## _0598ch2pdf - Fiscal consolidation, Asian crisis spillovers, and global outlook ## Source details **Canonical URL:** [_0598ch2pdf - Fiscal consolidation, Asian crisis spillovers, and global outlook](https://www.imf.org/-/media/websites/imf/imported-flagship-issues/external/pubs/ft/weo/weo0598/pdf/_0598ch2pdf.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-flagship-issues/external/pubs/ft/weo/weo0598/pdf/_0598ch2pdf.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-flagship-issues/external/pubs/ft/weo/weo0598/pdf/_0598ch2pdf.pdf.json) --- ### Fiscal consolidation and country-specific fiscal assumptions - Japan: - Consolidation plans legislated in the Fiscal Structural Reform Act assumed implemented, including front-loaded measures through 2000/01. - Target: Lowering of the general government deficit (excluding social security) to 3 percent of GDP by 2003/04. - Public investment spending (1995/96–2004/05) projected at approximately ¥470 trillion. - Modest supplementary budgets with extra spending of the order of ¥1 trillion will be announced late in 1998 and subsequent years. - Income tax rebate for 1998 will be withdrawn gradually. - Interest rate costs of plans to inject public money into the banking system are included. - Germany: - 1998 projection incorporates the 1998 federal budget, Financial Planning Council projections for other government levels, official tax estimates, and the unwinding of temporary measures implemented in 1997. - Difference from government’s 1998 deficit projection (2!/2percent of GDP) mainly due to slightly less sanguine macroeconomic assumptions. - Medium-term: unchanged policies, implying a constant structural primary balance. - France: - 1998 projection accounts for the 1998 budget, social security plans in the 1998 social security financing law. - 1999: slight decline in expenditure/GDP ratio reflecting measures to reduce social security expenditure (implementation of the 1995 health care reforms, limited means-testing of family allowances). - Beyond 1999: ratio of revenue to GDP projected to remain constant; unchanged structural primary balance assumed. - Italy: - Projections include measures in the 1998 budget and change in schedule of pension payments. - 1999–2000 based on IMF staff estimates for the “current services” budget (tendenziale), corrected for measures in the three-year plan. - Assumes measures fully implemented and yield officially estimated amounts; beyond 2000 assumes unchanged structural balance. - United Kingdom: - Budgeted spending ceilings for 1997–98 and 1998–99 assumed observed. - Thereafter noncyclical spending grows in line with potential GDP. - Revenues reflect announced commitment to raise excises on tobacco and road fuels each year in real terms for 1997–98 and 1998–99; thereafter real tax rates constant. - Canada: - Federal outlays conform to February 1997 budget commitments except medium-term floor for transfers under the Canada Health and Social Transfer raised beginning in 1997–98. - Employment insurance premium cuts: cut by 20 cents in January 1998, and assumed cut by 5 cents a year during 1999–2003. - After 1998/99, federal government assumed to maintain a small budget surplus. - Provincial fiscal positions assumed consistent with stated medium-term targets. - Australia: - Projections based on commonwealth 1997–98 midyear fiscal and economic outlook, adjusted to IMF staff projections. - State and local government policies assumed unchanged from 1998. - Growth in 1998 expected to remain broadly unchanged at about 3!/4percent. - Current account deficit expected to widen to 5 percent of GDP. - Other country notes: - Belgium: 1998 based on official budget and revised targets; thereafter slight deterioration in structural primary surplus. - Greece: 1998 reflects IMF staff assessment and corrective measures at ERM entry; beyond 1998 unchanged structural primary balance. - Israel: 1998 budget and medium-term fiscal plan with annual central government deficit targets to 2001; thereafter unchanged fiscal deficit as percent of GDP. - Korea: medium-term assumes central and general government budgets broadly in balance; short-term unemployment expected to pick up sharply with small fiscal deficits; real GDP now expected to decline by #/4of 1 percent in 1998. - Netherlands: current expenditure framework yields a small increase in primary structural balance over the medium term. - Portugal: 1998 based on official budget; 1999–2003 assumes unchanged structural primary balance. - Spain: 1998 budget implemented but allowance for small overruns; beyond 1999 no major tax change; public sector wages grow at same rate as private sector and public employment rises moderately. - Sweden: includes a surplus of 1!/4percent of GDP in 1998 and an average surplus of 2 percent of GDP over the cycle starting in 2001. - Switzerland: 1998 based on 1998 budget plans; 1999–2001 include a 1 percentage point VAT increase in 1999 and phasing out of a 1 percent unemployment contribution surcharge from mid-1999; beyond 2001 structural primary balance unchanged. ### Monetary policy and interest rate assumptions - General framework: - Based on established country frameworks, typically implying a nonaccommodative stance over the business cycle. - Assumes Economic and Monetary Union (EMU) implemented from start of 1999 in accordance with the agreed timetable. - Until EMU start, ERM countries assumed to move official interest rates in line with those in Germany, subject to fiscal consolidation progress affecting differentials. - Short-term LIBOR benchmarks: - Six-month U.S. dollar LIBOR will average 6.1 percent in 1998–99. - Six-month Japanese yen LIBOR will average 0.7 percent in 1998 and 1.2 percent in 1999. - Six-month deutsche mark LIBOR will average 3.9 percent in 1998 and 4.5 percent in 1999. ### Global repercussions of the Asian crisis — growth, capital flows, and regional spillovers - Growth and regional impacts: - Developing countries: growth expected to slow from about 5#/4percent in 1997 to about 4 percent in 1998, a 2!/4percentage point downgrade relative to October 1997 WEO; largest downward revisions for Asia and the ASEAN-4. - China: output growth expected to slow moderately to about 7 percent in 1998. - India: output growth expected to ease to some 5!/4percent in 1998. - Pakistan: output growth projected to rise to 5!/2percent in 1998. - Western Hemisphere (developing): growth projected to slow to some 3!/2percent in 1998. - Africa: GDP growth declined from 5!/2percent in 1996 to 3!/4percent in 1997; projected to rebound to around 4!/2percent in 1998. - Middle East and Europe (developing): output slowed to 4!/2percent in 1997 and projected to weaken further in 1998. - Countries in transition: output in 1998 projected to increase by 3 percent (down about 1!/4percent from October 1997 WEO). - Capital flows and current account adjustments: - Net private capital flows to emerging market countries: record high of $240 billion in 1996; 1997 net inflows estimated $67 billion less than in 1996. - New financing peaked in Q2–Q3 1997 and dropped off sharply as crisis unfolded; by November 1997 bond issuance was very low. - Net capital flows to emerging market countries in 1998 projected some $52 billion lower than in 1997 (about half the 1996 record and lowest since 1992). - Net inflows to developing Asia projected at $1.5 billion in 1998, versus $102 billion in 1996. - For the five most severely affected Asian countries (Indonesia, Korea, Malaysia, the Philippines, Thailand): large depreciations and compressed domestic demand expected to generate a shift toward current account surplus between 1996 and 1998 amounting to about $75 billion. - Aggregate 1998 projection: improvement of $13 billion in current account positions for developing, newly industrialized, and transition countries combined; industrial countries’ current account deficit projected to widen by about $70 billion (U.S. deterioration about $61 billion; EU surplus narrows by $23 billion). - Global current account discrepancy implied to widen by about $57 billion. - Regional spillovers: - Korea: strengthened commitment to policy action and agreement with foreign banks to roll over short-term debt helped confidence begin to subside in late January; spillovers expected to slow growth in Hong Kong SAR, Singapore, and Taiwan Province of China. - Australia and New Zealand: New Zealand growth aided by depreciation, expected to reach about 2#/4percent in 1998; New Zealand current account deficit projected to narrow slightly from 7#/4percent of GDP in 1997. - Australia: weaker export growth offsets stronger domestic demand; noted current account widening to 5 percent of GDP. ### Major industrial countries — activity, labor markets, inflation, and fiscal positions - United States: - Above-potential growth throughout 1997; unemployment fell to 4.7 percent by end-1997. - Real GDP growth for 1998 projected to moderate to about 3 percent. - General government deficit nearly eliminated in 1997. - United Kingdom: - Unemployment declined to 5 percent; inflation close to 2!/2percent target. - Real GDP growth expected to moderate to 2!/4percent in 1998. - Canada: - Real GDP expanded by 3#/4percent in 1997. - Bank of Canada raised interest rates by a total of 125 basis points in late 1997–Jan 1998. - Growth projected to ease to about 3!/4percent in 1998. - Continental Europe: - Germany: real GDP growth expected to strengthen to 2!/2percent in 1998. - France: real GDP growth expected to be 3 percent in 1998. - Italy: real GDP growth likely about 2!/4percent in 1998. - Austria, Belgium, Sweden: expected growth of 2!/2–3 percent in 1998. - Fiscal balances and debt (selected indicators from Table 4): - Major industrial countries (actual balance series, percent of GDP): –2.9 (1981–91), –3.8 (1992), –4.3 (1993), –3.5 (1994), –3.4 (1995), –2.8 (1996), –1.4 (1997), –1.3 (1998), –0.6 (2000), 0.3 (2003). - United States actual balance series (percent of GDP): –2.8, –4.4, –3.6, –2.3, –1.9, –1.1, –0.2, 0.1, 0.5, 1.4 (1981–91199219931994199519961997199820002003). - United States net debt series: 37.4, 50.1, 52.1, 52.8, 52.8, 52.7, 50.7, 49.1, 45.4, 37.8. - United States gross debt series: 51.6, 64.6, 66.4, 65.7, 65.9, 65.9, 63.1, 61.1, 56.4, 47.0. - Japan actual balance series (percent of GDP): –0.4, 1.5, –1.6, –2.3, –3.6, –4.3, –3.4, –3.8, –2.1, –1.1. - Japan net debt series: 19.7, 4.2, 5.2, 7.7, 13.3, 15.4, 18.5, 29.2, 32.8, 33.2. - Japan gross debt series: 67.8, 70.0, 75.1, 82.2, 89.7, 94.2, 99.7, 113.6, 120.3, 121.5. - Inflation and bond yields: - Average inflation among major industrial countries slowed to just over 2 percent in 1997 from just under 2!/2percent in 1996. - Bond yields in late 1997 and early 1998 fell to levels not seen since the early 1960s across the maturity spectrum. ### Currency realignments, competitiveness, and implications - Real effective exchange rate and competitiveness observations: - Since mid-1995 the real effective value of the U.S. dollar has risen by about 25 percent, reaching its highest level since late 1986. - Pound sterling strengthened further on a real effective basis since mid-1997, reaching a new 17-year high. - In crisis countries, initial declines in currencies took exchange rates "below any reasonable assessment of their equilibrium levels on a real multilateral basis," implying scope for rebounds. - Measurement approaches: - INS-based real effective indices: partner weights capture bilateral and third-country effects (data for 1988–90). - DOTS-based indices: bilateral trade weights from DOTS (1994–96); more up-to-date but do not capture third-market effects. - Real effective rates calculated using consumer price indices; alternatives using relative unit labor costs in manufacturing noted. - Selected country outcomes: - ASEAN-4 and Korea: large depreciations in nominal and real effective terms; DOTS-based depreciations slightly smaller than INS estimates. - Singapore and New Taiwan dollars: fell 12–14 percent against the U.S. dollar in nine months to March 1998; real effective movements more modest; DOTS weights show an appreciation for Singapore. - Hong Kong dollar: appreciated in real effective terms by about 11–14 percent. - China (renminbi): estimated real effective appreciation of 3 percent (INS) and 7 percent (DOTS). - Indian rupee: little changed on a real effective basis despite a 10 percent fall against the U.S. dollar. - Australia: modest real effective appreciation using DOTS weights. - New Zealand: real effective depreciation somewhat less than nominal fall against the U.S. dollar. - Latin America (four largest economies): currencies all appreciated somewhat in real effective terms. - Limitations and dynamics: - INS weights based on 1988–90 trade patterns do not capture expanded intra-Asian trade since late 1980s. - Over time, higher inflation could erode competitiveness gains from depreciation; initial inflation effects fairly limited except in Indonesia. ### Financial-sector crises, recovery shapes, and policy implications for afflicted countries - East Asia recovery prospects and adjustment channels: - Combined output of the five most affected countries projected to decline in the crisis year after 1990–96 average annual growth of 7–8 percent. - Key cushioning factors: trade balance response to large real depreciations and recovery of financing flows. - If trade responses akin to Mexico (1995), improvements of 10 percent of GDP or more in trade positions seem possible, potentially offsetting roughly half of the combined shock to domestic demand. - Limits: larger shocks in Asia, disrupted financial systems, and financing constraints could reduce exporters’ ability to expand output. - Historical lessons on addressing bad loans and bank failures: - Successful turnarounds (U.S. 1930s, Chile early 1980s, Mexico mid-1990s) involved decisive actions to deal with bad loans and wind up insolvent institutions; recoveries began in the year following such actions. - Japan: intensified late-1997 package included provision of up to ¥17 trillion (3!/2 percent of GDP) in public funds to the Deposit Insurance Corporation to protect depositors of failed banks and an additional ¥13 trillion to purchase preferred shares and subordinated debt of solvent banks. - Public capital injections can avoid a contraction in bank lending but require appropriate, transparent criteria to ensure restructuring and longer-term viability. - Policy implications for Indonesia, Korea, Thailand: - Actions needed to close insolvent institutions and recapitalize viable banks. - Longer-term structural reforms to strengthen prudential standards and supervision. ### Regional assessments — Latin America, Africa, Middle East, and transition countries - Latin America: - Brazil: exchange rate band since March 1995; late 1997 pressures led to monetary tightening and a fiscal package to reduce fiscal deficit to 3!/2 percent of GDP in 1998 from 6 percent in 1997; 1998 growth revised to 1!/2 percent from ~4 percent. - Argentina: growth projected to slow from almost 8!/2 percent in 1997 to 5!/2 percent in 1998. - Mexico: peso declined ~7 percent in late October 1997; 1998 budget aimed at overall fiscal deficit about 1!/4 percent of GDP; 1998 growth projected around 4#/4 percent (from ~7 percent in 1997). - Chile: policy tightening contained pressures; real output growth expected to slow to 6 percent in 1998 from about 6!/2 percent in 1997. - Africa: - Sub-Saharan Africa real GDP growth averaged 4!/4 percent a year during 1995–97 versus 1!/2 percent during 1990–94. - Per capita real output rose about 1#/4 percent annual rate over past three years. - Average annual inflation dropped to about 14 percent in 1997. - Improvements largely due to improved macroeconomic discipline and structural reforms; private investment and trade liberalization critical for sustaining growth. - Vulnerabilities from weaker commodity prices and higher risk premia following the Asian crisis. - Middle East — Egypt: - Stabilization from April 1991 led to fiscal consolidation (fiscal deficit cut by 15 percentage points over three years to about 2 percent of GDP). - Real output growth reached 5 percent in 1997; inflation about 4 percent by end-1997. - Near-term risks: lower oil prices, tourism decline, weaker remittances; external current account expected to move from a small surplus in 1997 to a deficit of 2!/2 percent of GDP by 1999. - Policy priorities: continued macro discipline, accelerated structural reforms, export diversification, financial sector modernization. - Transition countries: - Heterogeneous spillovers: Czech Republic, Hungary, Poland affected mainly via equity markets; Estonia, Ukraine, Russia saw pressures in interest rates, exchange rates, and equities. - Ukraine: exchange rate pressure from late October 1997; measures (widening exchange band, higher refinance rate, higher reserve ratio) insufficient, heavy FX intervention required. - Russia: FX pressures with repeated central bank tightening and market volatility. - Czech Republic (May 1997 crisis): switch to floating exchange rate with 10 percent koruna depreciation; expenditure cuts of 2!/2percent of GDP; GDP growth slowed from 4 percent (1996) to 1!/4percent (1997); inflation around 10 percent; policy priorities include fiscal restraint, wage discipline, structural reforms for EU accession. *Italic: Source — _0598ch2pdf - 1998. Consolidation plans legislated in the Fiscal; "Changes in interest rate assumptions compared"; and chapter "Implications of Recent Currency Realignments for Countries’ International Competitiveness."* ### 1998. Consolidation plans legislated in the Fiscal ### _0598ch2pdf - 1998. Consolidation plans legislated in the Fiscal ### Fiscal consolidation and Japan-specific assumptions - Consolidation plans legislated in the Fiscal Structural Reform Act are assumed to be implemented, including the front-loaded measures associated with the intensive reform period through 2000/01. - Resulting targets and assumptions for Japan: - Lowering of the general government deficit (excluding social security) to 3 percent of GDP by 2003/04. - Public investment spending between 1995/96 and 2004/05 projected at approximately ¥470 trillion. - Modest supplementary budgets with extra spending of the order of ¥1 trillion will be announced late in 1998 and subsequent years. - The income tax rebate for 1998 will be withdrawn gradually. - The interest rate costs of plans to inject public money into the banking system are included. ### Country-by-country fiscal projection assumptions and notable measures - Germany: - 1998 projection incorporates the 1998 federal budget, Financial Planning Council projections for other government levels, official tax estimates, and the unwinding of temporary measures implemented in 1997. - Difference from government’s 1998 deficit projection (2!/2percent of GDP) mainly due to slightly less sanguine macroeconomic assumptions. - Medium-term projections assume unchanged policies, implying a constant structural primary balance. - France: - 1998 projection accounts for the 1998 budget, social security plans in the 1998 social security financing law, and authorities’ information on other government levels. - 1999 projection entails a slight decline in the ratio of expenditure to GDP reflecting measures to reduce social security expenditure (implementation of the 1995 health care reforms, and limited means-testing of family allowances). - Beyond 1999, ratio of revenue to GDP is projected to remain constant; unchanged structural primary balance assumed. - Italy: - Projections account for measures in the 1998 budget and a recently announced change in the schedule of pension payments. - 1999–2000 projections based on IMF staff estimates for the “current services” budget (tendenziale), corrected for measures announced in the three-year plan. - Assumes plan’s measures are fully implemented and yield the officially estimated amounts. - Beyond 2000, assumes an unchanged structural balance. - United Kingdom: - Budgeted spending ceilings for 1997–98 and 1998–99 are assumed to be observed. - Thereafter, noncyclical spending assumed to grow in line with potential GDP. - Revenue projections incorporate announced commitment to raise excises on tobacco and road fuels each year in real terms for 1997–98 and 1998–99; thereafter, real tax rates assumed to remain constant. - Canada: - Federal outlays for departmental spending and business subsidies assumed to conform to commitments in the February 1997 budget, except the medium-term floor for transfers under the Canada Health and Social Transfer raised beginning in 1997–98. - Employment insurance premium cuts: cut by 20 cents in January 1998, and assumed to be cut by 5 cents a year during 1999–2003. - Other outlays and revenues assumed to evolve in line with IMF staff macroeconomic projections. - After 1998/99, the federal government assumed to maintain a small budget surplus, implying some small cuts in taxes and increases in program spending; provincial fiscal positions assumed consistent with stated medium-term targets. - Australia: - Projections based on commonwealth government’s 1997–98 midyear fiscal and economic outlook, adjusted for differences with IMF staff projections. - Unchanged policies assumed for state and local government sector from 1998. - Growth in 1998 expected to remain broadly unchanged at about 3!/4percent with weaker export growth offsetting stronger domestic demand. - Current account deficit expected to widen to 5 percent of GDP. - Belgium: - 1998 projections based on official budget and revised targets. - Thereafter, fiscal projections based on current primary expenditure and revenue policies, resulting in a slight deterioration in the structural primary surplus over the medium term. - Greece: - 1998 projection reflects IMF staff assessment of official budget and corrective measures announced at the time of the drachma’s entry into the ERM. - Beyond 1998, projections assume an unchanged structural primary balance. - Israel: - Projections based on the 1998 budget and the government’s medium-term fiscal plan establishing annual deficit targets for the central government until 2001. - Thereafter, projections assume an unchanged fiscal deficit as a percent of GDP. - Korea: - Medium-term projections assume central and general government budgets broadly in balance. - Short-term: unemployment expected to pick up sharply, with associated social safety net expenditure increases implying small fiscal deficits. - Regional crisis context: economic slowdown likely sharper than projected in December, with real GDP now expected to decline by #/4of 1 percent in 1998. - Netherlands: - Projections assume continued current expenditure framework leads to a small increase in the primary structural balance over the medium term. - Portugal: - 1998 projection based on the official budget; 1999–2003 projections assume an unchanged structural primary balance. - Spain: - 1998 projections assume budget implemented as passed but allow for small expenditure overruns partially offset by lower interest payments and higher tax revenues from more rapid domestic demand growth. - For 1999 and beyond, no major change in tax policy assumed; public sector wages grow at same rate as private sector wages; public sector employment rises moderately. - Sweden: - Projections based on fiscal objectives in the 1997 Fall Budget Bill. - Includes a surplus of 1!/4percent of GDP in 1998 and an average surplus of 2 percent of GDP over the cycle starting in 2001. - Switzerland: - 1998 projection based on 1998 budget plans. - 1999–2001 projections in line with official current service estimates but include a 1 percentage point increase in the standard value-added tax rate in 1999 and a phasing out of the unemployment contribution surcharge of 1 percent from mid-1999 onward. - Beyond 2001, general government’s structural primary balance assumed to remain unchanged. ### Regional and crisis spillover notes - Asian regional crisis effects: - With Korea’s strengthened commitment to policy action and an agreement with foreign banks to roll over short-term debt, crisis in confidence began to subside in late January. - Spillover effects expected to slow growth in Hong Kong SAR, Singapore, and Taiwan Province of China. - Impact on Australia noted above. ### Monetary policy assumptions and short-term interest rate benchmarks - General monetary policy framework assumptions: - Based on established frameworks in each country, typically implying a nonaccommodative stance over the business cycle: official interest rates firm when indicators point to rising inflation above acceptable range, and ease when inflation prospects are benign, prospective output growth is below potential, and slack is significant. - Assumes Economic and Monetary Union (EMU) in Europe will be implemented from the start of 1999 in accordance with the agreed timetable. - Until EMU start, ERM countries assumed to move official interest rates in line with those in Germany, subject to fiscal consolidation progress affecting interest differentials. - Short-term LIBOR assumptions: - London interbank offered rate (LIBOR) on six-month U.S. dollar deposits will average 6.1 percent in 1998–99. - LIBOR on six-month Japanese yen deposits will average 0.7 percent in 1998 and 1.2 percent in 1999. - LIBOR on six-month deutsche mark deposits will average 3.9 percent in 1998 and 4.5 percent in 1999. *Source: _0598ch2pdf - 1998. Consolidation plans legislated in the Fiscal* ### 1999. Changes in interest rate assumptions compared ### 1999. Changes in interest rate assumptions compared ### Global repercussions of the Asian crisis and near-term growth outlook - Australia and New Zealand: impact of Asian crisis smaller in New Zealand; easing of monetary conditions since mid-1997 via depreciation of the New Zealand dollar expected to help growth reach about 2#/4percent in 1998. Current account deficit projected to narrow slightly from the level of 7#/4percent of GDP reached in 1997. - Developing countries: growth expected to slow from about 5#/4percent in 1997 to about 4 percent in 1998, a 2!/4percentage point downgrading relative to the October 1997 World Economic Outlook; largest downward revisions are for Asia and the ASEAN-4 countries. - China: financial markets relatively unaffected; output growth expected to slow moderately to about 7 percent in 1998; inflation should remain low following the sharp drop in 1997. - India: output growth expected to ease to some 5!/4percent in 1998, reflecting political uncertainties and high real interest rates owing to significant fiscal deficits. - Pakistan: output growth projected to rise to 5!/2percent in 1998 and inflation to fall, assuming adjustment and reform policies are implemented as planned. - Western Hemisphere (developing countries): growth projected to slow to some 3!/2percent in 1998, partly from spillovers of the Asian crisis and policy measures to reduce vulnerability, and a natural slowdown in Mexico. - Africa: GDP growth declined from 5!/2percent in 1996 to 3!/4percent in 1997 (!/2of 1 percentage point lower than October 1997 WEO projection); projected to rebound to around 4!/2percent in 1998 assuming disciplined macroeconomic policies and resolution of conflicts; downside risks from El Niño and commodity price declines. - Middle East and Europe (developing countries): output growth slowed to 4!/2percent in 1997 and projected to weaken further in 1998; Turkey faces high inflation and near-term activity slowdown; Iran’s growth slowed to about 3!/4percent in 1997 and lower oil prices will restrain growth in 1998. - Countries in transition: output in 1998 projected to increase by 3 percent (a downward revision of about 1!/4percent from October 1997 WEO); weaker forecasts mainly for Bulgaria, Russia, Turkmenistan, Ukraine, and Uzbekistan; Hungary and Poland show stronger prospects. ### Major industrial countries — activity, labor markets, and fiscal positions - United States: - Above-potential growth throughout 1997. - Unemployment rate fell to 4.7 percent by the end of 1997. - Inflation remains low; strong dollar and weak commodity prices expected to help keep inflation low in the near term. - Productivity advances outpacing wage rises; buoyant investment in new capacity containing cost pressures. - General government deficit nearly eliminated in 1997 (see Table 4). - Real GDP growth for 1998 projected to moderate to about 3 percent, reflecting weaker external demand from the Asian crisis, the strong dollar, and some modest monetary tightening. - United Kingdom: - Expansion in advanced stage; registered unemployment declined to 5 percent. - Inflation running close to its 2!/2percent target. - Growth in real GDP expected to moderate to 2!/4percent in 1998 as exports slow and domestic demand moderates partly due to monetary tightening in 1997 and fiscal consolidation. - Canada: - Real GDP expanded by 3#/4percent in 1997. - Bank of Canada tightened monetary conditions modestly in October 1997 and raised interest rates in November and December 1997 and January 1998 by a total of 125 basis points to maintain monetary conditions given a depreciating Canadian dollar. - Federal budget expected to be balanced in the 1997–98 fiscal year, with small surpluses thereafter. - Growth projected to ease to about 3!/4percent in 1998. - Continental Europe: - Recovery gathered strength in 1997; expected pause in further fiscal consolidation, depreciated currencies, lower long-term interest rates, and stronger confidence support moderate strengthening. - Germany: growth in 1997 driven mainly by exports; real GDP growth expected to strengthen to 2!/2percent in 1998. - France: recovery became better balanced with a pickup in domestic demand; real GDP growth expected to be 3 percent in 1998. - Italy: growth firmed in 1997 despite large fiscal correction; real GDP growth likely about 2!/4percent in 1998 supported by lower interest rates and EMU-related buoyancy of expectations. - Austria, Belgium, Sweden: expected growth of 2!/2–3 percent in 1998. - Labor markets and capacity: - Differences in cyclical positions across major industrial countries persist (see Figure 6 output gaps). - Some risk of overheating in several continental European countries. ### Fiscal balances and debt (selected indicators from Table 4) - Major industrial countries (actual balance series, in percent of GDP): –2.9 (1981–91), –3.8 (1992), –4.3 (1993), –3.5 (1994), –3.4 (1995), –2.8 (1996), –1.4 (1997), –1.3 (1998), –0.6 (2000), 0.3 (2003). - United States: - Actual balance series (percent of GDP): –2.8, –4.4, –3.6, –2.3, –1.9, –1.1, –0.2, 0.1, 0.5, 1.4 (1981–91199219931994199519961997199820002003 columns). - Net debt: 37.4, 50.1, 52.1, 52.8, 52.8, 52.7, 50.7, 49.1, 45.4, 37.8 (same column series). - Gross debt: 51.6, 64.6, 66.4, 65.7, 65.9, 65.9, 63.1, 61.1, 56.4, 47.0. - Japan: - Actual balance series (percent of GDP): –0.4, 1.5, –1.6, –2.3, –3.6, –4.3, –3.4, –3.8, –2.1, –1.1. - Net debt: 19.7, 4.2, 5.2, 7.7, 13.3, 15.4, 18.5, 29.2, 32.8, 33.2. - Gross debt: 67.8, 70.0, 75.1, 82.2, 89.7, 94.2, 99.7, 113.6, 120.3, 121.5. - Notes: budget projections based on information through March 1998; output gap is actual less potential output as percent of potential; structural balances expressed as percent of potential output. Estimates subject to significant margins of uncertainty. ### Prospects for global inflation (and deflation) and interest rates - Bond yields: in late 1997 and early 1998, bond yields in most major industrial countries fell to levels not seen since the early 1960s; yields fell across the maturity spectrum, reflecting reduced expectations of inflation and of monetary tightening and a flight to safety from the Asian crisis. - Inflation trend: average inflation among the major industrial countries slowed to just over 2 percent in 1997 from just under 2!/2percent in 1996. - Channels by which the Asian crisis reduces inflation risks in the short term: - Weakening demand and activity in many countries. - Sharp drop in world prices for many primary commodities for which Asian countries account for a significant share of global demand. - Large depreciations of Asian currencies reducing U.S. dollar prices of products for which these countries are important suppliers. - Risk of global deflation: - Distinction emphasized between deflation (sustained fall in overall price level) and disinflation (decline in inflation rate). - Several factors argue against imminent global deflation: flexible exchange rate system allowing adjustment via currency depreciations; central banks and governments having leeway to ease monetary and fiscal policy; improved financial regulation and lender-of-last-resort understanding; existence of global monetary cooperation and financial support mechanisms. - Continued robust domestic demand across a broad range of advanced economies provides offset to deflationary effects of the Asian crisis. - Unless a much more serious downturn occurs, generalized price deflation does not appear to be a major risk; major central banks would have considerable scope to ease policy if downside risks materialized. ### Interest rate movements and monetary conditions - Short-term and long-term rates: long-term interest rates continued downward trend; short-term rates showed mixed movements (Figure 10). - Monetary conditions indices (Figure 7): marked tightening in the United Kingdom since 1996 expected to moderate growth; indices combine changes in real short-term interest rates and real effective exchange rates with country-specific weights. ### Recent currency realignments and international competitiveness - ASEAN-4 and Korea: currencies fell precipitously in late 1997 and early 1998; partial recovery since January 1998. - Specific currency moves (as reported): - Indonesian rupiah: in March 1998, in terms of the U.S. dollar, on average 74 percent lower than nine months earlier. - Other crisis currencies: declines of 31–39 percent in dollar values over the same nine-month period (Table 7). - Hong Kong SAR: exchange rate peg to the U.S. dollar maintained under the currency board arrangement. - China: stable exchange rate vis-à-vis the U.S. dollar maintained. - Other currencies: Singapore dollar, New Taiwan dollar, Indian rupee, Australian dollar, and New Zealand dollar weakened significantly in late 1997; among these only the Australian dollar had recovered significantly in early 1998. _Italic: Source — _0598ch2pdf - 1999. Changes in interest rate assumptions compared_._ ### 1998. These declines reflected market pressures stem- ### Implications of Recent Currency Realignments for Countries’ International Competitiveness ### Currency movements and immediate effects on competitiveness - In the crisis countries, initial declines in currency values took exchange rates "below any reasonable assessment of their equilibrium levels on a real multilateral basis," even allowing for crisis-related dislocation; undershooting pointed to scope for rebounds as confidence returned. - Since mid-1997 the pattern of multilateral trade-weighted exchange rates and international competitiveness has been "significantly altered." - The U.S. dollar and pound sterling strengthened further during the period, while the yen weakened against all other major currencies. - The sharp weakening in a number of Asian currencies contributed to the further strengthening of the U.S. dollar on a nominal and real multilateral basis. - Since mid-1995 the real effective value of the dollar "has risen by about 25 percent, reaching its highest level since late 1986 and implying a significant erosion of international competitiveness." - The pound sterling "has strengthened further on a real effective basis since mid-1997, reaching a new 17-year high." ### Measures and indices used to assess competitiveness - Real effective exchange rate indices based on consumer prices are computed at the IMF for most member countries and used in its Information Notice System (INS). - INS weighting scheme: reflects relative importance of partner countries in trade in manufactured goods, primary commodities, and, where significant, tourism services, and the importance of competition between countries in third-country markets for trade in manufactures. - Two sets of effective exchange rate indices discussed: - INS-based indices: partner country weights capture both bilateral and third-country effects, based on data for 1988–90. - DOTS-based indices: bilateral trade weights derived from IMF’s Direction of Trade Statistics (DOTS) database for 1994–96; advantage—more up-to-date trade data; disadvantage—higher aggregation level and third-market effects not captured. - Real effective exchange rates are calculated using consumer price indices to convert nominal into real indices; alternatives using relative unit labor costs in manufacturing are noted but not the primary focus here. ### Regional and country-specific outcomes (selected) - Asian crisis countries: large depreciations against the U.S. dollar entailed substantial depreciations in both nominal and real effective terms; differences between bilateral dollar depreciations and real effective depreciations reflect intra-regional trade links and inflation effects. - Inflation effects: competitiveness gains from depreciation are partially offset by higher domestic inflation related in part to rises in traded-goods prices; "as of early 1998, this effect has been fairly limited except in Indonesia." - ASEAN-4 and Korea: DOTS-based estimates of real effective depreciations are slightly smaller than INS estimates, but the overall picture is broadly similar. - Singapore and New Taiwan dollars: fell by 12–14 percent against the U.S. dollar in the nine months ended March 1998; real effective movements were more modest—DOTS weights show an appreciation for Singapore. - Hong Kong dollar: "appreciated in real effective terms by about 11–14 percent," suggesting competitiveness erosion given the peg to the U.S. dollar. - China (renminbi): estimated to have appreciated by 3 percent in real effective terms based on INS weights, and 7 percent based on DOTS weights. - Indian rupee: "little changed on a real effective basis, despite a 10 percent fall against the U.S. dollar." - Australian dollar: appears to have appreciated modestly in real effective terms using DOTS weights. - New Zealand dollar: depreciation in real effective terms was somewhat less than its fall against the U.S. dollar might suggest. - Latin America (four largest economies): currencies "all appreciated somewhat in real effective terms," reflecting close links to the dollar (Argentina and Brazil) and inflation differentials (Mexico). - For other major industrial countries with smaller trade exposure to Asia, recent movements in real multilateral rates mainly reflect exchange rate movements against other industrial country currencies. ### Limitations and dynamics affecting real effective measures - INS weights are based on trade data for 1988–90 and do not capture more recent trading-pattern changes, including expanded intra-Asian trade since the late 1980s. - DOTS weights (1994–96) capture more recent bilateral trade but do not capture third-market competition. - Over time, higher inflation could become a significant factor eroding initial competitiveness gains from depreciation, owing to lags between exchange rate changes and inflation and the influence of price controls or subsidies and compressed domestic demand. ### Prospects for global flows of funds and current account balances - Net private capital flows to emerging market countries reached a record high of $240 billion in 1996, with Asia attracting the largest share by far. - For 1997 as a whole, net inflows to emerging markets are estimated to have been $67 billion less than in 1996, with net inflows to the developing countries of Asia "falling to the lowest level since 1992." - New financing peaked in the second and third quarters of 1997; as the crisis unfolded, new bond issuance by the Asian economies "dropped off considerably." - By November 1997 bond issues by all emerging market countries had dropped to very low levels and remained low through the end of the year, before recovering somewhat outside Asia in early 1998. - Net capital flows to emerging market countries in 1998 are projected to be some $52 billion lower than in 1997, and thus about half the record level of 1996 and the lowest since 1992. - Net inflows to the developing countries of Asia are projected at only $1.5 billion, compared with the peak of $102 billion in 1996. *Source: IMF staff analysis from the chapter "Implications of Recent Currency Realignments for Countries’ International Competitiveness."* ### 1996. These projections assume that there is some ### GLOBAL REPERCUSSIONS OF THE ASIAN CRISIS AND OTHER ISSUES ### Capital flows and current account balances: overview and projections - Secondary market yield spreads on dollar-denominated Eurobonds issued by emerging market countries increased significantly in the latter part of 1997 as the Asian crisis deepened and spread to other emerging market countries. - Capital flows to Asia are expected to recover only slowly; Latin America and the transition countries are expected to experience increases in their shares of private capital flows to emerging market countries. - The sharp declines in private capital flows in 1997–98 will require substantial adjustments of external positions by many emerging market countries, particularly those in Asia, although this adjustment is being cushioned by official financing flows. - For the five most severely affected Asian countries—Indonesia, Korea, Malaysia, the Philippines, and Thailand: - The large currency depreciations and compression of domestic demand are expected to generate a shift toward current account surplus between 1996 and 1998 amounting to about $75 billion. - Current account surpluses are expected in 1998 in all these countries except Malaysia and the Philippines, and they could turn out to be larger than projected. - Other emerging market country projections and notable country outcomes: - Brazil: current account deficit is expected to narrow to 3!/4 percent of GDP in 1998, reflecting policy tightening. - Argentina: current account deficit projected to widen to 4!/4 percent of GDP in 1998 from 3#/4 percent in 1997 due to slower exports and higher interest payments. - Mexico: current account deficit projected to widen to 2!/2 percent of GDP in 1998 from 1#/4 percent in 1997 despite fiscal restraint partly offsetting lower oil prices. - Developing countries whose export earnings are dominated by exports of fuel: deterioration from 1997 projected at $26 billion in 1998 due to the sharp decline in oil prices. - Aggregate projection for 1998: - Taking all developing, newly industrialized, and transition countries together, an improvement of $13 billion in current account positions is projected for 1998 compared with 1997. - Industrial countries: overall current account deficit projected to widen by about $70 billion, with a $61 billion deterioration projected for the United States; European Union current account surplus expected to narrow by $23 billion. - U.S. current account deficit expected to increase to about 2#/4 percent of GDP from around 2 percent over the past several years. - U.K. current account expected to swing from a small surplus to a deficit of 1 percent of GDP partly owing to the appreciation of sterling. - Japan: current account surplus projected to increase somewhat to 3 percent of GDP in 1998–99. - Global current account discrepancy: - Outcome of projected changes in 1998 implies a widening in the global current account discrepancy of about $57 billion. - The report notes this increase seems unlikely given historical stability and suggests either larger current account adjustments by emerging market countries or smaller deteriorations in industrial countries’ current accounts than projected. - The assessment favors resolution through lower-than-projected capital flows to emerging market countries, implying larger current account adjustments by them and downside risks to their growth and imports. *Source: IMF World Economic Outlook chapter content provided.* ### Outlook for Japan - 1997 deterioration and drivers: - Economic conditions in Japan deteriorated sharply in 1997 following a temporary surge in activity prior to the April consumption tax increase. - Fiscal policy was more contractionary than initially expected. - Confidence undermined by continuing strains in the financial sector and concerns about spillovers from financial crises elsewhere in Asia. - Falling equity prices weakened banks’ capital bases and reinforced doubts about their ability to deal with nonperforming loans. - 1998 projection: - Zero growth in real GDP is projected in 1998, with continued weakness expected in domestic demand. - Trade linkages and partial trade impact estimate: - About 20 percent of Japan’s merchandise exports in 1996 were to the five Asian countries most affected by financial turmoil; about 17 percent of imports originated from these countries. - If the combined import volume of these countries hypothetically fell by 15 percent while their exports rose by half as much, Japan’s real trade balance would be reduced by about !/2 of 1 percent of GDP; allowing for second-round effects, overall impact on GDP could amount to about #/4 of 1 percent. - Exchange rate developments: - Yen depreciated sharply against other major currencies in the latter half of 1997, reaching in early 1998 its lowest level against the dollar since early 1992. - In multilateral terms, declines against major currencies were balanced by a rise in the yen versus other Asian currencies; nominal and real effective value of the yen fell by much less and in fact rose on the basis of DOTS weights. - Projections are based on the assumption that real effective exchange rates are constant at levels prevailing in the period February 9–March 4, 1998. - Financial sector strains and market response: - Intensified strains toward end-1997 as two major institutions failed, revealing unexpectedly large losses. - “Japan premium” rose to around 50–100 basis points by December, reflecting higher borrowing costs for Japanese banks in international interbank markets. - Government measures to restore confidence included: - Provision of up to ¥17 trillion (3!/2 percent of GDP) in public funds to the Deposit Insurance Corporation (DIC) to protect depositors of failed banks. - Provision of an additional ¥13 trillion in funds to the DIC to purchase preferred shares and subordinated debt of solvent banks. - These measures boost funds to resolve failed institutions and protect depositors, and have had some effect in boosting market confidence since mid-January. - Public capital injections into solvent banks are desirable to avoid unwarranted contraction of bank lending, but criteria must be appropriate and transparent to ensure restructuring and longer-term viability. - Over the medium term, measures highlight need for a competitive, efficient, market-based financial system consistent with Big Bang reform plans. - Fiscal policy: - Fiscal policy was strongly contractionary in 1997: - Consumption tax increase, ending of a temporary income tax cut, and a sharp decline in public investment led to a 1!/2 percentage point drop in the structural deficit as percent of GDP (including social security). - FY1998 budget envisages significant further spending cuts; structural deficit would decline by !/2 of 1 percent of GDP despite reintroduction of ¥2 trillion in temporary income tax cuts and other measures. - Late March proposals announced for a fiscal stimulus package amounting nominally to ¥16 trillion or more than 3 percent of GDP, but with insufficient detail to permit economic impact estimates. - As prospects for sustained recovery become more assured, firm consolidation measures will be needed to address existing fiscal imbalance and future strains associated with population aging. - Policy recommendations and structural reform: - Sound macroeconomic policies critical to supporting recovery. - More rapid implementation of structural reforms and further deregulation necessary to reinvigorate the Japanese economy. - Actions needed to restore confidence in financial sector and avoid a credit crunch. *Source: IMF World Economic Outlook chapter content provided.* ### Emerging Market Countries: selected issues Subsection: What shape is the recovery in East Asia likely to take? - Near-term impacts and drivers: - Combined output of the five most affected countries (Indonesia, Korea, Malaysia, the Philippines, Thailand) projected to decline in the crisis year after average annual growth of 7–8 percent during 1990–96. - Downturns led by sharp compressions of domestic demand due to lower currency values and equity prices, cut access to international capital markets, and financial sector problems disrupting domestic credit supply. - Key factors for cushioning downturns and enabling recovery: - Response of trade balances to improved competitiveness from large real currency depreciations. - Recovery of financing flows, internationally and domestically, enabling renewed private spending. - Trade adjustment potential and analogy to Mexico: - Mexico, 1995: domestic demand plunged by 14 percent in 1995 versus trend of about 5 percent; real effective exchange rate declined by about 33 percent; trade balance swung from deficit of almost 5 percent of GDP in 1994 to a 3 percent surplus in 1995. - In the five Asian economies, cumulative reduction in domestic demand during 1997–98 relative to trend projected at over 20 percent (over two years); real effective exchange rates as of early 1998 had fallen by an average of 40 percent from precrisis levels. - If response proportional to Mexico’s, swing in combined trade position from 1996 to 1998 would be larger (relative to GDP) than in Mexico; greater openness (exports/imports to GDP from 25 percent for Indonesia to 90 percent for Malaysia) would magnify effects. - Improvements of 10 percent of GDP or more in trade positions seem quite possible, potentially offsetting roughly half of combined shock to domestic demand. - Limits and caveats: - Extrapolation from Mexico may be problematic given larger shocks in Asia; diminishing marginal responses and financing constraints for exporters due to disrupted financial systems could limit production expansion. - Declines in currency values may not be sustained as their trade effects become apparent. - Financing and confidence: - Gross private financing flows to Asian emerging market economies plunged (example: $6 billion in December 1997 from $12 billion in December 1996 and a peak of about $20 billion in July 1997). - Collapse in external financing reduced credit availability and exacerbated domestic financial sector strains. - Domestic financial sector structural weaknesses and surge in bad loans have severely disrupted domestic financial intermediation. - Historical lessons from financial sector crises: - Episodes reviewed: U.S. Great Depression (1930s), Chile (early 1980s), Mexico (mid-1990s), Japan (1990s). - Turnarounds in the first three cases occurred only after decisive actions to deal with bad loans and wind up insolvent institutions (U.S. bank holiday 1933; Chile central bank purchase of bad loans 1984; Mexico bank recapitalization and nonperforming loan restructuring 1995). - Sustained recoveries began in the year following these actions, with macroeconomic stabilization also playing an important role. - In Japan, prior actions were limited and based on expectation banks could earn their way out; with intensified strains in late 1997 authorities responded with a more comprehensive plan including significant public funds to facilitate closure of insolvent institutions and recapitalize others. - Policy implications: - Implementation of decisive reforms to restore confidence in financial sector is key to initiating sustained recoveries. - For Indonesia, Korea, Thailand: actions needed to close insolvent institutions and recapitalize viable banks, combined with longer-term structural reforms to strengthen prudential standards and supervision. - Market responses have been favorable where progress has been made, but full effects on corporate bankruptcies and asset quality are yet to be felt and access to private capital remains limited. Subsection: How well has Latin America weathered the Asian storm? - Financial market pressures in late 1997 were felt in several Latin American countries (notably Brazil, and significantly in Argentina, Chile, and Mexico). - Policy responses and outcomes: - Brazil: - Maintained an adjustable exchange rate band since March 1995 and depreciated the real at an annualized rate of 7 percent against the U.S. dollar since 1996. - Late October 1997: real came under intense downward pressure as fiscal deficit and current account concerns grew. - Authorities intervened in exchange market, then tightened monetary conditions via a sharp increase in short-term interest rates. - November: strengthened fiscal package introduced to reduce fiscal deficit to 3!/2 percent of GDP in 1998 from 6 percent in 1997. - Markets reacted positively and exchange rate pressures eased. - Projected growth for 1998 revised down to 1!/2 percent from around 4 percent (per October 1997 WEO). - Argentina: - Spreads on sovereign debt widened in November; domestic interest rates rose, then declined as pressures eased. - Growth projected to slow: real GDP growth from almost 8!/2 percent in 1997 to 5!/2 percent in 1998. - Mexico: - Peso declined by about 7 percent against the dollar in late October 1997; moderate interest rate increase relieved pressure. - December 1997: congress approved 1998 budget aiming to maintain overall fiscal deficit at about 1!/4 percent of GDP. - January 1998: spending measures announced to contain deficit at this level despite lower oil prices and tax revenues. - Projected real GDP growth moderated to around 4#/4 percent in 1998 from an estimated 7 percent in 1997. - Chile: - Peso depreciated in December–early January despite moderate FX intervention; regained most losses after raising interest rates, tightening liquidity, and announcing public expenditure cuts. - Real output growth expected to slow to 6 percent in 1998 from about 6!/2 percent in 1997. - Assessment: - Fallout in Latin America was limited in part due to prompt monetary tightening and fiscal adjustment (especially Brazil). - Brazil’s policy tightening followed recognition that fiscal and current account imbalances required correction—Asian crisis brought forward needed policy action. - Stabilization achieved at cost of temporary slowdown in growth. - Continued reliance on privatization proceeds to finance current account deficits (in some countries) may be fragile in a less benign global environment for capital inflows. Subsection: Can Africa continue to improve its growth performance? - Recent improvements (sub-Saharan Africa, aggregate): - Real GDP growth across 49 countries averaged 4!/4 percent a year during 1995–97, compared with 1!/2 percent during 1990–94 and 2!/2 percent during 1981–89 (see Table 12). - Some countries realized average growth near 8 percent in recent years. - Per capita real output rose at about 1#/4 percent annual rate over past three years vs. average annual decline of over 1 percent in early 1990s. - Average annual inflation dropped to about 14 percent in 1997. - Fiscal and external current account deficits improved relative to early–mid 1990s. - Role of policy and reform: - Improvements appear largely due to improved macroeconomic discipline (particularly fiscal reforms) and structural reforms. - Trade liberalization is a potential element to strengthen medium-term growth; Africa’s share in world trade declined from 3 percent (mid-1950s) to 1 percent recently. - Estimates suggest if African economies had pursued more open commercial policies during 1965–95 they would have achieved an extra 1!/2 percentage points in annual per capita income growth. - Early liberalizers (e.g., Botswana, Mauritius) outperformed the rest of Africa. - Investment and public vs. private roles: - Share of public investment in total investment has tended to be large; private investment finance channels often underdeveloped. - Evidence suggests public investment has lower returns than private investment; social rate of return to private capital estimated about 50–60 percent higher than for public capital. - Implication: expanding private investment while maintaining or improving its efficiency will increase long-run growth. - Attracting private capital: - Private capital flows to non-CFA sub-Saharan African countries recovered to levels (proportionate to GDP) not much lower than developing regions outside Africa during 1980–95. - Africa receives about 2–3 percent of total world foreign direct investment, but FDI increased since late 1980s for non-CFA countries. - Largest recipients of net private capital flows were countries with open markets, minimal regulations, superior infrastructure, and low production costs. - Constraints in other countries: civil strife, macroeconomic instability, small domestic markets, slow privatization, weak infrastructure and governance—all deter investment. - Vulnerabilities to Asian crisis: - Given relatively low private capital flows, impact of the Asian crisis expected to be smaller in Africa than in other developing regions. - However, increases in risk premia for emerging market debt will raise cost of foreign borrowing for African countries. - Weakening commodity prices following the Asian crisis add uncertainties to near-term growth. Subsection: Egypt — an improved performer in the Middle East: can its success be sustained? - Background and turnaround: - Stabilization and reform beginning April 1991 produced sharp fiscal consolidation and macroeconomic stabilization. - Fiscal deficit cut by 15 percentage points over a three-year period to about 2 percent of GDP. - Exchange rate used as nominal anchor; monetary and credit targets supported the program; foreign exchange markets unified; interest rates liberalized; most prices decontrolled; public sector banks recapitalized. - Large-scale external assistance including grants and debt relief supported turnaround. - Outcomes by mid- to late-1990s: - Real output growth rebounded in 1993/94 and reached 5 percent in 1997, fueled primarily by private sector investment. - Inflation reduced to under 11 percent in 1993 and to about 4 percent by end-1997. - Privatization and structural reforms initially stalled but were reinvigorated by a new government in 1996: - One-third of state industrial portfolio divested (excluding infrastructure and utilities). - Private involvement increased in commercial banks, securities, and insurance firms. - Average tariff rates reduced. - Near-term vulnerabilities and projections: - With lower oil prices, decline in tourism due to an act of terrorism, and less favorable remittance inflows, external current account expected to move from a small surplus in 1997 to a deficit of 2!/2 percent of GDP by 1999. - Capital account has weakened in recent months; projected real GDP growth in 1998 revised downward somewhat and is unlikely to be stronger than in 1997. - Policy challenges and recommendations: - To sustain recovery and reduce poverty, continued strong macroeconomic policies, accelerated structural reforms, and export diversification are required. - Financial sector needs strengthening and modernization to stimulate private investment. - Maintaining disciplined macroeconomic policies and improving competitiveness will help minimize vulnerability given growing integration with global financial markets. Subsection: How serious have spillovers been on countries in transition? - Impact heterogeneity: - Financial and FX markets in several transition countries were significantly affected by the Asian crisis; impacts differed by country depending on financial market development, international integration, preexisting weaknesses, and economic links with affected countries. - Contagion most clear in Russia and Ukraine. - Russia specific developments: - FX pressures intensified end-October 1997, receded in early December, reemerged in January. - Central bank responses: raised interest rates several times, increased reserve requirements on FX deposits, intervened in FX and treasury bill markets. - A new exchange rate policy was announced as planned (details not restated here). - Stock market prices experienced volatility. - Overall assessment: - Transition economies experienced varying degrees of spillovers; policy responses included monetary tightening, FX intervention, and regulatory adjustments to stabilize markets. *Source: IMF World Economic Outlook chapter content provided.* ### 1998. The larger fluctuation margin is meant to reduce the risk of ### GLOBAL REPERCUSSIONS OF THE ASIAN CRISIS AND OTHER ISSUES ### Spillovers to Transition Countries: Overview and Patterns - Implementation of a strong stabilization program beginning in 1991 has resulted in markedly improved economic conditions. - The Asian financial crisis produced heterogeneous spillover effects across transition countries: - In some countries (e.g., Czech Republic, Hungary, Poland) effects were substantial primarily in equity markets. - In others (e.g., Estonia, Ukraine, Russia), pressures manifested in interest rates, exchange rates, and equity prices, often amplified by domestic imbalances. - In many transition countries, contagion effects were minor because domestic financial market development and integration into international financial markets are still at early stages. ### Ukraine and Russia: Exchange Rate and Market Pressures - In Ukraine: - Pressure on the exchange rate built up from the end of October 1997, particularly as nonresidents began to reduce their holdings of treasury bills. - Measures to defend the exchange rate included widening of the exchange rate band, increases in the refinance rate, an increase in the required reserve ratio, and a shortening of the maturity of treasury bills offered for sale; these were insufficient and the central bank had to intervene heavily in the foreign exchange market. - The exchange rate remained under pressure in early 1998, mainly reflecting problems financing the budget deficit. - Russia and Ukraine were more severely affected than central and eastern European countries because of: - Remaining weaknesses in structural and financial sectors, - A high dependence on short-term government borrowing, - In Russia, chronic revenue collection problems. ### Baltic Countries and Equity/Interest Rate Movements - Estonia: - Current account deficit in 1997 reached 13 percent of GDP. - The three-month interbank rate more than doubled during the last quarter of 1997. - The stock market slid more than 60 percent from its summer high by the middle of November 1997. - By the end of March 1998, interest rates had declined, although they remained above levels observed in the fall, while equity prices recovered modestly. - The Estonian stock market index rose more than 150 percent from the beginning of 1997 to the middle of October 1997. - In 1997 the current account deficit net of foreign direct investment amounted to around 9 percent of GDP. - Bulgaria and Kazakhstan: international financial turbulence created unfavorable conditions for the launch of stock exchanges in October and September 1997, respectively. ### Equity Markets in Central Europe; Capital Flows and Currency Effects - Czech Republic and Poland: - Equity markets fell around 20 and 25 percent, respectively, in November-December 1997, and as of late March 1998 were still below their October levels. - These countries received considerable short-term capital inflows in the first quarter of 1998; as a result their currencies appreciated in nominal terms against the U.S. dollar. - Hungary: - The stock market fell by about 35 percent during the initial weeks of the crisis in fall 1997, but subsequently recovered and consolidated earlier gains. - These countries avoided major interest rate and currency movements by: - Maintaining tight macroeconomic policies, - Maintaining exchange rate arrangements that allowed a significant degree of short-term flexibility (especially Poland). ### Access to International Bond and Credit Markets - In the early fall of 1997, there were more than 100 mandated international bond issues waiting to come to market from the region, with a total value of around $25 billion. - The cost of issuing international bonds after turmoil hit the markets in the early fall increased substantially, leading many borrowers in transition countries to postpone issues or switch to the syndicated loan market. ### Factors Limiting Major Currency Crises in Transition Countries - Several factors contributed to the containment of spillover effects and the avoidance of major currency crises: - Transition countries have accumulated relatively little foreign currency debt. - For many countries most foreign currency borrowing is centralized by the government. - Banking systems, capital markets, and financial systems as a whole are relatively small. - Nonetheless, differences in domestic economic conditions and policies explain variation in severity of spillovers; appropriate domestic macroeconomic and structural policies are important to limit vulnerability. ### Czech Republic: Crisis, Policy Response, and Remaining Challenges - Causes of the May 1997 crisis: - An unsustainable current account deficit resulting from large capital inflows and an associated real appreciation of the domestic currency. - Insufficiently tight fiscal policy and domestic demand pressures. - Wage growth in excess of productivity gains, reflecting weak corporate governance and uneven progress in privatization and structural reforms. - Policy response to the May 1997 crisis: - Switch to a floating exchange rate, which led to a 10 percent depreciation of the koruna. - Expenditure cuts of 2!/2percent of GDP aimed at restoring fiscal balance and reducing the current account deficit. - Further tightening of monetary policy in the months following the depreciation. - These steps restored stability to the koruna and contributed to a narrowing of the current account deficit to around 5 percent of GDP in the second half of 1997 from 7!/2 percent in the first half of the year. - Economic outcomes and indicators: - GDP growth slowed from 4 percent in 1996 to 1!/4percent in 1997 as investment contracted and consumption growth decelerated. - Unemployment rose to 5!/4 percent at the end of 1997. - Severe flooding in July 1997 caused damage equivalent to 3!/2–4 percent of GDP and accounted for about !/2of 1 percentage point of the decline in GDP growth in 1997. - Inflation has remained stuck at around 10 percent, although moderation in wage growth has for the most part offset the inflationary effects of the depreciation. - Spillovers from east Asia and heightened domestic political uncertainty affected the Czech foreign exchange market from late October 1997 to early January, leading to increased interest rates and official intervention in support of the koruna. - Remaining challenges and required policies: - Depreciations of Asian currencies will increase competition for Czech exporters. - Competitiveness gains from the 1997 depreciation may be eroded if wage increases continue to outpace productivity growth. - Slowing demand has reduced enterprise profitability, affecting investment and putting pressure on the quality of banks’ loan portfolios. - Limits exist on raising interest rates given the prevailing financial position of highly geared enterprises and the large share of nonperforming assets held by banks. - Policy priorities include: - Continued fiscal restraint, - Greater wage discipline, - Deepening structural reforms aimed at improving corporate governance and productivity growth, - Preparing the Czech Republic for eventual accession to the EU. - The authorities stand ready to increase interest rates to stabilize the currency and support adjustment, constrained by the financial fragility of enterprises and banks. *Source: Excerpts from "Global Repercussions of the Asian Crisis and Other Issues" (1998).* --- _Source: https://www.imf.org/-/media/websites/imf/imported-flagship-issues/external/pubs/ft/weo/weo0598/pdf/_0598ch2pdf.pdf_