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Remarks by Mr. Takatoshi Kato, Deputy Managing Director, International Monetary Fund
April 9, 2006
I very much appreciate the opportunity to address this ministerial gathering, which represents a large share of the Fund's membership. There are a good number of important global economic issues I could address. In the time assigned to me, I intend to focus on four issues relating to the international community: the Fund's assessment of the world economic outlook; the outlook for the global oil market, the continuing threat posed by current account imbalances, and the Fund's role in controlling the financial and economic risks posed by an avian flu pandemic.
I. Summary of the Global Economic Outlook
The performance of the global economy continues to exceed expectations. Its real rate of growth reached 4.8 percent in 2005, and is projected to stay at about that rate in 2006-2007. With the strong performance of emerging market economies—especially China, India and Russia, but also the rest of emerging Asia—the expansion in Japan, which is now firmly established, and the recovery in Europe, which is strengthening, the sources of the global expansion are now more balanced regionally. This is a welcome development.
The short-run outlook for the United States remains favorable. To judge from incoming data, growth is now back on track after a slow-down in the fourth quarter of 2005. The main risk to the U.S. outlook is an abrupt adjustment in the housing market (the staff estimate that a 10 percent fall in the rate of appreciation of housing prices would reduce the growth of personal consumption by 2 percentage points).
Despite the near doubling of the price of crude oil since late 2003, inflationary pressures are surprisingly moderate. Global core inflation has declined to 1½ percent, and expectational indicators imply that inflation should remain under control in most countries. This being said, the bias to the outlook for inflation is on the upside for several reasons: first, capacity utilization rates are rising world-wide, and in some countries are starting to affect wage settlements; second, the impact of the increase in oil and other commodity prices to date may not have been fully felt, and in some emerging market countries large current account surpluses are complicating the task of monetary control. In addition, global liquidity remains ample. In these circumstances, central banks must be especially vigilant to signs of incipient inflationary pressures such as rising import prices.
The global financial environment remains favorable. Although short term rates have been rising, long-term rates are still relatively low, as a result of both unique factors—like increasing demand for long-dated bonds from pension and insurance companies—and more fundamental factors—like high corporate and emerging market saving. Spreads on corporate and emerging market debt are also low, partly because of improved fundamentals, and partly because of ample global liquidity and the related search for yield.
Financial markets are pricing in a moderate increase in short and medium-term interest rates during 2006. The impact of such an increase on the global economy should be manageable. An unexpected spike in interest rates, however, could entail problems for a few vulnerable emerging market economies and for overextended households, particularly in countries with elevated housing prices.
Despite the favorable short-run outlook, the balance of risks is slanted to the downside. On the positive side, global growth might actually be boosted by a more rapid growth of investment in industrial market countries, and growth in some emerging markets might surpass expectations. On the negative side, there is the risk of tightening financial market conditions, which I have already mentioned, as well as the risks entailed by high and volatile oil prices, the global economy's increasing vulnerability to a disorderly adjustment of the current account imbalances, and avian flu.
II. The Global Oil Market
The impact of the near doubling in the price of oil since late 2003 has not had the effect many observers feared on either growth or inflation. Fund staff estimates that the increase reduced global GDP in 2005 by 1-1½ percent, or about one-half the impact such an increase would have had in the past. We attribute the comparatively moderate impact of the increase in the oil price to date to a combination of factors, including well-anchored inflationary expectations and the mostly demand-driven nature of the price increase.
The impact of any future oil price increase may not be so moderate. Spare capacity, both upstream and downstream is very limited, and the expected rate of investment is not enough to increase it appreciably given the expected growth of demand. In these circumstances, prices are particularly sensitive to perceived or actual threats to supply, such as the kinds of geopolitical events and disturbances that have occurred in recent months. The most recent increases, unlike the previous two years, have mainly reflected concerns over the adequacy of supply. Negative supply shocks not only increase the price of oil; they constrain global growth.
Although the impact of the recent increase has been manageable, a number of policies can be taken to alleviate current strains in the oil market:
III. The Global Current Account Imbalances
The unbalanced pattern of current account deficits—a large deficit in the United States, and large surpluses in Japan, emerging Asia, and now in the oil-exporting countries—has become even more pronounced over the past year. There is general agreement that this configuration is not sustainable and that a disorderly adjustment could be very costly. Fund staff simulations suggest that a market-based adjustment supported by measures that increase domestic demand in surplus regions and lower it in deficit regions, complemented by appropriate exchange rate adjustments would have moderate short-term costs in terms of output foregone, but large longer-term gains. In the United States, this will require fiscal consolidation and increased saving incentives. In emerging Asia, reforms could improve the environment for investment and saving; particularly important are reforms to make financial intermediation more efficient. Exchange rate adjustment is also necessary in China and several other Asian economies. In Europe and Japan, boosting both potential supply and demand will require structural reform to make labor and product markets more efficient.
Some limited progress has been achieved thus far, but in general implementation has lagged. The global imbalances conference being held on the eve of the upcoming IMFC meetings in Washington aims at fostering a meeting of minds as to concrete steps to carry the agenda forward. From an economic perspective, there is unlikely to be a more favorable environment for meaningful reform.
I would also like to stress the importance of a successful conclusion to the Doha Round, which is facing stiff resistance. Given the recent unsettling increase in protectionist sentiment, any chance of achieving substantial progress will require a political commitment at the highest level.
IV. The Policy Implications of Avian Flu
In addition to its toll in death and suffering, an avian flu pandemic with human to human transmission could cause costly financial and economic dislocation. The Fund's role in mitigating this risk involves encouraging central banks and financial regulators to ensure that they and private financial institutions have appropriate contingency plans to deal with the consequences of an avian flu pandemic, and notably the possible loss of key personnel through death, illness or absenteeism.
Our main focus is to minimize the risk of operational disruptions in the financial system. To carry this out, the Fund is raising awareness by disseminating information and discussing preparations with country authorities on missions, and we have organized a series of information-sharing regional seminars for country officials. In this connection, I need to share with you the staff's view that some of the Fund's member countries are not as yet far advanced in preparing the necessary contingency plans. We see such measures as a cost-effective form of insurance against an event that, even if unlikely, would have catastrophic consequences, and I would impress upon you all the importance of prompt and concerted action. In addition to a natural concern for the health and welfare of the world's citizens, we would all recognize that an outbreak of a highly infectious disease in any one country or region is a threat to the whole world.
Thank you for your attention.
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