The International Monetary Fund brings out a much-awaited forecast of the world economy twice a year. The latest World Economic Outlook came out in September 2003 and has put forth its analysis of the prospects of the global economy for 2003 and 2004. It estimates the global economy to grow at 3.2 per cent in 2003 and 4.1 per cent in 2004. In the advanced economies of the United States of America, the European Union and Japan, economic growth is expected to hit a low figure of 1.8 per cent in 2003 and 2.9 per cent in 2004. In particular, the US, the main engine of growth for much of the world, is expected to grow only at 2.6 per cent in 2003 and 3.9 per cent in 2004. Japan will record only 2 per cent growth in 2003 and 1.4 per cent in 2004. These estimates are reminder of how sluggish global economic prospects are with all their implications for other countries.
The brighter spots in the global economy stakes seem to be India and China, which are clocking relatively higher rates of growth. India is expected to grow at 5.6 per cent in 2003 and at 5.9 per cent in 2004, while China is expected to reach a rate of growth of 7.5 per cent in each of these two years. The estimated global economic rate of growth — low as it is — is itself sustained by these two economies. The WEO has assumed in its calculations that their economies are weighted in accordance with their gross domestic product valued at exchange rates allowing for purchasing power parity.
The WEO 2003 notes that the greenback continued to depreciate through end May 2003, reflecting the high current account deficits and fiscal imbalance of the US. There has been, however, an upward trend in private capital outflows on a global basis, peaking at $110 billion in the year, the highest level since 1990. In particular, an important feature of the global scenario has been the behaviour of crude price, due to geopolitical developments. It peaked at $ 34 a barrel pre-Iraq War and declined sharply thereafter. In early September 2003, it fell further. The WEO expects oil prices to fall sharply in 2004 to $ 25.5 barrel. The WEO 2003, however, is bullish about non-oil commodity prices — good news for these developing countries, which are exporters of non-oil commodities.
Turning to the current structural imbalance in the shape of high current account deficit of the US, the WEO 2003 points out that the resulting depreciation of the US dollar has so far been quite orderly and generally welcome. The repercussions of the dollar decline were offset in the EU area by reduction in the interest rates. The WEO 2003, however, is of the view that further US dollar devaluation cannot be ruled out. This, of course, when it happens, would have serious repercussions, particularly on export competitiveness of the EU economies, if the pressure falls mostly on the euro.
The WEO 2003 is convinced that economic growth on a global scale is on an upward trend, strengthened by reduced global tensions and a higher fiscal stimulus in the US budget pipeline. Further contributory factors are a decline in oil prices, relaxed interest rate stance and easier credit policies. The WEO 2003, however, estimates that the interest rate stimulus may be withdrawn, come 2004, indicating that higher interest rates may be around the corner by that time.
The WEO estimates that recovery at the global level will continue to be led by the US economy, in spite of a weak labour market and large excess capacity. Recent data from the US also show signs of improvement, with higher fiscal stimulus on the cards. The Japanese economy also seems to be on the mend, given stronger than expected second quarter outturns. Japan’s revival is, however, crucial as the global economy should not depend only on the US for its sustained growth. That will amount to flying on one engine, so to speak. Japanese growth, in turn, depends on the US’s growing fast, in as much as Japan is an export-led economy.
For the first time in recent years, the WEO 2003 discounts the fears of global deflation. In its view, the risk of a global deflationary spiral appears remote as inflationary expectations have recently edged up, reflecting increased expectations of recovery and recent monetary and fiscal policy measures. However, in the event of any adverse shock, such a development cannot be totally ruled out. Germany may be one of the likely candidates for such a deflationary outcome. Its degree of freedom is, however, limited, constrained as Germany is by the fiscal limits laid down by the Growth and Stability Pact, which prescribes strict ceilings for fiscal deficits and public debt to GDP ratio. Further, the external commercial borrowings have not been quick to react to developments. The possibility of Germany facing deflation cannot therefore be ruled out.
As a contrast to its plea for a stimulative stance on the EU, the WEO 2003 attacks increased resort to public debt by poorer countries. In a special section, the WEO 2003 stresses the need for developing countries to be cautious about their current levels of public debt. It points out that the public debt as a percentage of GDP is high in developing countries. It notes that the countervailing factors, which obtain in developed countries, which have high debt-GDP ratios do not occur in developing countries. One such factor is the relatively low direct tax-GDP ratio in developing countries compared to the higher ratios of developed countries. Further, the effective rate of direct tax in developing countries — allowing for exemptions — is only 10 per cent compared to 30 per cent in the developed world. Hence, in the WEO’s views, the developing countries have to practise an attitude of caution when resorting to high public debt.
The WEO 2003 is, however, fair in pointing out that in spite of high levels of public debt to GDP ratio, countries, like Malaysia and India, have not suffered too perceptibly in their macroeconomic conditions. This is because they have not resorted too much to external debt. Perhaps the reason is also that they are still relatively closed on the capital account.
The WEO 2003 stresses the necessity for better exchange rate management practices, in particular by developing countries. It devotes particular attention to the high level of reserve accumulation by certain emerging market economies, like China. It also stresses the need for a more flexible exchange rate policy. It particularly targets the “fixed” exchange rate policy of China, which has been pegging its remninbi to the dollar at a constant level since 1995. The implied pressure on China to revalue, mentioned in the WEO 2003, is a reflection of the US-centred approach of the Bretton Woods Institutions. It is not, however, clear why China and other emerging market economies should bear the pain of adjustment caused by the US’s economic imbalance. However, geopolitics has its own logic or illogic, notwithstanding the fact that a considerable part of the accumulation of foreign exchange reserves goes towards funding the US budget deficit besides filling its current account gap.
The WEO 2003 has come at a time when the world is starting to grow, based not only on the US’s demand, but on the growth of the emerging economies, like China. The policies it advocates should be carefully studied and responded to only if justified in the particular situation of developing countries. It does not follow necessarily that what is good for the US is good for the world economy as a whole. The WEO should start learning and advocating lessons based on the experience of countries, like China, which have grown at a rapid pace over the last two decades. It should not shy away from drawing lessons from the eastern half of the world merely because they violate the Washington Consensus. The WEO should make a departure by giving due importance to Chinese experience.
Perhaps, this is a suggestion which will be treated with contempt by the pundits of Bretton Woods. China has demonstrated that an economy can develop starting from scratch, in spite of its not being overly market-oriented but governed by a state, which rules with a sharp focus on growth and equity. China’s own focus on infrastructure and small enterprises and agriculture has itself been responsible for the scorching rate of growth, which in turn has turned China into a magnet for FDI. It is ironic that China today sustains the US’s economic growth, low as it is, by contributing as much as $100 billion a year to investment in US securities. That is what helps to keep US interest rates low and consumption levels higher. A WEO which ignores the obvious lessons of Chinese triumph against adversity cannot claim to be a truly “world”-oriented outlook.