People's Republic of China and the IMF
Japan and the IMF
United States and the IMF
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Remarks by Rodrigo de Rato y Figaredo
Managing Director, International Monetary Fund
At Instituto Cervantes
New York City, June 16, 2005
As Prepared for Delivery
1. Thank you, Mr. Muñoz, for that kind introduction. Good evening. It is a great pleasure to be here today, and to be associated with the activities of Instituto Cervantes.
2. As you may know, it was just over a year ago that I assumed the position of IMF Managing Director. The IMF is a key institution of the international monetary system, and plays a critical role in the promotion and maintenance of global growth and stability. For my remarks today, I would like to draw from the IMF's work and experience on global economic issues to offer some thoughts on the outlook and challenges for world economic growth.
The Global Economy—Developments and Outlook
3. Global economic growth was strong in 2004, underpinned by accommodative macroeconomic policies, improving corporate balance sheets, and supportive financial market conditions. The expansion recorded last year was the highest rate in almost three decades. It represented not just growth, but also a significant rise in per capita incomes in all regions of the world. Sub-Saharan Africa, in particular, posted its highest GDP increase in a decade. These encouraging results were due partly to strong global demand and prices for commodity exports, but they also point to better policies in a number of countries.
4. Growth this year is expected to slow moderately, but still remain above trend at around 4¼ percent. After exceeding expectations in the first quarter of 2005, recent data suggests that global growth has slowed in the second quarter, in part reflecting the further rise in oil prices. Assuming oil prices stabilize, we expect this slowdown to be temporary. Correspondingly, our forecasts for global growth remain at about 4.3 to 4.4 percent in 2005 and 2006.
5. The continuing economic expansion, however, has not been evenly-balanced across regions. Growth has been strong in the United States, China, and most emerging market and developing countries. Recent news from Japan has also been encouraging. In contrast, the performance of Europe continues to disappoint, with political developments there adding even more uncertainty. Consistent with this pattern, global current account imbalances have also widened. The U.S. current account deficit was a record 5.7 percent of GDP for 2004, and has not yet been moderated by the depreciation of the U.S. dollar since 2002. This deficit is matched by corresponding surpluses in emerging Asia, Japan, oil-producing countries in the Middle East and the Commonwealth of Independent States (CIS), and—to a much lesser extent—the euro area. I shall return to this issue in greater detail later.
6. Inflation and inflationary pressures remain relatively subdued. To date, higher oil prices have not significantly affected core inflation or inflationary expectations. With diminishing slack in these countries, inflation needs to be increasingly carefully monitored, as the pace of tightening may have to be quickened if signs develop that underlying inflation is picking up.
7. Financial market conditions also remain generally favorable. These are continuing to support the global economic upswing. Long-term bond yields have fallen in recent weeks, although some emerging market and corporate spreads have risen above their historical lows. Nonetheless, many borrowers have been able to take advantage of what are exceptional conditions to lock in favorable rates. Emerging market external borrowing has also been strong to date, and many countries have nearly completed their 2005 financing needs.
8. Within this overall positive outlook loom some short-term risks. First, the future price of oil remains a possible risk variable. Recent economic indicators suggest a "soft patch" in some major industrial countries, mostly attributed to the lagged impact of higher oil prices. The underlying crude oil market continues to be driven by strong demand, particularly in the United States and China, and long-dated futures remain high. At the same time, there is very little upstream excess capacity. Growth is declining in non-OPEC supply, and there are uncertainties about OPEC's ability to cope with increasing demand.
9. Second, financial market conditions could tighten significantly. This risk is heightened by the currently very low benchmark yields, renewed dollar strength, and stimulative environment for risk-taking. For example, an unexpected pick-up in inflation could lead to an abrupt increase in interest rates. This could trigger a U.S. house price correction, and a sharp decline in the consumption of U.S. households. The consequences for growth in the United States and elsewhere would be negative, and financing conditions for emerging market countries would deteriorate. Higher short-term interest rates could also prompt financial market de-leveraging and downward adjustments in the price of riskier assets, underscoring the need for vigilance by both supervisors and regulators.
10. Third, the increasingly unbalanced global expansion is another risk factor. As I mentioned earlier, global growth remains unduly dependent on the United States and China. If this situation persists, it will further widen global imbalances, increasing the potential for abrupt corrections in currency and capital markets. The risks for a more significant slowdown later on will also be raised, especially if growth in the U.S. and China were to weaken simultaneously. In addition, and as discussed below, the U.S. current account deficit remains at record levels. Its potential to cause a possibly disorderly depreciation of the U.S. dollar cannot be ruled out.
11. Fourth, monetary policy management could become increasingly difficult in some emerging market economies, notably in Asia and the CIS. Strong external inflows can be expected to add to inflationary pressures in these regions, especially in the absence of greater upward exchange rate flexibility. In Latin America, where some countries have had recurrent bouts of inflation, central banks have already begun monetary tightening to help restrain expectations. As the global economic expansion continues and labor market conditions tighten, inflationary pressures could rise further, and will need to be monitored closely. This is more likely to be the case if labor productivity growth were to weaken at the same time.
Longer-Term Policy Challenges
12. In some respects, industrial and developing countries are better placed to manage these risks than they were in the past. Macroeconomic policy frameworks, particularly on the monetary side, have improved, and economies have generally become more flexible, albeit to differing extents. Further, external vulnerabilities in emerging markets have also been reduced significantly. That said, three overarching vulnerabilities remain which continue to pose longer-term policy challenges. These vulnerabilities could also affect the short-term outlook.
13. To begin with, fiscal positions in many countries remain very difficult, posing a significant medium-term threat to macroeconomic stability. In the largest industrial countries, fiscal deficits remain high, with Canada being a notable exception. Projected improvements, in addition to being generally unambitious, are also in many cases not underpinned by credible measures. And while some steps have been taken to address the implications of having to accommodate aging populations—particularly in the euro area and Japan—the policy response remains inadequate so far. In the case of emerging markets, although fiscal indicators have generally improved, many countries still have a long way to go to bring public debt-to-GDP ratios to sustainable levels.
14. Next, structural weaknesses continue to constrain growth in key areas, and are contributing to increase countries' vulnerability to shocks. The challenges faced by different regions and countries vary widely, but they include:
• Inflexible labor and product markets in the euro area and Japan;
• Corporate and financial sector weaknesses in much of emerging Asia;
• Unfavorable investment climates in Latin American countries;
• Weak banking supervision systems in central and eastern Europe; and
• For the Middle East, a need to greater develop institutional infrastructure for non-oil sector development.
15. Lastly, I return again to the issue of the deepening global imbalances. By this, I am of course referring to today's situation where the balance of transactions in international trade, services, and transfers is very uneven across countries. This has resulted in large differences in the external current accounts of countries. At present, there is a large current account deficit in the United States, with counterpart surpluses concentrated in a few other countries, mainly in emerging Asia and oil-exporting countries. While it is true that the large U.S. current account deficit has so far been financed relatively easily, aided by continued capital inflows from around the world, the demand for U.S. assets is not unlimited. Further, experience shows that deficits of the size that the U.S. has been running cannot be sustained indefinitely. A continuing sharp rise in U.S. net external liabilities will therefore carry increasing risks.
16. The broad strategy to address the imbalances problem is generally agreed. However, firm implementation of the necessary measures is still lacking. It is therefore worthwhile to review what these measures are, and why they must be carried out without further delay.
17. First, in the United States, credible and sustained measures must be taken towards fiscal consolidation, particularly in the medium-term. This is a key step for maintaining investor confidence in U.S. assets. The U.S. administration's budget proposals for the next fiscal year contain some signs of fiscal restraint, a necessary step on the path towards sustainability. Over the medium-term, even more ambitious fiscal objectives seem warranted, especially in view of the longer-term demographic challenges, the current account imbalance, and the relatively favorable U.S. cyclical position.
18. Second, growth in the euro area and Japan must be increased, so as to re-establish these regions as leaders in the global economic expansion. Structural reform remains the key to unleashing the potential of the European and Japanese economies. Policy requirements in the euro area would differ across countries, but in general, there is a need to increase labor utilization, further liberalize product markets, and promote greater financial sector integration. Similarly in Japan, greater improvements are needed in labor market flexibility and product market competition. Additionally, barriers to inward foreign direct investment should be lowered, and agricultural policies liberalized.
19. Third, in China and emerging Asia, moving towards greater exchange rate flexibility, and strengthening financial sectors, continue to be priorities. Exchange rate flexibility would also carry the added benefit of greater monetary control for countries. China's vibrant growth has benefited not only the region, but also other parts of the world. A more flexible exchange rate system, together with broad structural reforms in the financial and enterprise sectors, will facilitate China's continued global integration.
20. Through coordinated and determined effort as outlined above, the current global imbalances can be unwound with less disruption to international economic stability. The IMF stands ready to facilitate an orderly adjustment of the imbalances, including by helping to coordinate the various policy measures required.
21. That then is a general overview of the current state of the world economy. As I indicated at the beginning, these are relatively good times. By the same token, there are also risks to the outlook, as is to be expected. The key to sustaining growth and stability is for countries to take advantage of the positive environment that exists now to address weaknesses and risks. The IMF—with its mandate to promote and maintain global economic stability—is a principal actor in helping countries identity those weaknesses and devise measures to address them. By tackling the issues boldly—particularly the imbalances problem—continued and stable economic growth can be ensured.
22. The benefits of that growth will flow to all regions worldwide, but will be of special importance to low-income countries. Stable and sustained growth plays a crucial role in poverty reduction and the march towards the Millennium Development Goals. The IMF is committed to the war against poverty and the quest for the MDGs. In that regard, last weekend's proposal by the Group of Eight on debt relief for Heavily Indebted Poor Countries (HIPCs) is to be welcomed, for it goes a long way toward helping these countries escape their heavy debt burdens. We will work with our membership to examine the details and implementation of that proposal, and look forward to an early agreement on those matters.
23. Once again, thank you for inviting me to speak here today. I would be happy to take some of your questions.
IMF EXTERNAL RELATIONS DEPARTMENT