Documents Related to the September 28, 2002 International Monetary and Financial Committee (IMFC) Meeting

Statements Given on the Occasion of the IMFC Meeting, September 28, 2002

Managing Director's Statement
to the International Monetary and Financial Committee On the World Economic Outlook

September 25, 2002

Following a surprisingly strong first quarter, concerns about the pace and durability of the global recovery have risen in recent months. Financial markets have also weakened, with equity markets having fallen sharply since end-March, accompanied by a depreciation of the U.S. dollar; financing conditions for a number of emerging market borrowers, especially in South America, have weakened further; and current and forward-looking indicators for the United States, Europe, and several other regions have fallen short of expectations. That said, there are still good reasons to expect a pickup in growth in the period ahead, and it is encouraging that the global financial system has proved remarkably resilient to the substantial shocks of the last year. Overall, I expect the global recovery to continue, but at a weaker pace than earlier anticipated, and with downside risks appearing to predominate. Correspondingly, policymakers will need to remain vigilant, and if incoming data were to suggest that the recovery is faltering, additional monetary easing would need to be considered.

Recent developments in financial markets are helping to reduce imbalances that have been of concern for some time, notably the earlier possible overvaluations of both equity markets and the U.S. dollar. However, as described in detail in the World Economic Outlook, these developments are likely to have a negative effect on growth in most advanced economies in the short run, in some cases (including the United States and United Kingdom) partly offset by continued buoyant housing markets. The bursting of the equity market bubble has caused stresses in specific financial institutions, notably in Japan and Europe. However, as described in the IMF's Global Financial Stability Report, the system as a whole has remained resilient, in part because the flexibility and depth of markets has allowed credit risk to be widely distributed. Nonetheless, uncertainties have continued to rise, and financing conditions for higher risk borrowers have become much more difficult.

Against this background, global growth is projected to rise to 2¾ percent in 2002 and to 3¾ percent in 2003, underpinned by the turn in the inventory cycle and continued accommodative macroeconomic policies (Table). While the 2002 projection is the same as that in the April World Economic Outlook, this entirely reflects stronger-than-expected first quarter outturns in several regions; from the second quarter onward the pace of the recovery is expected to be weaker than earlier anticipated, reflecting the adverse developments described above.

  • In the United States, the adverse impact of lower equity prices will be offset in part by lower long term interest rates and the depreciation of the dollar, as well as rising housing wealth. However, the upturn will be considerably slower than earlier thought, and much depends on the pace with which private investment picks up and on the resilience of household consumption.

  • Recent indicators in Japan suggest that the economy may be bottoming out, aided by a pickup in net exports, and we expect a modest rebound during the rest of 2002 and in 2003. However, domestic demand remains very weak, and the outlook remains contingent on a further strengthening in global activity.

  • In the euro area, domestic demand has also proved weaker than expected, especially in Germany and Italy, with the tepid recovery to date driven largely by net exports. While rising household earnings, lower inflation—partly as a result of the stronger euro—and improvements in labor market performance over recent years should support demand looking forward, much again depends on the external outlook.

In emerging market economies, the outlook has become increasingly diverse. Key influences include the hesitant recovery in industrialized economies; heightened risk aversion in international financial markets and a retrenchment in capital flows, particularly to sub-investment grade borrowers in Latin America; and significant economic and political uncertainties in some major economies with large external financing requirements.

  • The sharp deterioration of economic conditions in Latin America over the past six months is of concern. The region's difficulties mainly reflect circumstances and developments in individual countries, including domestic political developments, spillover effects, and in some cases concerns about policy sustainability. However, some regional economies have been quite resilient to recent pressures, and investor sentiment has improved somewhat in recent weeks, aided in part by support from the Fund and steps to assure policy continuity.

  • In contrast, growth in emerging Asia has picked up markedly, with substantial improvements among countries most oriented to the information technology sector, and relatively limited contagion from developments in Latin America. While external developments remain key, there are signs that domestic demand—initially strongest in China, India and Korea—is now picking up more broadly. Rising intra-Asian trade, including with China, is also contributing to regional stability and growth.

  • Growth among countries in central and eastern Europe and in the Commonwealth of Independent States has been relatively well sustained during the global slowdown, with robust domestic demand—and in some EU accession countries, strong inflows of foreign direct investment—offsetting external weaknesses. GDP growth in Turkey has also exceeded expectations, although political uncertainties and still high interest rates remain sources of vulnerability.

  • In the Middle East and Africa, commodity price developments continue to have an important influence on conditions and prospects. Energy exporting countries are clearly being helped by the recent strength of oil prices, but this same strength—together with still low non-fuel commodity prices—will adversely affect energy importers, including many of the poorest countries. Growth in these regions is also being held back by regional security concerns and conflicts; and the severe drought in southern Africa is exacting a huge human and economic toll.

At the present juncture, the outlook remains subject to unusual uncertainty. A faster-than-expected pickup is possible, for instance if productivity growth in the United States were to surprise on the upside, but overall the risks appear predominantly on the downside. In particular:

  • The global outlook depends unduly heavily on the United States, particularly since the pickup in Western Europe is not yet self sustaining, and domestic demand in Japan is likely to be constrained by structural problems for some time. Moreover, given the global impact of economic and financial developments in the United States, downside risks to the U.S. outlook imply downside risks to other regions.

  • Oil prices could spike sharply if the security situation in the Middle Eastern region deteriorates further. This would seriously affect global activity, and increase the chance of other risks (including those noted below) occurring.

  • Financial markets remain volatile. While a considerable portion of earlier irrational exuberance may now have been eliminated, markets could decline further—particularly if more accounting scandals were to emerge, or retail investors were to lose confidence.

  • A number of emerging market economies remain particularly vulnerable to a further retrenchment in risk taking. Risks facing emerging market borrowers have increased in recent months, and would be exacerbated by a further weakening of investor confidence and/or additional slowing in the global recovery.

  • The global imbalances remain a source of concern. While currency movements so far have been orderly, the possibility of a sudden adjustment cannot be ruled out.

Against this background, policymakers in both advanced economies and developing countries will need to be vigilant. In my view, the main policy priorities are the following:

  • Macroeconomic policies in the large advanced economies will need to remain accommodative for longer than had been anticipated earlier in the year. If incoming data were to suggest that the recovery were faltering, some further easing in monetary policy would likely be needed in the United States and in the euro area, provided inflationary pressures remain subdued in the United States and come down as expected in Europe. In Japan, more aggressive monetary stimulus is needed, combined with a public commitment to end deflation in the near future. On the fiscal side, most countries have much less room for maneuver, and—while the automatic stabilizers should be allowed to operate—medium-term fiscal consolidation is the priority. However, if structural reforms are accelerated in Japan—which should be a priority to build confidence—further steps to contain the withdrawal of fiscal stimulus in prospect may be desirable.

  • Among emerging market economies, policy priorities vary widely. Where there is room for policy maneuver, the macroeconomic stance should, in general, remain accommodative. But in countries facing external financing difficulties, policies focused on the restoration of financial market confidence should be the priority. Alongside the maintenance of appropriate policies in industrial countries, this will also help reduce the risk of contagion.

  • Notwithstanding the increased short term risks, attention needs increasingly to focus on medium-term policies to support growth and reduce macroeconomic vulnerabilities:

      There is a pressing need in many advanced countries, as well as in emerging market regions, to improve productivity and potential growth. In addition to boosting overall living standards, such improvements would strengthen countries' resilience to economic shocks, better enable them to meet the impending economic and fiscal challenges arising from aging populations, reduce global dependence on U.S. growth, and foster an orderly reduction of global imbalances. While reform priorities vary, further labor, product, and financial market reforms are needed in the euro area to support economic adjustment and to take full advantage of the scope for increased area-wide efficiency and integration arising from the introduction of the euro. In Japan and—for different reasons—emerging Asia, prospects for sustained growth need to be supported by measures to further strengthen banking and corporate sectors. In this regard, forceful measures are needed in Japan to address the bad loan problem and inadequate capital base of the banking sector.

      As recent experience has shown, transparency is not just for developing countries. There is a clear need to strengthen corporate governance and transparency in the United States and elsewhere, including through effective implementation of recent reforms.

      A strengthening of medium-term fiscal positions is also widely needed. In advanced economies, this would—along with pension and health care reform—help prepare countries to meet the aging challenge. And, especially in Latin America but also increasingly in Asia, fiscal consolidation would help reduce vulnerabilities arising from high levels of public debt. In many cases, improving underlying fiscal positions would require structural reforms to broaden tax bases, tighten spending control, and strengthen public sector management more generally.

Finally, it is critical to remain focussed on the overarching goal of poverty reduction. In this connection, it is encouraging that growth in Africa, China and India—which account for the bulk of global poverty—has remained relatively resilient during the global downturn. That said, in Africa and India, growth rates remain well below those needed to achieve the targeted degree of poverty reduction by 2015.

  • In the poorest countries, the key requirement is to improve the overall environment for investment and growth. It is particularly important for these countries to strengthen their economic infrastructure and main market institutions, and to improve the quality of governance. I welcome the fact that the New Partnership for Africa's Development (NEPAD) embraces these key priorities, and look forward to the sustained implementation of this initiative.

  • The international community must support such efforts through additional financial and technical assistance, focussed on the poorest countries. The G-8 Africa Action Plan announced in June, and the increased aid commitments for countries that reform made at the Monterrey summit, are welcome steps; and the HIPC Initiative is also making a crucial contribution. But there is still a long way to go before aid flows reach the U.N. target of 0.7 percent of advanced economies' GNP.

  • Trade liberalization is even more important for promoting growth, reducing poverty, and facilitating the diversification of the economies of low income countries. Industrial country barriers impose significant costs on the developing world (and on themselves), as the latest World Economic Outlook underscores. This is not a one way street: developing countries' own trade barriers impose even bigger costs on their economies. But advanced economies, which are much better placed to manage the transitional costs of restructuring, have a special responsibility to lead the way. Following the regrettable intensification of protectionist pressures earlier this year, I am encouraged that both the United States and the European Commission have put forward proposals to reduce agricultural protection. I look forward to early progress on this, and, more generally, in multilateral trade negotiations in the context of the Doha round.