IMFC Meeting November 17, 2001

Documents Related to the November 17, 2001 IMFC Meeting



Managing Director's Note for the International Monetary and Financial Committee: An Initial Assessment of Prospects for the Global Economy Following the Events of September 11

November 13, 2001

Since late last year, growth has weakened sharply in most regions of the world, accompanied by a marked decline in trade growth and deteriorating financing conditions in emerging markets. Before the terrorist attacks of September 11, it appeared that there was a reasonable prospect of recovery in late 2001. However, more recent data indicate that the situation before the attacks was weaker than earlier projected in a number of regions, including the United States, Europe, and Japan, as well as a number of emerging market economies in Asia and Latin America.

From the perspective of the global economy, the tragic events of September 11 therefore came at a particularly difficult time. Since the attacks, consumer and business confidence have weakened across the globe, and there has been a generalized shift away from risky assets in both mature and emerging markets (Figure 1). Preliminary data confirm a significant initial impact on demand and activity in the United States and other industrial countries, and unemployment has begun to rise. With the outlook for global growth weakening, commodity prices have fallen, particularly for oil, as have equity values in many emerging markets. In contrast, after falling sharply in the fortnight after the attacks, industrial country equity markets have subsequently recovered their losses, while exchange rate movements among major currencies have generally been moderate, with both the euro and the yen recently depreciating somewhat against the U.S. dollar.

At the present juncture, the outlook remains subject to great uncertainty. It is extremely hard to form a judgment on whether the recent deterioration in confidence and increase in risk aversion will be relatively short-lived or more prolonged, with much continuing to depend on non-economic developments, including the war in Afghanistan. That said, macroeconomic policy in many parts of the world—particularly in the United States—has moved to sustain activity. In addition, for many countries lower oil prices will be supportive of recovery, while low inflation and strong fiscal positions are providing considerable room for maneuver for macroeconomic policies. The resilience of many emerging markets to shocks has also been improved over recent years by the adoption of flexible exchange rate regimes, stronger reserve positions, and more limited short-term obligations, as well as reforms of the international financial system. There are therefore reasons to expect that a recovery will develop during 2002.

The staff's revised baseline projections envisage that the global slowdown will be more prolonged than foreseen in the October 2001 World Economic Outlook, with recovery being delayed until around the middle of 2002. As a result, global GDP growth has been revised downward by 0.2 percentage points to 2.4 percent for 2001 (Table 1 and Figure 2), and by 1.1 percentage points to 2.4 percent for 2002:

 

Selected Financial Market Indicators

Table 1. Overview of the Baseline Projections
(Annual percent change unless otherwise noted)


Difference from October

       

Current Projections

 
2001 Projections1
   

1999

2000

2001

2002

 

2001

2002


World output

 

3.6

4.7

2.4

2.4

 

-0.2

-1.1

Advanced economies

 

3.4

3.8

1.0

0.8

 

-0.3

-1.3

   Major advanced economies

 

3.0

3.4

0.9

0.6

 

-0.2

-1.3

      United States

 

4.1

4.1

1.1

0.7

 

-0.3

-1.5

     Japan

 

0.8

1.5

-0.9

-1.3

 

-0.4

-1.5

     Germany

 

1.8

3.0

0.7

0.8

 

-0.1

-1.0

     France

 

3.0

3.4

2.0

1.3

 

-0.8

     Italy

 

1.6

2.9

1.8

1.2

 

0.1

-0.8

     United Kingdom

 

2.1

2.9

2.3

1.8

 

0.2

-0.6

     Canada

 

5.1

4.4

1.4

0.8

 

-0.5

-1.4

   Other advanced economies

 

4.9

5.2

1.4

1.9

 

-0.4

-1.4

                 

Memorandum

               

European Union

 

2.6

3.4

1.7

1.4

 

-0.1

-0.8

   Euro area

 

2.7

3.5

1.6

1.3

 

-0.2

-0.9

Newly industrialized Asian   economies

 

7.9

8.2

0.3

1.7

 

-0.7

-2.5

                 

Developing countries

 

4.0

5.8

4.0

4.4

 

-0.4

-0.9

  Africa

 

2.5

2.8

3.5

3.6

 

-0.3

-0.8

  Developing Asia

 

6.1

6.8

5.6

5.6

 

-0.2

-0.5

    China

 

7.1

8.0

7.3

6.8

 

-0.2

-0.3

     India

 

6.8

6.0

4.4

5.2

 

-0.1

-0.5

    ASEAN-4 2

 

2.8

5.0

2.1

2.9

 

-0.2

-1.2

  Middle East, Malta, and  Turkey

 

2.0

5.9

1.7

4.0

 

-0.6

-0.7

  Western Hemisphere

 

0.1

4.1

1.1

1.7

 

-0.6

-1.9

     Brazil

 

0.5

4.4

2.0

2.0

 

-0.2

-1.5

                 

Memorandum

               

Sub-Saharan Africa

 

2.5

2.9

3.1

3.4

 

-0.4

-0.8

Heavily indebted poor countries3

 

3.8

3.7

3.8

4.5

 

-0.5

-1.1

                 

Countries in transition

 

3.6

6.3

4.7

3.9

 

0.7

-0.2

  Central and eastern Europe

 

2.0

3.8

3.0

3.3

 

-0.5

-0.9

  Commonwealth of Independent

               

    States and Mongolia

 

4.6

7.8

5.9

4.3

 

1.4

0.3

    Russia

 

5.4

8.3

5.8

4.2

 

1.8

0.3

    Excluding Russia

 

2.8

6.8

6.1

4.3

 

0.7

0.2

                 

World trade volume (goods and services)

 

5.4

12.4

1.3

2.6

 

-1.4

-2.6

                 

Commodity prices (in U.S. dollars)

               

Oil 4

 

37.5

56.9

-11.4

-16.0

 

-6.4

-7.4

Nonfuel (average based on world   commodity export weights)

 

-7.0

1.8

-5.1

1.7

 

-2.5

-2.8

                 

Consumer prices

               

Advanced economies

 

1.4

2.3

2.4

1.4

 

-0.1

-0.3

Developing countries

 

6.8

5.9

6.0

5.2

 

0.1

Countries in transition

 

43.9

20.1

16.5

11.0

 

0.1

0.3

                 

Six-month London interbank

               

  offered rate (LIBOR, percent)

               

On U.S. dollar deposits

 

5.5

6.6

3.8

2.8

 

-0.3

-0.9

On Japanese yen deposits

 

0.2

0.3

0.2

0.1

 

On euro deposits

 

3.0

4.6

4.1

2.9

 

-0.2

-1.0

                 

Memorandum

               

World growth based on market

               

  exchange rates

 

3.0

3.9

1.3

1.2

 

-0.3

-1.2


Note: Real effective exchange rates are assumed to remain constant at the levels prevailing during September 17-October 16, 2001.
   1
Using updated purchasing-power-parity (PPP) weights, summarized in the Statistical Appendix, Table A.
   2Includes Indonesia, Malaysia, the Philippines, and Thailand.
   3
The 42 countries eligible for HIPC assistance from the Fund's program for Highly Indebted Poor Countries      for whom data is available.
   4
Simple average of spot prices of U.K. Brent, Dubai, and West Texas Intermediate crude oil. The average      price of oil in U.S. dollars a barrel was $28.21 in 2000, the assumed price is $25.00 in 2001, and $21.00 in      2002.

11/13/2001


Global Indicators

  • Among the industrial economies, the United States is now expected to experience a mild recession in the second half of 2001, followed by a recovery which strengthens through 2002, supported by the substantial macroeconomic stimulus in the pipeline, a gradual recovery of confidence, and the end of the inventory correction. As a result, real GDP growth in 2002 is now projected at 0.7 percent, 1.5 percentage points lower than projected earlier, while growth in Canada has been marked down significantly, in line with developments in the United States. Projections for the euro area have also been reduced, especially for Germany, reflecting recent data indicating a weaker-than-expected situation before the September 11 attacks as well as the aftermath while in the United Kingdom growth is expected to remain relatively resilient, buoyed by domestic demand growth and the easing of monetary policy. The outlook for Japan has become increasingly worrying, and the economy is now expected to experience two consecutive years of contraction for the first time in the post-war period.

  • Among emerging market countries, the impact of recent events varies widely, depending on the structure of the economy and the strength of economic fundamentals:

    • For the Western Hemisphere, GDP growth in 2002 has been revised down by 1.9 percentage points to 1.7 percent, because of the deterioration in external financing conditions, which has seriously affected a number of countries in the region, and weaker external demand for goods, including the downturn in tourism, which has particularly affected many central American and Caribbean countries. Lower oil prices have lessened financing requirements for many countries, including those suffering from declines in the prices of other commodities, while further weakening the outlook for net oil exporters.

    • In emerging Asia, growth is expected to remain reasonably robust in China and to a lesser extent India, which are less exposed to external developments. Elsewhere, notwithstanding increased policy stimulus and the generally beneficial effect of lower oil prices, growth has been marked down sharply owing to weakening external demand together with the further deterioration in the IT sector (which has particularly affected a number of the newly industrialized economies).

      o In the Middle East, growth will be adversely affected by lower oil prices, and in some cases weaker remittances and tourism revenues, reflecting both the fallout from the September 11 events and the worsened security situation in the region. In Turkey, the outlook has been affected by weaker external demand, especially for tourist services, and more difficult financing conditions, while domestic real interest rates remain extremely high.

    • In the transition economies, the impact of recent events is expected to be relatively moderate. Indeed, although slowing compared to 2000, growth in Russia has been revised upward for both 2001 and 2002, buoyed by relatively strong domestic demand. Growth in central and eastern Europe is also expected to remain reasonably resilient, partly owing to the benefits of lower oil prices.

  • The poorest countries are being hurt by weaker external demand and weakness in prices of commodities, with oil exporters particularly affected. Nonfuel commodity exporters will also be affected by further weakness in already depressed prices, especially for agricultural commodities, although the benefits from the lower cost of oil imports will help limit the increase in external financing requirements. On the macroeconomic side, while growth is projected to be relatively well sustained for the group as a whole—not least, because a number of countries are benefiting from the cessation of armed conflicts—this masks wide differences in the outlook for individual countries. Moreover, the aggregates may understate the impact on poverty, as lower prices for agricultural goods will hurt rural areas, where most of the poor live, while the benefits of lower oil prices tend to accrue in urban areas.

With substantial policy stimulus in the pipeline, there is a possibility that recovery in 2002 will come more rapidly than presently expected. However, given the already difficult situation for the global economy, the major policy issue at the current juncture is clearly the possibility that a worse outcome could occur. In this context, I would focus on four key areas of risk:

  • Confidence and activity in the United States may pick up more slowly than presently expected, for instance if the effects of the terrorist attacks themselves prove more prolonged, or if recovery is hampered by the imbalances accumulated in the past, including over-investment and consumers' relatively high indebtedness, particularly given higher interest rates for risky borrowers. In addition, there are also downside risks to activity in the other major currency areas. With no major region providing substantive support to activity, further weakness in any one would reinforce the already synchronized downturn, with consequences that would be difficult to predict given the progressively stronger and more complex economic and financial linkages across countries. This could likely result in a greater and more prolonged withdrawal from risk taking in financial markets, as well as lower commodity prices, both of which would adversely affect developing countries.

  • The outlook for emerging market countries depends critically on how long global risk aversion remains elevated and bond issuance is basically limited to only high grade borrowers, as well as the extent of the squeeze generated by refinancing pressures in the meantime. Recent declines in global interest rates have helped limit the increase in borrowing costs, and—with dedicated emerging market investors holding extremely large cash cushions—there is technical support for the market. However, bond markets—historically the largest source of external financing for emerging markets—are essentially closed for many countries, and financing pressures could become significantly larger and more widespread, particularly if the global outlook deteriorates further, or credit event concerns worsen.

  • The financial imbalances in the global economy remain an important source of risk. Mature equity markets appear to be pricing in a relatively rapid recovery; however it remains unclear whether asset markets have fully priced in the deterioration in corporate credit quality and earnings prospects that has occurred thus far. Currency options market data suggest that expectations of a sharp depreciation in the U.S. dollar have not increased since the attack, partly reflecting a lack of financial market confidence in Europe's ability to decouple from the present slowdown in the United States. However, an abrupt adjustment in either market remains possible, particularly if the global growth outlook were to prove worse than expected, especially given the recent reduction in market liquidity—notably for credit swaps and derivatives—and the financial difficulties faced by some major market participants, including insurance companies.

  • Slowing growth and a flight to quality in financial markets would increase pressure on corporate and financial sectors across the globe. This is of particular concern in Japan, where banks are highly exposed to developments in equity and bond markets, but may also become more important in other countries in Asia and Latin America.

The long-term influence of the terrorist attacks on the global economy is also difficult to determine. Productive potential could be reduced by higher "transactions" costs associated with more uncertainty, such as greater spending on security, higher insurance premiums, and more stringent checks of traded goods. For this reason, it will be essential to resist protectionist pressures, which are often aggravated by a slowing of economic activity. That said, and while acknowledging the possibility of a lasting adverse impact on the global economy, I would align myself with the widespread view that the impact on long-term growth potential is likely to be reasonably small.

In summary, the global economy was already slowing prior to the events of September 11. The aftermath has led to a further deterioration in the short-term global outlook, added to the difficulties faced by a number of emerging market countries, and mat well have an adverse impact on the poor. Partly because of the strong policy response since the attacks, however, the economic effects may be reasonably brief, with recovery beginning around the middle of next year. However, major uncertainties and risks continue, and there remains a concern that a measurably worse outcome could occur—including significant further external financing pressures in emerging markets and other developing countries. It is essential in this environment to strengthen confidence. As discussed in more detail in my October 5 statement, this underscores the need for policies among the major industrial countries, on which the outlook for global growth primarily depends, to be proactive; for emerging market and developing countries to support activity while recognizing that there will be little market tolerance for weak fundamentals; and, last but not least, for a coordinated and collaborative response by the international community, including the Fund. I look forward to a positive outcome at the WTO Ministerial meeting in Doha and a rapid initiation of a new trade round, as a key element in a strategy for boosting confidence and reinforcing global growth prospects.

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