up potential growth and reduce poverty.' These views are shared by economists in India who favour revenue increases instead of compressing expenditure.
The WEO devotes a lot of attention to the problems faced by developed countries by the 'greying' of their people, the fiscal burden of higher pensions and medical expenditure. Possible solutions lie in opening the doors to immigrants ' a solution that is politically explosive, especially in the context of rising unemployment and existing racial tensions.
Overall, the WEO offers a clear outline of the problems posed by the developments in the world economy. Whether the finance ministers will listen to such well-meant advice is not too certain. A crisis, such as the one the global economy faces, calls for decisive action. But whether such action will be taken depends on various factors. It is ultimately politics that governs economics. With the presidential elections in the US, the scene is particularly unclear. The statesmen of the world will do well to listen and act, rather than be forced by the trauma of a crisis to undertake the necessary adjustments.