## _0599ch1pdf ## Source details **Canonical URL:** [_0599ch1pdf](https://www.imf.org/-/media/websites/imf/imported-flagship-issues/external/pubs/ft/weo/1999/01/_0599ch1pdf.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-flagship-issues/external/pubs/ft/weo/1999/01/_0599ch1pdf.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-flagship-issues/external/pubs/ft/weo/1999/01/_0599ch1pdf.pdf.json) --- ### Contents and structure (high-level) - Major parts: Preface; Chapter I–IV; Annex; Statistical Appendix; Boxes, Tables, and Figures. - Chapter I: World Economic Outlook and Policy Responses to the Global Slowdown (topics include New Phase in the Global Crisis, Latin America (Brazilian crisis), Policy Failures in Russia, Japan, Asia and the Pacific, Africa and the Middle East, North America, Europe). - Chapter II: Global Repercussions of the Crises in Emerging Markets and Other Conjunctural Issues (topics include Brazil’s Financial Crisis, Russia, Financial Flows after Brazil, Foreign Exchange and Financial Markets, Commodity exporters, U.S. saving-investment imbalance). - Chapter III: International Financial Contagion (changing nature of currency crises, fundamentals vs contagion, policy implications). - Chapter IV: Chronic Unemployment in the Euro Area: Causes and Cures. - Annex: Summing Up by the Acting Chairman; World Economic Outlook, Executive Board Meeting, April 2, 1999. - Statistical Appendix: assumptions, data and conventions, country classification, extensive tables (Output, Inflation, Financial Policies, Foreign Trade, Current Account, Balance of Payments, External Debt, Flow of Funds, Medium-Term Baseline Scenario). ### Assumptions and conventions used in projections - Real effective exchange rates: assumed to remain constant at their average levels during February 16–March 15, 1999, except for bilateral rates among ERM currencies, which are assumed to remain constant in nominal terms. - National policies: established policies of national authorities are assumed to be maintained. - Oil price assumptions: - average price of oil assumed to be $12.00 a barrel in 1999 and $13.60 a barrel in 2000, and to remain unchanged in real terms over the medium term. - The average price of oil in U.S. dollars a barrel was $13.07 in 1998. - Interest rate assumption: - six-month London interbank offered rate (LIBOR) on U.S. dollar deposits assumed to average 5.2 percent in both 1999 and 2000. - Projections based on statistical information available in early-April 1999; characterized as working hypotheses rather than forecasts. - Conventions: “ . . . ” indicates data not available; “—” indicates zero or negligible; “–” between years indicates period covered; “/” indicates fiscal or financial year; “Billion” = thousand million; “trillion” = thousand billion; “Basis points” refer to hundredths of 1 percentage point. - Presentation note: shaded areas in figures and tables indicate IMF staff projections. - Aggregates computed on the basis of purchasing-power-parity (PPP) weights. ### Preface — Major developments and balance of risks - Net assessment: "some significant positive developments in the world economy have been broadly balanced by some important setbacks, so that the global outlook is little changed." - Setbacks and sources of risk: - Crisis in Brazil: abandonment of crawling-peg in mid-January; "Financial contagion from the Brazilian crisis has been limited" but it "has imparted a new contractionary impulse to the global economy." - Financial sector fragilities in several emerging market economies, including China. - Russia: delay in adopting coherent stabilization and reform policies. - Conflict in the Federal Republic of Yugoslavia (Serbia/Montenegro) with "severe effects on small neighboring countries" and broader adverse consequences for southeastern Europe. - Japan’s economy "remains weak, and resumption of self-sustaining growth is not yet clearly in sight." - Increased global trade imbalances among the United States, the euro area, and Japan may trigger destabilizing exchange-rate movements and protectionist pressures. - Positive developments: - Activity "has recently turned around in Korea and seems to have bottomed out in Malaysia and Thailand." - Investor sentiment toward many emerging market economies "has rallied." - Mature financial markets improved after a "broad-based easing of monetary conditions." - "The introduction of the euro has proceeded smoothly, with the new currency immediately assuming the role of the second-largest international reserve currency." - Most advanced economies of North America and Europe, and Australia, "have proved resilient to the crises in emerging markets." - Continued strong growth of the U.S. economy; inflation "has generally remained subdued." ### Overall outlook, scenarios, and policy priorities - Balance of risks remains on the downside; several hurdles could prevent global growth returning to potential within two or three years in the baseline. - Staff baseline assumes: - financial market conditions for emerging market economies will gradually improve further; - the U.S. economy will experience a soft landing; - growth in the euro area will pick up (see Box 1.1 for detailed policy assumptions). - Downside scenarios delaying recovery until 2001 at the earliest include: - more adverse financial conditions for emerging markets than in most of the 1990s; - a more abrupt U.S. slowdown (if inflation picks up, the stock market corrects significantly, or private sector corrects saving shortfall faster than assumed); - persistent weakness in the euro area despite rate reductions; - prolonged Japanese weakness. - Policymaker priorities: - Be ready to attend to new emergencies. - Sustain growth in the short run and over the medium term. - Address obstacles to structural reform even where short-run benefits may be limited. - Avoid short-run expedient policies that carry greater long-term costs or harm trading partners. - Strengthen international economic cooperation. ### Key quantitative indicators and policy assumptions (selected) - World trade growth in 1998: "3!/4percent." - World growth reference: "last year’s rate of 2!/2percent." - Oil prices: - $13.07 a barrel in 1998 (actual average). - Assumed $12.00 a barrel in 1999 and $13.60 a barrel in 2000. - Six-month U.S. dollar LIBOR: 5.2 percent in both 1999 and 2000 (assumption). - Real GDP projections and fiscal assumptions referenced to country-specific Box 1.1 entries (examples preserved exactly in source). ### Interest rate and deposit rate assumptions (detailed) - Six-month U.S. dollar deposit rate: 5.2 percent in both 1999 and 2000. - Six-month Japanese yen deposit rate: assumed to average 0.2percent in 1999 and 0.3percent in 2000. - Six-month euro deposit rate: assumed to average 3.0percent in 1999 and 3.1percent in 2000 (3.0percent is 30 basis points less than projected in the Interim Assessment). - "Changes in interest rate assumptions compared with the December 1998 Interim Assessment are summarized in Table 1.1." ### Global outlook, external imbalances, and policy implications - Baseline: world output "will remain reasonably resilient... and that the Japanese recession will bottom out in 1999... global economic growth should pick up again in 2000 as adjustments in the emerging market economies run their course." - Major risk: "uneven pattern of growth among the three large currency areas" → marked widening of external current account imbalances. - Risks from imbalances: - potential rise in protectionist pressures; - excessive and potentially destabilizing movements in major exchange rates. - Policy implications: - priority to generate early recovery in Asia and reverse slowdown in continental Europe; - for the United States, tighten policies if domestic demand does not slow as expected; - adjustments in exchange rates among major currencies will "probably also need to be part of this process." ### Financial market turbulence, contagion, and policy discipline - Determinants of contagion: economic and financial linkages, origins and nature of initiating crisis, and strength of fundamentals/policies. - Policy recommendations to fend off contagion: - Fiscal and monetary discipline. - Avoid large external imbalances and overvalued exchange rates. - From an international viewpoint, avoid defensive measures that harm trading partners and long-term welfare (examples: excessive depreciations, trade protection, distortionary exchange restrictions). - Observations on exchange rate regimes: - Most currency crises of the past two years occurred in countries with pegged exchange rates. - Trend toward greater exchange rate flexibility among emerging market economies in recent decades. - Flexible exchange rates do not remove the need for policy discipline and robust financial systems. ### Latin America and Brazil — crisis dynamics and policy response - Regional slowdown: "Most countries in Latin America experienced sharp economic slowdowns during the second half of 1998." - Western Hemisphere developing economies projected decline in output of !/2of 1 percent in 1999; Brazil accounts for roughly one-third of the group’s output. - Brazil developments: - Real depreciated to early March level more than 40 percent below its end-1998 value in U.S. dollar terms. - Authorities announced intention to adopt inflation-targeting and target reducing inflation to "an annualized monthly rate in the middle single digits by the end of 1999." - Central bank adopted a quantity-based framework with net domestic assets target. - Reference overnight rate raised from 39 percent to 45 percent in early March; reserve requirement on time deposits increased the previous day. - After tightening and IMF agreement, the real recovered to early April level about 30 percent below end-1998 value, permitting the reference rate to fall back to about 39 percent. - Historical note: Real Plan reduced inflation from about 450 percent a year during 1980–94 (and above 2,000 percent in 1993–94) to 3!/2percent in 1998. - Fiscal effects: depreciation raised domestic-currency value of public debt where part linked to U.S. dollar; revised program incorporated more ambitious primary balance targets and required structural reforms (social security, taxation), privatization, and expenditure targets. - Regional projected external current account narrowing totals $30 billion (equivalent to 1 percent of GDP), with Brazil accounting for the bulk. - Policy advice for the region: - stringent policy discipline amid weakening growth; - reinvigoration of reform efforts; - attention to financial sector fragilities and bank problems; - fiscal consolidation to reduce pressures on interest rates and address unsustainable imbalances in countries such as Colombia, Ecuador, and Venezuela. ### Y2K (Year 2000) computer problem — macro considerations (Box 1.2) - Nature: two-digit year fields may misinterpret "00" as 1900; many systems including embedded microprocessors in utilities, transportation, industrial control, health, and security may fail or generate errors. - Remediation: governments and businesses spent considerable resources; many entities, especially small and medium-sized enterprises, have not finished remediation or begun it; interconnected systems complicate full protection. - Macro characterization: comparable to a negative supply shock because part of capital stock in hardware/software may become temporarily unusable or obsolete. - Quantitative treatment: "projections in the World Economic Outlook do not attempt to incorporate any estimate of these effects." - U.S. note: repair efforts estimated to have boosted measured output by "several tenths of a percentage point in each of the past few years." - Stylized time profile: anticipatory spending → temporary boost; Y2K disruptions → drop in output; repair spending → renewed upswing; possible small negative impact as extra spending is unwound. - Central banks: some preparing for increased demand for currency; example U.S. Federal Reserve will have an extra $50 billion worth of currency in reserve (compared with a stock of currency in circulation outside banks of approximately $470 billion in March 1999). - Developing and transition country vulnerabilities: - generally less dependent on computer-based technology, but countervailing vulnerabilities include limited investment and human resources for remediation and dependence of critical infrastructure on older computer systems; - risk of failures in payment and financial systems could disrupt international trade and capital flows. - Policy implications: - continue remediation efforts; - prepare for temporary demand and supply shifts associated with anticipatory spending, disruptions, and repair spending; - monitor and support critical infrastructure and financial systems to limit spillovers. ### Japan — recession, policy stance, and reform needs - Recent developments: - real GDP fell to a level 5!/4percent below its peak of early 1997. - unemployment rose to a new postwar peak of 4.6 percent in February. - Projections: - after fiscal stimulus through mid-1999, activity assumed to weaken before moderate recovery in 2000; - real GDP projected to decline by about 1!/2 percent in 1999 after a contraction of 2#/4percent in 1998. - Fiscal position: - fiscal deficit (excluding social security) projected to reach more than 10 percent of GDP in fiscal year 1999 (beginning April 1). - Monetary policy: - Bank of Japan lowered overnight call rate target from 0.25 percent to 0.15 percent in mid-February and since early March the rate has been virtually zero. - Room for reduction of short-term rates essentially exhausted; recommendation to continue stimulative monetary policy using available instruments and possibly adopt supplementary operating targets. - Banking and structural reform: - recent legislation established framework including public funds for recapitalization and tools for temporary nationalization, sale, or liquidation. - Long-Term Credit Bank and Nippon Credit Bank nationalized. - In late March, 15 major banks received injections of public funds amounting to ¥7.4 trillion for recapitalization; these and other banks plan to raise ¥2!/2trillion from private sources. - Policy recommendations: intensify supervisory pressure for full recognition of bad loans; use public capital injections to catalyze restructuring; pursue bold structural reforms (bankruptcy code, tax, labor mobility, deregulation). ### Asia and the Pacific — near-term bottoming and required reforms - General assessment: - economies hit in the first wave appear close to bottom; recovery begun in Korea; Malaysia and Thailand seem to have bottomed out. - Country-specific notes (selected): - Thailand: activity stabilized; modest positive growth projected for 1999; expansionary fiscal policy appropriate; bank recapitalization and corporate debt restructuring needed. - Korea: recovery fostered by financial stabilization; unemployment close to 9 percent; budget aims at deficit of 5!/2percent of GDP to ensure stimulus; financial and corporate restructuring on schedule but genuine restructuring requires market discipline. - Indonesia: behind Korea and Thailand in stabilization; recovery expected in latter part of year; high real interest rates to maintain exchange-rate stability; progress needed in bank restructuring. - Malaysia: modest positive growth projected for 1999 after sharp contraction in 1998. - China: growth well maintained in 1998; moderate slowing projected for 1999; current account remains in significant surplus; pilot asset management company announced. - Hong Kong SAR: recession expected to bottom out in second half of 1999; fiscal position weakened during recession; banking sector remains strong by international standards. - India: growth projected close to 5 percent in 1999 and 2000; main priority to rein in public sector deficit near almost 10 percent of GDP. - Singapore: modest positive growth projected for 1999 as expansion resumes during year. - Australia: growth accelerated in 1998; projected to slow significantly in current year; need to raise national saving. - New Zealand: growth in 1999 should reach 2!/2–3 percent; current account deficit at 6 percent of GDP in 1998. ### Africa and the Middle East — uneven spillovers and adjustment needs - Sub-Saharan Africa: - limited direct financial effects for many countries due to limited capital market access; exception South Africa (growth near zero in 1998, expected below 1 percent in 1999). - declining oil revenues pressured fiscal positions of oil exporters (Angola, Gabon, Nigeria, Republic of Congo). - large terms-of-trade losses have reduced real incomes in many instances. - severe risks from armed conflicts in Angola, Sierra Leone, Democratic Republic of Congo, and Ethiopia–Eritrea. - Middle East and North Africa: - lower oil prices caused oil export earnings to fall by one-third in 1998 in the six Gulf Cooperation Council countries, deteriorating fiscal balances by 5–8 percentage points of GDP. - adjustment needed mainly through reductions in government expenditures, tax measures, and utility price adjustments. - some countries need tighter credit policies and active interest-rate management (example: Egypt). ### North America — United States as engine of global growth and risks - U.S. 1998 performance: - domestic demand growth of 5 percent in 1998 (up from 4!/4percent in 1997). - U.S. consumers and investors accounted for almost half of the growth in world demand in 1998. - fourth-quarter 1998 growth surged to 6 percent after Federal Reserve cuts. - Medium-term constraints: - potential growth estimated at 2!/4–2#/4percent. - personal saving rate fell sharply; corporations likely to slow capital spending. - long-term interest rates rose about a full percentage point from their trough of last October. - Risks: - possibility of inflationary pressure leading to monetary tightening and a sharp stock-market correction, risking a hard landing. ### What Are the Implications of the U.S. Saving‑Investment Imbalance? (excerpts) - Risks and adjustments: - foreign investors’ willingness to finance the U.S. external deficit at current interest rates may not continue; reduced willingness could put downward pressure on the dollar and raise interest rates. - such adjustments could produce larger and more abrupt private-sector behavior changes and a more abrupt slowdown than in the baseline. - U.S. monetary contingencies: - if growth moderates more than projected, monetary conditions may need easing to help ensure a soft landing; - if growth does not moderate sufficiently, the Federal Reserve may need to tighten policy. - U.S. fiscal policy considerations: - resist political pressures to spend the budget surplus; in cyclically adjusted terms the budget surplus estimated at about !/2of 1 percent of GDP in 1998–99. - large tax cuts could increase overheating risk and worsen the external current account. - projected budget surpluses provide room to meet longer-term financing needs (Social Security and Medicare) and for temporary stabilization if needed. - Canada: growth slowed in 1998; Bank of Canada lowered official rates by 25 basis points at end of March; scope to ease further if outlook worsens. ### Europe, EMU, and labor market reform urgency - EMU stage 3 began with 11 members adopting the euro and the ESCB assuming monetary policy responsibility. - ECB initial repo rate announced at 3 percent; cut by 50 basis points in early April to 2!/2percent. - Staff projection for euro-area growth in 1999 revised down to 2 percent; pickup to almost 3 percent in 2000 projected but downside risks remain. - HICP inflation stable at 0.8 percent in recent months; ECB primary objective: price stability defined as annual increase below 2 percent. - Fiscal constraints: - limited room for maneuver in fiscal policies of member countries; structural fiscal positions still short of medium-term requirements despite consolidation to 1997. - potential risk of breaching reference deficit value of 3 percent and debt benchmark of 60 percent of GDP in some countries if recovery does not materialize. - policy advice: use budget contingencies and cut unproductive expenditures; in fast-growing countries strengthen fiscal consolidation. - Labor markets: - large secular rise in European joblessness over past quarter century. - need for labor market flexibility and structural reforms, especially given absence of exchange-rate adjustment within euro area. - Chapter IV addresses structural unemployment causes and cures. ### Transition economies and southeastern Europe - Transition economies: Brazilian crisis had no sustained impact; Hungary and Poland estimated growth about 5 percent in 1998; Czech Republic in recession following 1997–98 tightening. - Southeastern Europe: conflict in the Federal Republic of Yugoslavia to adversely affect Albania, Former Yugoslav Republic of Macedonia, Bulgaria, Romania, and Croatia via refugees, trade disruption, and tourism loss. - Baltic countries: more affected by Russian crisis; Lithuania current account deficit close to 12 percent of GDP; Estonia lowered deficit to about 9 percent of GDP in 1998. - Turkey: suffered contagion from Russian crisis; needs strong structural measures and monetary framework to cure chronic inflation. *Italic: _0599ch1pdf - World Economic Outlook and Policy Responses to the Global Slowdown (IMF World Economic Outlook publication content as supplied).* ### 1. Economic history—1971–—Periodicals.I. International ### 1. Economic history—1971–—Periodicals.I. International ### Publication and distribution details - Published biannually. - ISBN: 1-55775-809-3 - Price: US$36.00 (US$25.00 to full-time faculty members and students at universities and colleges) - Orders: International Monetary Fund, Publication Services, 700 19th Street, N.W., Washington, D.C. 20431, U.S.A. - Tel.: (202) 623-7430 - Telefax: (202) 623-7201 - E-mail: publications@imf.org - Internet: http://www.imf.org - Cataloging and classification numbers and codes as listed on the title page: - HC10.W797984-640155 - 338.5’443’09048–-dc19 - AACR 2 MARC-S - Library of Congress8507 - Printed on recycled paper. ### Contents and structure (high-level) - Major parts: - Preface; Chapter I–IV; Annex; Statistical Appendix; Boxes, Tables, and Figures. - Chapter I: World Economic Outlook and Policy Responses to the Global Slowdown - Topics include: New Phase in the Global Crisis, Latin America (Brazilian crisis), Policy Failures in Russia, Japan, Asia and the Pacific, Africa and the Middle East, North America, Europe. - Chapter II: Global Repercussions of the Crises in Emerging Markets and Other Conjunctural Issues - Topics include: Brazil’s Financial Crisis, Russia, Financial Flows after Brazil, Foreign Exchange and Financial Markets, Commodity exporters, U.S. saving-investment imbalance. - Chapter III: International Financial Contagion - Topics include: Changing nature of currency crises, fundamentals vs contagion, policy implications. - Chapter IV: Chronic Unemployment in the Euro Area: Causes and Cures - Topics include: Underlying causes, integrated cures, obstacles to labor market reform. - Annex: Summing Up by the Acting Chairman; World Economic Outlook, Executive Board Meeting, April 2, 1999. - Statistical Appendix covers assumptions, data and conventions, country classification, extensive tables (Output, Inflation, Financial Policies, Foreign Trade, Current Account, Balance of Payments, External Debt, Flow of Funds, Medium-Term Baseline Scenario). - Numerous boxes, tables, and figures listed covering macro indicators, country-specific analyses, financial flows, labor market measures, and scenario simulations. ### Assumptions and conventions used in projections - Real effective exchange rates: assumed to remain constant at their average levels during February 16–March 15, 1999, except for bilateral rates among ERM currencies, which are assumed to remain constant in nominal terms. - National policies: established policies of national authorities are assumed to be maintained (see Box 1.1 for specific fiscal and monetary policy assumptions in industrial countries). - Oil price assumptions: average price of oil assumed to be $12.00 a barrel in 1999 and $13.60 a barrel in 2000, and to remain unchanged in real terms over the medium term. - Interest rate assumption: six-month London interbank offered rate (LIBOR) on U.S. dollar deposits assumed to average 5.2 percent in both 1999 and 2000. - Projections are characterized as working hypotheses rather than forecasts; estimates and projections are based on statistical information available in early-April 1999. - Conventions: - “ . . . ” indicates data not available or not applicable. - “—” indicates the figure is zero or negligible. - “–” between years or months (for example, 1997–98 or January–June) indicates the period covered, including beginning and ending years or months. - “/” between years or months (for example, 1997/98) indicates a fiscal or financial year. - “Billion” means a thousand million; “trillion” means a thousand billion. - “Basis points” refer to hundredths of 1 percentage point (example given: 25 basis points are equivalent to 1/4 of 1 percentage point). - Presentation note: In figures and tables, shaded areas indicate IMF staff projections. - Minor discrepancies between sums of constituent figures and totals are due to rounding. - Terminology: the term “country” may cover territorial entities for which statistical data are maintained on a separate and independent basis, not necessarily states as understood by international law. ### World Economic Outlook database and methodology - The report and its projections are an integral element of IMF surveillance of economic developments and policies. - Publication history: World Economic Outlook published annually from 1980 through 1983 and biannually since 1984. - Data sources and preparation: - Projections draw primarily on information gathered through IMF staff consultations with member countries, carried out by area departments together with the Policy Development and Review Department and the Fiscal Affairs Department. - Country projections are prepared by IMF area departments based on internationally consistent assumptions about world activity, exchange rates, and conditions in international financial and commodity markets. - For approximately 50 of the largest economies (accounting for 90 percent of world output), projections are updated for each WEO exercise. - For smaller countries, projections are based on those prepared at the time of the IMF’s regular Article IV consultations or in connection with the use of IMF resources, and adjusted incrementally to reflect changes in assumptions and global conditions. - Data availability online: - The full report and a larger compilation of WEO database files are available on the IMF’s Internet site, www.imf.org; files contain series most frequently requested and may be downloaded for use in various software packages. - Contact for database inquiries: - World Economic Studies Division, Research Department, International Monetary Fund, 700 19th Street, N.W., Washington, D.C. 20431, U.S.A. - E-mail: weo@imf.org - Telefax: (202) 623-6343 ### Project preparation and contributors - Analysis coordinated in the Research Department under Michael Mussa, Economic Counsellor and Director of Research. - Project directed by Flemming Larsen, Deputy Director of the Research Department, together with Graham Hacche, Assistant Director for the World Economic Studies Division. - Primary contributors to the current issue include Francesco Caramazza, John H. Green, Peter Sturm, Mark De Broeck, Luca Ricci, Ranil Salgado, Phillip Swagel, Cathy Wright, and Harm Zebregs. - Other contributors include Paula De Masi, Esteban Jadresic, Douglas Laxton, and Robert Sharer. - Fiscal Analysis Division of the Fiscal Affairs Department computed structural budget and fiscal impulse measures. - Research assistance: Gretchen Gallik, Mandy Hemmati, Yutong Li, and Anthony G. Turner. - Data processing and computer systems management: Allen Cobler, Nicholas Dopuch, Isabella Dymarskaia, Yasoma Liyanarachchi, Olga Plagie, and Irim Siddiqui. - Word processing: Susan Duff, Caroline Bagworth, and Lisa Marie Scott-Hill. - Manuscript editing and production coordination: James McEuen, External Relations Department. - The analysis benefited from comments by staff from other IMF departments and from Executive Directors following discussions of the WEO on March 31 and April 2, 1999; projections and policy considerations are those of the IMF staff and should not be attributed to Executive Directors or national authorities. *Source: _0599ch1pdf - 1. Economic history—1971–—Periodicals.I. International (IMF World Economic Outlook publication content as supplied).* ### Preface ### Preface ### Major developments and balance of risks - Since the end of 1998, "some significant positive developments in the world economy have been broadly balanced by some important setbacks, so that the global outlook is little changed." - Setbacks and sources of risk: - Crisis in Brazil that led to the abandonment of its crawling-peg exchange rate arrangement in mid-January; "Financial contagion from the Brazilian crisis has been limited" but the crisis "has imparted a new contractionary impulse to the global economy." - Financial sector fragilities in several emerging market economies, including China. - In Russia, delay in adopting coherent stabilization and reform policies has postponed improvements. - Conflict in the Federal Republic of Yugoslavia (Serbia/Montenegro) will have "severe effects on small neighboring countries and broader adverse consequences for other countries in southeastern Europe." - Japan’s economy "remains weak, and resumption of self-sustaining growth is not yet clearly in sight." - Increased global trade imbalances due to emerging market crises and uneven growth among the United States, the euro area, and Japan — these imbalances "may give rise to destabilizing movements in exchange rates and may also increase protectionist pressures." - Positive developments: - After deep output contractions in Asia’s crisis-afflicted economies, activity "has recently turned around in Korea and seems to have bottomed out in Malaysia and Thailand." - Investor sentiment toward many emerging market economies "has rallied." - Mature financial markets have improved following a "broad-based easing of monetary conditions" undertaken partly in response to Russia’s default last August and ensuing turbulence. - "The introduction of the euro has proceeded smoothly, with the new currency immediately assuming the role of the second-largest international reserve currency." - Most advanced economies of North America and Europe, and Australia, "have proved resilient to the crises in emerging markets." - Continued strong growth of the U.S. economy; "further downward revisions to the growth projections for Latin America—most markedly for Brazil—in the current IMF staff projections are largely offset by upward revisions for the United States (Table 1.1)." - Inflation "has generally remained subdued, including in the United States and other economies that have been operating close to full capacity." ### Overall outlook and scenarios - The balance of risks remains on the downside; several hurdles could prevent global growth from returning to potential within two or three years, as in the IMF’s baseline scenario. - Policymaker priorities: - Be ready to attend to new emergencies. - Focus on policies required to sustain growth in the short run and over the medium term. - Address obstacles to structural reform; structural reforms may bring little short-run benefit in some cases but are "often essential to restore and maintain economic dynamism in the longer run." - Policy effects: - Economic policies cannot fully pre-empt swings in market sentiment, but can "reduce the risk and virulence of adverse shifts in confidence, including those arising from financial contagion." - Policy responses to a financial crisis have a "substantial impact on the depth, duration, and social costs" of the recession that follows. - In a highly interdependent global economy, countries not directly affected should take timely policy action, when appropriate, "to support demand and thus to help smooth the global business cycle"; all countries should avoid short-run expedient policies that carry greater long-term costs or harm trading partners; and all should work to strengthen international economic cooperation. ### Characterization of the global slowdown - The current weakening marks "the fourth global economic slowdown in the past quarter-century." - Origins and phases: - First phase began with sharp domestic demand and activity declines in Thailand, Indonesia, Korea, and Malaysia—those economies "felt the brunt of the Asian crisis." - Japan’s deepening recession in 1998 both contributed to and reflected the difficulties in Asia. - In most of the rest of the world, activity was relatively well-maintained during 1998, but industrial activity slowed and "the growth of world trade slowed sharply to 3!/4percent, the lowest since 1985." - During the first phase, redirection of financial flows toward mature markets and sharp commodity price declines offset negative trade effects from Asia; the United States was able to absorb much of the counterpart without much impact on its own growth rate through the end of 1998. - Indicators suggest activity in the Asian crisis economies is "close to its trough," but this does not imply an early reversal of the global slowdown. - A second phase of the slowdown in 1999 is driven by spillovers from the Russian crisis and the crisis in Brazil (and its spillovers to the rest of Latin America), and by adjustment pressures on exporters of oil and other commodities who have experienced dramatic loss of export revenue since the start of the Asian crisis. - Some industrial countries that experienced vigorous expansions—such as the United Kingdom and Norway—have experienced cyclical slowdowns; U.S. growth is expected to slow moderately; continental western Europe faces near-term growth somewhat below potential. - Near-term expectation: - "Overall, world growth in 1999 seems likely to be slightly weaker than last year’s rate of 2!/2percent, while the expansion of world trade is expected to remain well below the long-term trend growth rate." - Question of a third phase: - The staff’s baseline projection assumes: - For emerging market economies, "financial market conditions will gradually improve further." - The U.S. economy will experience a soft landing. - Growth in the euro area will... (projections and policy assumptions summarized in Box 1.1). ### Selected numeric projections, assumptions, and indicators (as reported) - World trade growth in 1998: "3!/4percent" (growth of world trade slowed sharply to 3!/4percent, the lowest since 1985). - World growth reference: "last year’s rate of 2!/2percent." - Oil prices: - "The average price of oil in U.S. dollars a barrel was $13.07 in 1998; the assumed price is $12.00 in 1999 and $13.60 in 2000." - Six-month LIBOR assumption on U.S. dollar deposits: reported in Table 1.1 as values such as "5.9", "5.6", "5.2", "5.2" (see table for context and exact year-by-year entries). - Fiscal and monetary policy assumptions are based on official budgets adjusted for outturn deviations and reflect information available through early April 1999. - Specific country policy assumptions summarized in Box 1.1 (examples): - United States: fiscal years (to end-September) 1999–2004 projections based on the administration’s February 1999 budget proposal (including the Social Security reform proposal); state and local government fiscal balances assumed to remain constant as a percent of GDP. - Japan: projections take account of the ¥24 trillion stimulus package announced in November 1998 and the FY1999 initial budget; stimulus measures assumed to raise public investment by ¥4#/4trillion through FY1999; of ¥9.3 trillion in tax cuts, ¥1 trillion assumed to occur in the first quarter of calendar year 1999; a "typical" supplementary budget of ¥1trillion included for FY2000. - Canada: after FY1998/99, federal government assumed able to maintain budget surpluses which would reach "1 percent of GDP"; this implies new measures of "$1–2 billion (around !/4percent of GDP)" could be introduced each year. - Singapore: FY1999/2000 projected to reach a primary operating balance deficit "of about 3!/2percent of GDP." - Aggregation and technical notes: - Real effective exchange rates are assumed to remain constant at levels prevailing during February 16–March 15, 1999. - Aggregates are computed on the basis of purchasing-power-parity (PPP) weights (see Statistical Appendix). *Source: Preface, World Economic Outlook and Policy Responses to the Global Slowdown (IMF), as presented in the supplied content.* ### 5.2 percent in both 1999 and 2000; and the rate on six- ### IWORLD ECONOMIC OUTLOOK AND POLICYRESPONSES TO THE GLOBALSLOWDOWN ### Interest rate and deposit rate assumptions - Six-month U.S. dollar deposit rate: 5.2 percent in both 1999 and 2000. - Six-month Japanese yen deposit rate: assumed to average 0.2percent in 1999 and 0.3percent in 2000. - Six-month euro deposit rate: assumed to average 3.0percent in 1999 (30 basis points less than projected in the Interim Assessment) and 3.1percent in 2000. - "Changes in interest rate assumptions compared with the December 1998 Interim Assessment are summarized in Table 1.1." ### Global outlook, scenarios, and key risks - Baseline: world output "will remain reasonably resilient in the face of an unfavorable external environment, and that the Japanese recession will bottom out in 1999... In such a scenario, global economic growth should pick up again in 2000 as adjustments in the emerging market economies run their course." - Downside scenarios that could delay recovery until 2001 at the earliest: - Financial conditions facing many emerging market economies remain more adverse than in most of the 1990s. - A more abrupt U.S. slowdown if inflation picks up, the stock market corrects significantly, or the private sector corrects its large saving shortfall more quickly than assumed. - Weakness in the euro area may not be transitory despite interest rate reductions. - Japanese weakness may be further prolonged. ### External imbalances and exchange rate considerations - Amajor risk: "uneven pattern of growth among the three large currency areas since the beginning of the decade" has led to a marked widening of external current account imbalances. - Risks arising from these imbalances: - Potential rise in protectionist pressures. - Excessive and potentially destabilizing movements in exchange rates among the major currencies. - Policy implications: - Priority on policies to generate an early recovery in Asia and to counter and reverse the slowdown in continental Europe. - For the United States, policies will need to be tightened if domestic demand does not slow in line with current expectations. - Adjustments in exchange rates among major currencies will "probably also need to be part of this process." ### Financial market turbulence, contagion, and policy discipline - Key uncertainty: potential for further financial market turbulence and contagion given heightened perception of, and aversion to, risk. - Determinants of contagion include: economic and financial linkages, origins and nature of initiating crisis, and strength of economic fundamentals and policies in potentially affected countries. - Policy recommendations to fend off contagion: - Fiscal and monetary discipline. - Avoidance of large external imbalances and overvalued exchange rates. - From an international viewpoint, avoid defensive measures that harm trading partners and long-term welfare—examples: excessive depreciations, trade protection, distortionary exchange restrictions. - Observations on exchange rate regimes: - Most currency crises of the past two years occurred in countries with pegged exchange rates. - Trend toward greater exchange rate flexibility among emerging market economies in recent decades. - Flexible exchange rates do not remove the need for policy discipline and robust financial systems. - Some countries with pegged rates, including those with currency board arrangements, have successfully resisted currency pressures and served as regional anchors of stability. ### Latin America and Brazil: crisis dynamics and policy response - "Most countries in Latin America experienced sharp economic slowdowns during the second half of 1998." - "Brazil’s abandonment of its crawling-peg exchange rate arrangement in mid-January... have added to the adjustment challenges the region faces." - "Adecline in output of !/2of 1 percent is now projected for the Western Hemisphere group of developing economies in 1999—the most significant worsening of the outlook among all regions from the December 1998 Interim Assessment of the World Economic Outlook—and there is a considerable risk of a more severe contraction (Table 1.2)." - Brazil-specific developments and policy actions: - Real depreciated to a level in early March that was more than 40 percent below its end-1998 value in terms of the U.S. dollar. - Authorities announced intention to put in place an inflation-targeting framework and target of reducing inflation to "an annualized monthly rate in the middle single digits by the end of 1999." - Central bank adopted a quantity-based framework with a target for net domestic assets consistent with projected inflation, real GDP, and net international reserves. - Reference rate for the overnight interbank market raised from 39 percent to 45 percent in early March; reserve requirement on time deposits increased the previous day. - After monetary tightening and agreement with the IMF on a revised program, the real recovered to a level in early April about 30 percent below its end-1998 value in terms of the U.S. dollar, permitting the reference rate to fall back to about 39 percent. - Historical achievement: the Real Plan reduced inflation from about 450 percent a year during 1980–94 (and above 2,000 percent in 1993–94) to 3!/2percent in 1998. - Fiscal implications: depreciation increased domestic currency value of public debt because part is linked to the U.S. dollar; Brazil’s revised program deliberately incorporated more ambitious targets for the primary balance and requires progress on structural reforms (social security, taxation), privatization, and maintenance of revised expenditure targets. - Regional impact: - "With the Brazilian economy representing roughly one-third of the output of the Western Hemisphere group of developing economies... this year’s recession in Brazil will inevitably have a significant regional impact." - So far, Brazilian crisis effects on financial markets elsewhere in Latin America have been "moderate." - Projected narrowing of external current account deficits in the region this year totals $30 billion (equivalent to 1 percent of GDP), with Brazil accounting for the bulk of the improvement. - Policy advice for the region: - Stringent policy discipline amid weakening growth. - Reinvigoration of reform efforts. - Attention to financial sector fragilities and bank problems arising from the adverse environment. - Fiscal consolidation to reduce pressures on interest rates and address unsustainable imbalances in countries such as Colombia, Ecuador, and Venezuela. ### Y2K (Year 2000) computer problem: nature and macroeconomic implications - The Y2K problem arises from two-digit year fields in software that may misinterpret "00" as 1900 instead of 2000. - Many systems, including those with embedded microprocessors in utilities, transportation, consumer electronics, industrial control, health, and security, may fail or generate errors. - Remediation efforts: - Governments and businesses have spent considerable resources to assess, fix, and test vulnerable systems. - Uncertainty remains about the extent of the remaining problem; many entities, particularly small and medium-sized enterprises, have not finished remediation or begun it. - Interconnected systems make full protection difficult. - Macroeconomic characterization: - The Y2K problem may be compared with a negative supply shock (e.g., a natural disaster) because part of the capital stock in hardware and software may become temporarily unusable or obsolete. - Because it has been foreseen and remediation has been under way, some damage can be reduced—but global scale could constrain repair resources early in 2000. - Quantitative treatment in the projections: - "Thus, the projections in the World Economic Outlook do not attempt to incorporate any estimate of these effects." - Qualitative note: in the United States, repair efforts are estimated to have boosted measured output by "several tenths of a percentage point in each of the past few years." - Toward the end of 1999, GDP may be stimulated by stockbuilding as a precaution. *IWORLD ECONOMIC OUTLOOK AND POLICYRESPONSES TO THE GLOBALSLOWDOWN* ### Box 1.2.Potential Macroeconomic Implications of the Year2000 ComputerBug ### Box 1.2.Potential Macroeconomic Implications of the Year2000 ComputerBug ### Y2K risk and software legacy - Newer software programs are not necessarily immune to the “millennium bug” because the practice of using two digits instead of four continued even into the 1990s, despite dramatic reductions in computer memory costs, particularly for programs that were upgrades or modifications of older programs. ### Central bank preparations and currency demand - Some central banks are preparing for the possibility of an increase in demand for currency by building up inventories of currency during 1999. - Example: the U.S. Federal Reserve will have an extra $50 billion worth of currency in reserve (compared with a stock of currency in circulation outside banks of approximately $470 billion in March 1999). ### Aggregate demand, output timing, and stylized scenario - Anticipatory spending (remediation and precautionary actions) may initially boost activity. - As Y2K-related disruptions occur, a drop in output is expected. - Subsequent repair spending may lead to a renewed upswing in GDP, possibly followed by a small negative impact as extra spending is unwound. - The figure offers a stylized depiction of the time profile of the net outcome: an initial boost to activity resulting from anticipatory expenditures, followed by a drop in output as Y2K takes its main toll, and then a renewed upswing resulting from repair spending. ### Sectoral effects: prices, profits, and productivity - Macro effects could include higher prices or lower profits and lower productivity, similar to other types of supply shocks. - Wages among COBOL programmers, those most involved with the compliance effort, have risen significantly. - Prices may rise to cover higher wage costs and other remediation costs. - Firms that face relatively high costs will realize a reduction in profits. ### Developing and transition countries: vulnerabilities and transmission risks - Developing and transition economies are generally less dependent than advanced economies on computer-based technology, which might suggest smaller potential disruptions. - Rapidly growing economies may have a larger share of recently installed investment and therefore a greater likelihood of being Y2K-compliant. - Countervailing vulnerabilities: - Sufficient investment to fix the Y2K problem may be lacking due to financial and human resource constraints. - Greater vulnerability to infrastructure failures in electricity, water, communications, transportation, and health services, which tend to rely on older computer systems. - Risk of failures in government tax collection and statistical systems. - Failures in payment and other financial systems that are not Y2K-compliant could lead to disruptions in international trade. - Perceived or actual compliance problems might increase capital flight and affect the cost and availability of external financing, especially where potential problems affect export production and the balance of payments. - If problems occur, developing and transition countries may take a longer time to fix systems because of financial and human resource constraints. ### Uncertainties, recovery prospects, and policy implications - The macroeconomic effects of the Y2K problem are potentially significant but extremely difficult to quantify. - Experience suggests economies can quickly recover from temporary shocks; effects should not be exaggerated. - In industries and sectors where compliance problems have been identified, there may still be time to alleviate the problem, but it is unlikely that all problems can be addressed in time. - Policy implications (implied from analysis): - Continue remediation efforts where possible to reduce disruption risks. - Prepare for temporary demand and supply shifts associated with anticipatory spending, disruptions, and repair spending. - Monitor and support critical infrastructure and financial systems to limit spillovers to trade and external financing. *Source: Box 1.2, _0599ch1pdf - Box 1.2.Potential Macroeconomic Implications of the Year2000 ComputerBug.* ### Box 1.3 (concluded) ### Box 1.3 (concluded) ### Colombia: financial deterioration - The health of Colombia’s financial system deteriorated in 1998 owing to increased interest rates and weak economic activity, which partly reflected a deterioration in the public finances. - Nonperforming loans are noted as a problem. ### Policy failures in Russia and spillovers to neighboring transition countries - Causes of the Russian crisis: - Devaluation of the ruble and unilateral restructuring of domestic debt (August 1998), with subsequent meltdown in foreign exchange and financial markets. - Serious and persistent shortcomings in structural reform and institution-building. - Repeated slippages in fiscal adjustment and reform. - Excessive buildup of short-term government debt, including to foreign investors. - Exacerbation by emerging market crises and spillovers, especially on oil and other commodity prices. - Accumulation of budgetary arrears and domestic (nonbank) and external borrowing suppressed inflationary pressures. - Large-scale capital flight; increase in external debt not matched by higher investment and export potential. - Widespread graft and a culture of nonpayment by government levels eroding the social fabric. - Lack of political consensus and commitment to reform. - Policy elements under discussion with the IMF for a new program: - Tightening of fiscal policy to achieve a primary surplus equivalent to 2 percent of GDPin 1999. - Reinvigoration of structural reform, including early implementation of a plan for bank restructuring. - IMF staff tentative projections (on the assumption of such policies): - Output contraction of some 7 percent in 1999. - Stabilization of activity in 2000 (on an annual average basis). - Decline in inflation to about 50 percent on a 12-month basis at the end of 1999, with a further reduction in 2000. - Risks if coherent stabilization and reform policies are absent: - Continued high inflation and economic contraction. - Continued lack of access to international financial markets. - Potential loss of progress achieved during 1991–98, setting back the transition process by many years. - Need for international community preparedness to assist a strengthened, domestically backed reform commitment. - Spillover effects on neighboring transition countries: - Russian crisis contributed to currency depreciations in Belarus, Georgia, the Kyrgyz Republic, and Moldova in late 1998, and in Kazakhstan in April 1999, worsening near-term inflation prospects. - Near-term growth outlooks deteriorated across much of the region. - Additional official financial support announced for some smaller countries with particularly affected external positions. - Policy recommendations for neighbors: - Maintain relatively tight macroeconomic policies to limit widening external imbalances and contain price pressures from exchange rate weakness. - Maintain structural reform efforts and resist pressures to reverse exchange and trade liberalization. - Ukraine: some recent efforts to strengthen the fiscal position and advance structural reforms, but external position remains vulnerable without further sustained fiscal and structural adjustment. ### Japan: seeking a turnaround - Recent developments: - Japan’s recession deepened in late 1998, with real GDP falling to a level 5!/4percent below its peak of early 1997. - Indicators for early 1999 are mixed; survey evidence points toward a modest recovery in business confidence; financial market developments suggest a turnaround in investor sentiment. - Unemployment rose to a new postwar peak of 4.6 percent in February. - Projection assumptions and outcomes: - After fiscal stimulus through mid-1999, activity is assumed to weaken before a moderate recovery begins in 2000. - On that basis, real GDP is projected to decline further—by about 1!/2 percent—in 1999 after a contraction of 2#/4percent last year (Table 1.4). - Fiscal position and policy guidance: - Fiscal deficit (excluding social security) projected to reach more than 10 percent of GDPin fiscal year 1999 (beginning April 1). - Limits to further fiscal expansion are evident from limited effects of recent fiscal packages on private demand and rising government bond yields since November (Table 1.5). - It is critical to implement fully the fiscal stimulus already planned to support the economy. - Maintain adequate fiscal stimulus until recovery in private demand is under way, then proceed gradually with medium-term consolidation of public finances. - Monetary policy developments and recommendations: - Appreciation of the yen and rising long-term interest rates tightened monetary conditions in late 1998 and early 1999. - Bank of Japan lowered the overnight call rate target from 0.25 percent to 0.15 percent in mid-February and indicated it would seek to reduce the rate as low as possible; since early March, the rate has been virtually zero. - Room for reduction of short-term interest rates has been essentially exhausted. - The Bank of Japan should continue stimulative monetary policy using available instruments, including open-market operations in private and government debt. - To convince markets of its determination to combat deflation, the central bank might adopt a supplementary operating target—such as for the growth of the monetary base or an interest rate objective for somewhat longer-maturity instruments—to signal willingness to ease liquidity until price stability is ensured. - Structural reform and banking sector actions: - Macroeconomic policy alone is insufficient; structural reforms are needed to facilitate corporate restructuring, reduce inefficiencies, and remove obstacles to new enterprises and activities. - Banking sector problems require attention; recent legislation established a comprehensive framework including public funds for recapitalization and tools for temporary nationalization, public administration, sale, or liquidation of failed banks. - Long-Term Credit Bank and Nippon Credit Bank have been nationalized. - In late March, 15 major banks received injections of public funds amounting to ¥7.4 trillion for recapitalization; these and other major banks plan to raise ¥2!/2trillion from private sources. - Banks’ submitted restructuring plans do not appear to go far enough in cutting costs or reorienting business to profitable areas. - Policy recommendations: - Intensify supervisory pressure to ensure full recognition of the bad loan problem. - Use leverage from public capital injections to catalyze restructuring and consolidation, dispose of bad bubble-period loans, and shed unprofitable business. - Pursue bold, comprehensive, and coherent structural reforms to complement banking reforms, including bankruptcy code and tax structure reforms to facilitate corporate restructuring and enhance labor mobility. - The industrial sector’s relative importance is likely to decline; greater potential for growth in services suggests need for deregulation and removal of distortions in agriculture, distribution, transportation, and construction. ### Asia and the Pacific: toward recovery - General assessment: - Economies hit in the first wave of the emerging market crisis appear close to the bottom of deep slumps. - Recovery has begun in Korea, with an upturn in activity late last year. - Among newly industrialized Asian economies, projected growth in 1999 was revised upward for Korea and Singapore since December 1998 Interim Assessment. - For the ASEAN-4 (Indonesia, Malaysia, the Philippines, and Thailand), small downward revisions for Indonesia and Thailand were offset by a larger upward revision for Malaysia; projected growth for the group in 1999 is little changed, indicating a bottoming-out of activity during the year. - Factors supporting recovery: - Financial stabilization and strengthening exchange rates, allowing monetary policies to be relaxed. - Supportive fiscal policies. - Improvements in domestic and external confidence. - Large-scale recoveries in stock markets and narrowing of international bond-yield spreads toward mid-1997 levels in some cases. - IMF programs with Indonesia, Korea, the Philippines, and Thailand remained broadly on track as of mid-1998. - Remaining requirements: - Considerable further progress needed on initiated structural reforms to secure sustainable growth. - Country snapshots and policy notes: - Thailand: - Activity stabilized recently; strengthened exchange rate allowed further declines in interest rates to well below precrisis levels. - Credit growth has yet to recover; revival depends on bank recapitalization and corporate debt restructuring. - Passage in March of key legislation on bankruptcy and foreclosure should facilitate restructuring. - Expansionary fiscal policy remains appropriate; measures announced at end of March include tax cuts and timely spending on labor-intensive investment projects and the social safety net to ensure stimulus. - These measures and structural reforms should lead to resumption of growth in the second half of the year; modest positive growth projected for 1999 as a whole. - Korea: - Recovery fostered by financial stabilization, easier macroeconomic policies, and improved investor sentiment. - Output gap remains large; unemployment close to 9 percent. - Significant foreign exchange purchases by the central bank and further reductions in interest rates have accompanied exchange rate appreciation. - Budget aims at a deficit of 5!/2percent of GDP to ensure stimulus. - Financial sector restructuring on schedule; bank recapitalization plans making progress. - Corporate restructuring: plans for the top five chaebol announced in December; important decisions on eliminating excess capacity remain. - Policy caveat: genuine restructuring requires exposing companies to market discipline and avoiding government favors. - Indonesia: - Behind Korea and Thailand in stabilization due to initial delays and political/social tensions. - Recovery expected to begin in the latter part of the year, but downside risks remain. - Real interest rates remain high to maintain exchange rate stability; fiscal policy has provided stimulus since late last year. - Progress in bank restructuring, but much remains to be done, especially for state banks. - Corporate restructuring under the Jakarta Initiative needs revitalization. - Malaysia: - Modest positive growth projected for 1999 following sharp contraction in 1998. *Source: Box 1.3 (concluded).* ### 1998. External demand appears to be benefiting from ### _0599ch1pdf - 1998. External demand appears to be benefiting from ### Asia and the Pacific: Country developments and outlook - Malaysia - External demand appears to be benefiting from the improvement in Malaysia’s competitive position vis-à-vis other countries in the region, reflecting the appreciation of their currencies against the U.S. dollar since Malaysia pegged the ringgit to the dollar in September 1998. - Despite stimulative monetary and fiscal measures introduced last year, domestic demand is expected to strengthen only gradually, and inflationary pressures are expected to remain low. - Private sector investment is likely to remain inhibited by the ongoing financial restructuring of the banking system and corporate sectors, together with uncertainties regarding the future of Malaysia’s capital controls. - Philippines - Less severely affected by the Asian crisis; would probably have experienced positive growth in 1998 if not for a weather-related drop in agricultural output late in the year. - A moderate recovery is projected for 1999. - Interest rates have been reduced cautiously as exchange rate stabilization has taken hold; further gradual easing seems likely in 1999 as inflation declines and the external sector strengthens. - Less scope for fiscal policy support because of the Philippines’ higher level of public sector debt. - China - Growth appears to have been well maintained in 1998, helped by large increases in public investment outlays and cautious reductions in interest rates. - A moderate further slowing is projected for 1999. - Net exports have weakened considerably despite measures to bolster exports and limit import growth, but the current account remains in significant surplus. - External vulnerability is limited by very large foreign exchange reserves, moderate foreign debt, and regulation of capital movements. - Recent strengthening of regional currencies has helped maintain renminbi stability against the U.S. dollar, contributing to restoration of regional financial stability. - Downside risks to projected growth include: - slowing external demand, - financial sector weaknesses, - concerns about cutbacks in external financing to Chinese companies following the failure of a major international trust and investment corporation, - past overbuilding and excess inventory accumulation. - Need for reforms of both the financial sector and the state-owned enterprises. - Authorities announced a pilot project in January to create an asset management company to take over the bad loans of one of the big four state commercial banks. - Fiscal policy is providing stimulus with a further increase in the fiscal deficit in the 1999 budget; interest rate policy needs to remain cautious to avoid recurrence of exchange rate pressures. - Hong Kong SAR - Effects of the regional crisis hit with full force in 1998 despite strong fundamentals; output, employment, and asset prices declined significantly. - Flexibility of domestic wages and prices, falling prices and labor costs, and depreciation since last August of the U.S. dollar (especially in terms of regional currencies) have contributed to a significant recovery of international competitiveness. - Recession is expected to bottom out in the second half of 1999; recovery strength may be limited by high real interest rates as domestic prices decline. - Fiscal position weakened significantly during the recession partly due to supportive measures; authorities have appropriately postponed restoring balance until after 1999 given substantial fiscal reserves. - Financial position of the SAR’s banks remains strong by international standards. - India - More resilient to regional turbulence, partly reflecting a relatively closed economy. - Growth projected to remain close to 5 percent in 1999 and 2000. - Main priority: rein in the public sector deficit, which has widened to almost 10 percent of GDP. - Recent budget implies some modest deficit reduction at the central government level; state governments and public enterprises also need measures to ensure overall public sector consolidation. - Need to contain rapid monetary growth to reduce risks of a renewed upturn in inflation. - Structural reforms (trade liberalization, privatization, strengthening financial sector) need to be strengthened to sustain medium-term growth and poverty reduction. - Pakistan - Despite debt relief, resumption of lending by international financial institutions, and structural measures, growth in 1999 is unlikely to exceed 3 percent. - Constraints: severe import constraints, tightened fiscal policy, a wait-and-see attitude by investors, and a poor cotton crop. - A rebound in official foreign exchange reserves is allowing a rapid winding down of trade and payments restrictions introduced during the 1998 crisis. - Singapore - Strong fundamentals and easing of macroeconomic policies moderated contractionary forces, but the economy experienced a sharp slowdown in 1998. - Substantial easing of fiscal policy in 1998/99 and prospectively in 1999/2000 is appropriate given large fiscal and external reserves. - Absence of inflation provides scope for modest further easing of monetary policy in the near term. - Expansion expected to resume during the year, resulting in modest positive growth for 1999 as a whole. - Australia - Growth accelerated in 1998 despite the East Asian recession, boosted by easing of monetary conditions including depreciation of the Australian dollar. - Weakness of commodity markets is expected to take a heavier toll in the current year as certain export contracts are renegotiated; growth is projected to slow significantly. - Inflation remains low; scope for further modest monetary easing if inflationary pressures remain muted. - Demand can be supported by automatic fiscal stabilizers, but priority must continue to be attached to raising national saving given Australia’s large external liabilities, which precludes discretionary fiscal easing beyond the personal income tax cuts in the tax reform package to be implemented next year. - New Zealand - Economic recovery seems under way following last year’s recession, underpinned by stronger domestic demand and exports. - Growth in 1999 should reach 2!/2–3 percent. - Monetary conditions have firmed slightly after substantial easing during 1997–98. - Inflation expected to remain below the midpoint of the authorities’ target range of 0–3 percent. - Current account deficit at 6 percent of GDP in 1998 and a very high ratio of net external liabilities to GDP highlight the need to strengthen national saving over the medium term. ### Africa and the Middle East: Uneven spillovers and adjustment needs - Sub-Saharan Africa - Limited access to international capital markets has shielded many countries from direct financial turbulence effects; direct financial effects have been relatively small for most countries. - Exception: South Africa was affected by global market turmoil in early 1998, necessitating a sharp rise in interest rates; more recently interest rates have been declining reflecting sound monetary and fiscal policies. - Real interest rates have remained high in South Africa, exacerbating weak economic activity: growth was near zero in 1998 and is expected to be below 1 percent in 1999. - Cautious fiscal policies need to be maintained to restore confidence; accelerated implementation of structural reforms remains essential for medium-term growth and employment. - Many other African countries feel the crisis mainly indirectly through commodity price and export earnings declines, leading to the need to tighten budgets. - Declining oil revenues have particularly pressured fiscal positions and external accounts of oil-exporting countries: Angola, Gabon, Nigeria, and the Republic of Congo. - In Nigeria, associated with governance improvements, a comprehensive adjustment and reform program was adopted in early 1999, monitored by IMF staff. - Exporters of non-oil commodities (notably exporters of minerals such as Botswana and Zambia) have also been hard hit. - Many other African countries are coping reasonably well due to reforms over the past decade, trade orientation toward North America and Europe, and favorable effects of the drop in oil prices on petroleum importers. - Large terms of trade losses have entailed significant real income reductions in many instances (see Chapter II). - Recent initiatives to reduce debt burdens for some of the poorest countries and improved market access in industrial countries for developing country exports—particularly agricultural products—are important. - Severe economic and political risks attach to armed conflicts in Angola, Sierra Leone, the Democratic Republic of Congo, and between Ethiopia and Eritrea, which have set back prospects for economic progress. - Middle East and North Africa - Lower oil prices (in real terms, recently back to levels prevailing before the first (1973–74) oil shock) have had major consequences for oil exporters. - In the six Gulf Cooperation Council countries, oil export earnings fell by one-third in 1998, causing fiscal balances to deteriorate by 5–8 percentage points of GDP. - Drawing on reserves and external borrowing is only a short-term solution to the loss of earnings. - Risk of a prolonged slump in oil prices and little improvement in international financial market conditions argues against financing any large share of the shortfall. - Large oil exporters face an acute need to adjust chiefly through reductions in government expenditures, tax measures, and adjustments in prices of utilities. - Other economies in the region are more diversified; some have made good progress in financial stabilization and structural reform, easing the task of adjusting to lower oil earnings and reduced remittances from emigrant workers. - Some countries, such as Egypt, will need to introduce tighter credit policies and active interest rate management to cope with loss of reserves by the banking sector. - Many countries maintain exchange rate pegs vis-à-vis the dollar; in some cases these pegs have come under pressure but pressures have been manageable in part because of limited exposure to international financial markets. - In some instances exchange rate adjustment may need to play a part in the adjustment process. ### North America: United States as engine of global growth and risks - 1998 U.S. performance and contributions - Growth rate in domestic demand of 5 percent in 1998 (up from 4!/4percent in 1997). - U.S. consumers and investors accounted for almost half of the growth in world demand (and output) in 1998. - Contributing factors: virtual price stability, low interest rates, low unemployment, a rising budget surplus resulting from fiscal discipline, and agile monetary policy achieving medium-term price stability. - Buoyancy of the stock market boosted domestic demand. - After shocks from the Russian default and the near failure of Long-Term Capital Management, Federal Reserve cuts in interest rates quickly restored confidence; economic growth surged to 6 percent in the fourth quarter of 1998. - Medium-term constraints and projections - With unemployment at a 29-year low of 4.2 percent, expansion is increasingly constrained by underlying productivity growth and labor force increases, pointing to potential growth of 2!/4–2#/4percent. - Growth of demand is expected to moderate: personal saving rate fell sharply, induced in part by increased stock market wealth, requiring private consumption growth to converge toward personal income growth if the stock market stabilizes. - U.S. corporations are likely to reduce the pace of spending on capital goods as growth prospects diminish. - Long-term interest rates have risen by about a full percentage point from their trough of last October as growth exceeded expectations. - In absence of inflationary pressures that might trigger tightening, slowdown in demand is likely to be gradual and moderate—a soft landing is possible. - Downside risks and potential hard landing - Danger of inflationary pressure and other potentially unsustainable imbalances. - Factors that helped keep inflation low (declines in oil and other commodity prices since 1996, and earlier dollar appreciation) could lose momentum or reverse. - With high resource utilization, unless growth slows to potential or lower, domestic inflationary pressures could surface. - If inflation prospects deteriorate, required monetary tightening and bond market reactions could trigger a sharp correction in the stock market. - A stock market correction could slow domestic demand abruptly, especially given the deterioration in the private sector’s saving/investment position accompanying the strong expansion, which is unprecedented in recent history and unlikely to be sustainable. _Italic: IMF World Economic Outlook and Policy Responses to the Global Slowdown, Chapter excerpt._ ### Chapter II, the section “What Are the Implications of ### What Are the Implications of the U.S. Saving‑Investment Imbalance? ### Risks and potential adjustments in the United States - Foreign investors’ willingness to continue financing the rapidly growing external deficit of the United States at current interest rates may not continue; a reduced willingness could put downward pressure on the dollar and be another cause of higher interest rates. - These factors could give rise to larger and more abrupt adjustments in private sector behavior, and a more abrupt economic slowdown, than envisaged in the baseline. - The possibility of a hard landing poses a considerable challenge for U.S. policymakers and the rest of the world. ### U.S. monetary policy stance and contingencies - The Federal Reserve Board eased monetary conditions significantly during September–November in response to financial turbulence; subsequently, with risks more evenly balanced, monetary policy has remained on hold. - Looking forward: - If growth moderates by more than is projected, monetary conditions may need to be eased further, though not so much as to preempt the slowdown; the goal should be to help ensure a soft landing. - If growth does not moderate sufficiently, the Federal Reserve may well need to tighten monetary policy initially. - Allowing imbalances in the U.S. economy to continue building would carry much larger risks for both the domestic economy and the rest of the world. ### U.S. fiscal policy considerations - The challenge will be to resist political pressures to “spend” the budget surplus that has resulted from earlier consolidation efforts and the strength of economic activity. - In cyclically adjusted terms, the budget surplus is estimated to be only about !/2of 1 percent of GDP in 1998–99. - A large tax cut, for example, might extend the expansion briefly but would substantially increase the risk of overheating, of a further worsening of the external current account, and hence of a hard landing. - Projected budget surpluses need to be maintained to meet longer-term financing needs—particularly those related to Social Security and Medicare—and will also create room for fiscal policy to be used temporarily for stabilization purposes if the need arises. ### Canada - Growth in Canada slowed last year reflecting the fallout from developments in Asia and world financial markets, particularly on commodity markets. - The Canadian economy seems poised to resume faster growth in late 1999 and 2000, but further instability in global financial markets or weakness in commodity prices, or a sharper than projected slowdown in the U.S. economy, could diminish near-term growth prospects significantly. - The Bank of Canada lowered official interest rates by a further 25 basis points at the end of March; if the outlook worsens, there would be additional scope to ease monetary policy. ### Europe: EMU introduction and overarching challenges - Stage 3 of EMU began with 11 member countries adopting the euro and the European System of Central Banks (ESCB) assuming responsibility for monetary policy in the euro area. - The smooth introduction of the euro reflected careful technical preparations and substantial convergence in macroeconomic policies since the early 1990s. - Despite the successful start, the ESCB and euro-area governments face formidable challenges in making EMU a success; performance will be judged by EMU’s contribution to financial stability and sustainable growth in the area and worldwide. ### Euro-area monetary policy and growth outlook - The ECB announced in December that its repo rate would initially be 3 percent, more than !/2of 1 percentage point lower than the average of policy rates in the area in mid-1998. - Monetary conditions have been eased by the depreciation of the euro and the ECB lowered the repo rate by an additional 50 basis points in early April, to 2!/2percent. - The staff’s projection for growth in the area in 1999 has been revised down since December to 2 percent, below its potential rate; projections point to a pickup of growth to almost 3 percent in 2000, but downside risks remain significant. - HICP inflation has been stable at 0.8 percent in recent months; the ECB’s primary objective is maintenance of price stability defined as an annual increase of prices below 2 percent. ### Fiscal constraints in the euro area and policy advice - The cyclical responsiveness of monetary policy contrasts with very limited room for maneuver in fiscal policies of euro-area member countries. - Despite substantial consolidation up to 1997, structural fiscal positions in most countries still fall short of medium-term requirements; further progress since 1997 has been slow and budget plans promise little acceleration in the near term. - The projected slowing of growth in 1999 will tend to cause some widening of actual deficits this year in some cases unless measures are taken to offset the working of automatic stabilizers. - The extent to which deficits should be allowed to increase beyond budgeted levels varies among countries, depending on proximity to the reference values of 3 percent and 60 percent of GDP, respectively. - In several countries, including Germany, France, and Italy, full operation of stabilizers could lead to the deficit limit being breached in 2000 if the projected economic recovery does not materialize. - Significant procyclical budget tightening—especially through further hikes in already excessive levels of taxation—would not be desirable. - Policy recommendations include utilizing contingencies built into budgets and cutting unproductive expenditures to contain cyclical pressures on deficits; in countries experiencing strong growth and demand pressures (Ireland, Portugal, Spain), strengthened fiscal consolidation would help damp inflationary pressures and serve medium-term fiscal objectives. ### Labor markets, structural unemployment, and reform urgency - There has been a large secular rise in European joblessness over the past quarter century. - Chapter IV focuses on structural policies to address chronic unemployment and especially the roots of structural unemployment in a number of cases—including the three largest member countries of the euro area—where labor market reforms have yet to tackle root causes. - Some recent measures (for example, legislated reductions in working hours) may have little effect or could worsen unemployment. - A major part of the solution lies in measures to increase labor market flexibility; with the absence of exchange rate adjustment within the euro area, EMU makes such efforts more urgent. - Structural reforms that improve labor market functioning can help monetary policy support growth by moderating wage pressures; reforms need to be accompanied by supportive macroeconomic policies that accommodate potential output growth and help reduce cyclical unemployment. ### United Kingdom - Growth in the United Kingdom slowed sharply to below potential during 1998 due to tightening of monetary and fiscal policy since 1996 and weakening external demand, effectively forestalling overheating. - Inflation is close to its target of 2!/2percent. - The Bank of England has lowered short-term interest rates since October from their 7!/2percent peak to 5!/4percent, which in real terms is close to the average over recent cycles and probably broadly neutral in influence on demand. - Monetary conditions have also been eased by a moderate depreciation of sterling since early 1998. - The broadly balanced structural fiscal position should allow automatic stabilizers to operate fully; there is room for further reductions in interest rates in coming months if warranted. - Labor market caution is warranted: unemployment is still close to an 18-year low; growth of labor earnings has weakened since mid-1998; the introduction in April of a national minimum wage is expected temporarily to exert some limited upward pressure on wages and prices. ### Sweden, Norway, Denmark, Greece, Switzerland - Sweden: Inflation remains the lowest in Europe—recently negative on a 12-month basis, well below the 1 percent floor of the official target range—and in late March official interest rates were reduced below 3 percent. - Norway: Easing of downward pressure on the krone allowed official interest rates to be reduced by a full percentage point since the beginning of the year; interest rates remain above those elsewhere in Europe and room for additional easing will depend on prospective inflationary pressures and this year’s wage round. - Denmark: Monetary policy is dedicated to krone stability against the euro within narrow (±2!/4percent) fluctuation bands; given the differential still remaining over euro-area rates, there may be scope for additional easing. - Greece: Inflation has declined appreciably recently, helped by indirect tax cuts and other measures; market confidence in convergence with the euro area has strengthened. A tighter fiscal stance and structural measures to address root causes of inflationary pressures would help consolidate gains and allow further gradual monetary easing during 1999. - Switzerland: Inflation is virtually zero and interest rates are below euro-area level; slowing growth, continued slack, and a shift to fiscal restraint call for monetary policy to remain accommodative; the cut in interest rates in early April was appropriate. ### Transition economies (central and eastern Europe) - The Brazilian crisis has had no sustained impact on financial markets in the transition economies; market sentiment remains strong in countries most advanced in the transition process. - Hungary and Poland are among the most successful: - Both are estimated to have achieved growth of about 5 percent in 1998. - For Poland this was the fifth successive year with growth at or above this rate. - Only moderately slower growth is projected for 1999 due to slower exports to western Europe and Russia. - Annual inflation in both countries has recently been reduced to single digits, allowing interest rates to be lowered. - Current account deficits in excess of 4 percent of GDP partly reflect continued strong capital inflows but have recently widened as exports have slowed, contributing to weakness in exchange rates; external imbalances point to a need for continued fiscal consolidation. - Czech Republic remains in recession following policy tightening in 1997–98 needed to reduce fiscal and external imbalances; rapid disinflation has allowed interest rates to be reduced, contributing to some weakening of the koruna; only a slow economic recovery is projected in 1999–2000. ### Southeastern Europe, the Baltics, and Turkey - Southeastern Europe: Economic activity in transition countries of southeastern Europe is expected to be negatively affected by the conflict in the Federal Republic of Yugoslavia: - Strong influx of refugees will impose a heavy burden on Albania and the Former Yugoslav Republic of Macedonia; the latter will also face a loss of trade with Yugoslavia. - Neighboring countries, Bulgaria and Romania in particular, will be affected by disrupted transportation links and increased investor caution; Croatia will suffer from a drop in tourism. - The IMF and the World Bank, with other organizations and donors, are assessing additional financing needs of Balkan countries. - Baltic countries: More badly affected by the Russian economic crisis; maintained exchange rate pegs and access to capital markets but faced slower growth and complications in reducing wide external imbalances. - Lithuania: official data show the current account deficit recently close to 12 percent of GDP; adjustments of the policy mix, including tighter fiscal policies, will be needed. - Estonia: lowered its current account deficit significantly to about 9 percent of GDP in 1998 as exports to western markets rose and tighter macroeconomic policies reduced imports. - Turkey: Suffered significant contagion from the Russian crisis reflecting close trade links with Russia and macroeconomic imbalances of high inflation and large fiscal deficits. - International reserves have stabilized and foreign borrowing has tentatively resumed, but capital flight following the Russian crisis left tight liquidity and markedly slower growth. - High real interest rates and large debt-refinancing requirements point to continuing vulnerability despite progress in lowering inflation and strengthening the fiscal position. - To reduce vulnerability decisively and strengthen sustainable growth, Turkey needs to implement strong structural measures to put public finances on a sound medium-term basis and establish a monetary framework to cure chronic inflation. *Source: Chapter II, section “What Are the Implications of the U.S. Saving‑Investment Imbalance?” (excerpts).* --- _Source: https://www.imf.org/-/media/websites/imf/imported-flagship-issues/external/pubs/ft/weo/1999/01/_0599ch1pdf.pdf_