Latin America in a Global Context - Economic Briefing October 2004

Global Economy Remains on Track for Rock-Solid Growth

Despite increasing oil prices, the global economy remains on track for rock-solid growth this year.   Moreover, the prospects for next year are also positive, albeit somewhat less buoyant as in 2004 since the stimulating policies that have boosted growth in early this year are drawing to an end and the higher oil price will erode purchasing power.  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 on a slight downgrade to the Japanese outlook this month.  While the two economies lead growth, higher energy prices are casting a shadow over their short-term outlook.  In addition, both economies remain hampered with fundamental imbalances.  The U. S. economy is burdened with sizeable current account and public sector deficits, which could trigger a sudden adjustment in the foreign exchange markets.  In Japan, misalignments in the financial sector persist and the country remains mired in deflation.  Therefore, growth is seen to drop by half next year.  The prospects for the major European economies, on the other hand, remain sombre.  The Euro Area will recover from last year’s slump but economic growth will remain moderate and only increase gradually next year.  Finally, Latin America is seen increasingly optimistic, as buoyant global demand and higher commodity prices are rekindling economic activity.

Outlook for global growth stagnates at high level
The outlook for global economic growth this year is stabilising a notch below its peak of 4.3% reached in July.  Over the past three months, the estimate for global GDP growth remained unchanged at 4.2% with only minor changes occurring amid the major economic regions.  While the outlook for the U.S. and Japan dropped slightly, the projections for non-Japan Asia and the Euro Area gained a notch.  Latin America, in contrast to all other regions, experienced a strong upward revision of 0.4 percentage points since August.

IMF raises global outlook for 2004 but lowers 2005 projection
The robust growth scenario anticipated by the Consensus Forecast for the global economy is also reflected in the September edition of the World Economic Outlook (WEO) of the International Monetary Fund (IMF).  Since the last WEO in April 2004, the IMF has raised its forecast for global growth by 0.3 percentage points to 5.0% for this year.  The upward revision followed on stronger-than-expected economic growth in the first quarter of the year, bolstered by continued accommodative macroeconomic policies, rising corporate profitability, wealth effects from rising equity markets and housing prices, rising employment, and - particularly relevant for Asian countries - the very strong growth in China.  However, the Fund expects global growth to moderate from the second quarter of 2004, as the stimulating policies are drawing to an end and the higher oil price erodes purchasing power.  As a result, the IMF sees global growth dropping to 4.3% in 2005, slightly lower than the Fund’s April projection, but still significantly above the historical trend.

IMF estimate for United States in line with market
These figures refer to global output growth, when calculating individual countries’ weight based on purchasing power parity (PPP), as opposed to the current US$ weights underlying the LatinFocus Consensus Forecast.  The PPP methodology gives countries such as China and India a much higher weight in the global aggregate.  Since both countries continue to expand at a much quicker pace than industrialised economies, applying the PPP weights leads to higher global growth rates than with an exchange rate weighted global average.  The IMF’s exchange rate weighted outlook for this year also anticipates global growth at 4.1%, just 0.1 percentage point below the latest Consensus.  For next year, the IMF anticipates global growth to slow to 3.4% based on market exchange rates, which is also just a notch below the current Consensus. 

US economy remains robust but higher oil prices and waning policy stimulus will prompt slowdown in 2005
The IMF has cut its growth forecast for the United States this year by 0.3 percentage points over April to 4.3%.  The IMF lowered the forecast for 2004 because the above-potential growth in the first quarter was followed by a soft patch in the second in the wake of a slump in personal consumption (see August edition of the LatinFocus Consensus Forecast for details).  However, the Fund expects output growth to pick up in the second half of 2004, supported by continuing strength in profits and household labour income, as well as the restoration of incentives for automobile purchases.  Thus, the IMF forecast is bang in line with the Consensus Forecast, which remained unchanged over last month.  For next year, the Fund is once more on par with the panellist average, expecting economic growth of 3.5%.  The IMF’s forecast is based on a slowdown in household demand in the wake of higher energy prices, the waning effects of mortgage refinancing, tax cuts and a gradual rebound in the saving rate.  In addition, the IMF expects lower government spending, as the fiscal position improves.  On the other hand, economic activity will be buttressed by continued strength in business investment and a modest improvement in external demand, as trade volumes respond to the depreciation of the US$.  

Imbalances in current account and fiscal balance raise concerns
Despite the generally positive outlook, the Fund sees a number of uncertainties facing the recovery.  In particular, the recent rise in oil prices and declines in some forward-looking indicators could result in a less propitious development than expected.  These downside risks are compensated for by solid business confidence, healthy investment spending and rapidly rising labour productivity.  The most important threats to the U.S. economy, however, are the exceeding deficits in the current account and the fiscal balance.  The Fund projects the current account deficit to narrow to 5.0% of GDP in 2005 but to remain above 4% of GDP through the rest of the decade, assuming no further real depreciation of the US$ and a moderate fiscal consolidation.  The Fund acknowledges that the expansionary fiscal policy in recent years has supported the recovery but cautions that the more expansionary fiscal policy has also brought about the fastest deterioration in the U.S. budget position in the past fifty years.  The Bush administration has pledged to lower the deficit by half over five years, which does not appear sufficiently ambitious in the Fund’s eyes.

Fund more optimistic about recovery in Euro Area
For the Euro Area, the IMF is significantly more optimistic than in April.  The Fund projects economic growth to increase to 2.2%, following last year’s anemic 0.5% expansion, which is up 0.4 percentage points from the Fund’s April forecast.  Thus, the IMF is considerably more upbeat than the Consensus Forecast, which sees economic growth at 1.9%.  However, officials acknowledge that the upturn will remain moderate and so far has been heavily dependent on external demand.  Moreover, while industrial production and business confidence are gradually improving, consumer confidence and retail sales continue to lag.  With the momentum stemming from global impetus ebbing in next year, the recovery will have to be increasingly supported by domestic demand.  Consequently, the IMF does not expect economic growth to accelerate in 2005 and sees the rate of expansion remaining at 2.2%.  Once more, the Consensus is a notch more pessimistic, expecting the Euro Area economy to expand by 2.1% in 2005.