Speech

By Anne O Krueger, First Deputy Managing Director
International Monetary Fund
Sharm El-Sheikh, Egypt
May 21, 2006

As Prepared for Delivery

Thank you Mr. Chairman. Let me first offer my congratulations for the successful organization of this important meeting. I am very pleased to be here and to be able to outline the IMF's thinking on the problem of global imbalances and to look at the opportunity for countries in the MENA region to play an important role in resolving this problem.

The global outlook

Let me start by putting the problem in context. The current global outlook is basically bright. World real GDP grew by a very good 4.8 percent last year; and the Fund is currently expecting it to continue at about this pace both this year and next, with every region sharing in this expansion. Growth in the MENA region as a whole has been more rapid than the global average, with regional GDP expanding at an average of 5.8 percent a year since 2002.

And this global expansion has thus far taken place against a backdrop of low, or falling, inflation, in most parts of the world. In spite of the sharp rise in oil prices, inflationary pressures have, in general, been contained so far.

That said, it is clear that there are downside risks to our central expectations of continuing global growth. Of foremost concern are the large global imbalances in the world economy: low consumption and rising surpluses in Asia; the large and rising US current account deficit; sluggish growth in Europe; and, more recently, rising surpluses in the main oil-exporting countries. A disorderly unwinding of these imbalances is low risk but cannot be ruled out. Action by one country or group of countries alone could prove disruptive. Coordinated action could benefit all, making individual adjustments smoother.

Of course, there are other downside risks to the growth forecasts. Rising and increasingly volatile oil prices; accelerating inflation; tightening financial market conditions around the world; an Avian flu pandemic: any, or all, of these factors could weaken global growth prospects. This afternoon, though, I want to focus on the issue of global imbalances.

The problem of global imbalances

Thus far global imbalances have not hampered global growth performance: the US has been an engine of world growth and has been able to finance its current account deficit very easily. But the imbalances persist and at its meeting in April the International Monetary and Financial Committee (IMFC) reiterated the agreed strategy for reducing them. Key elements of the strategy include raising national saving in the United States—with measures to reduce the budget deficit and spur private saving; implementing structural reforms to increase flexibility and growth in the Euro area and several other countries; further structural reforms, including fiscal consolidation, in Japan; increasing consumption and increased exchange rate flexibility in a number of surplus countries in emerging Asia; and promoting the efficient absorption of higher oil revenues in oil-exporting countries with strong macroeconomic policies.

Coordinated action to reduce global imbalances will greatly increase the gains to be had. Any one country or region taking action alone will benefit less than if all act together: and in some cases unilateral action could have negative effects on other countries. A multilateral solution to the problem is vital, as emphasized in the IMFC's April communiqué. It was agreed that, as part of the process of strengthening the Fund's multilateral surveillance work, the Fund should seek ways for effective implementation of a multilateral solution to the imbalances problem.

Prospects for the MENA region

I noted that the outlook for the MENA region remains generally very favorable. There are significant differences in growth performance and prospects in many countries in the region, of course. But the region as a whole should continue to grow more rapidly than the world economy. Indeed, the current conjuncture brings the chance of a significantly improved economic performance over the medium and longer term, if the oil exporters take full advantage of their surpluses.

Although global imbalances have persisted for some time, surpluses had built up mainly in East Asia; the large and rapidly growing surpluses in the main oil-exporting countries of the MENA region are a much more recent phenomenon. They reflect the sharp rise in oil prices and rising demand for energy during a period of global expansion.

The surpluses are very large: between 2002 and 2005 additional oil receipts of the MENA oil exporters were equivalent to 39 percent of GDP. The current account surplus of these countries rose to about $210 billion last year, equal to more than a quarter of the US current account deficit.

Thus far, the oil exporting countries have approached these rapidly-rising surpluses with considerable caution. In the 1970s and 1980s, large surpluses were spent rapidly: and when oil prices fell, governments were obliged to undertake difficult and painful fiscal adjustment. This experience has made many policymakers cautious. Many countries have stabilization funds, intended to save much of surpluses now accruing.

Caution in these circumstances is appropriate. The main concerns that policymakers have in assessing the scope for spending large surpluses are, first, the need to ensure that inflationary pressures are contained; second, the need to ensure that what spending is undertaken is of high quality; and, third, the need to avoid long-term commitments that might be difficult to meet should projected surpluses fall or fail to materialize.

Containing inflation is clearly vital. The policy community as a whole learned much from the experience with policy responses to the earlier oil price shocks and with the unpalatable consequences of rapid inflation in the 1980s and 1990s. One of the striking features of the past few years has been the sharp decline in inflation rates worldwide. This has contributed greatly to the current global expansion.

The good news this time around is that inflationary pressures have remained modest in spite of the recent rise in oil prices. By and large, governments have adopted monetary policy responses that ensure inflation remains relatively subdued. There should, therefore, be scope for reducing surpluses without fuelling inflationary pressures.

Spending sensibly is also important. The experience of the 1970s and 1980s underlined the importance of well-targeted spending with high social or private rates of return.

It is also wise to avoid commitments that will prove difficult to sustain over the long term. But the extent of the rise in oil prices we have seen in the recent past suggests that here, too, there can be a significant increase in appropriate expenditures without taking undue risks with fiscal prudence. Calculations made by the Fund staff suggest that if even one third of the oil price shock is temporary in nature, permanent incomes for MENA oil exporters would increase by about $750 billion in net present value terms.

The oil exporters' large surpluses—and their increase in wealth—provide a rare opportunity to tackle some long-standing domestic problems, and at the same time—as an important by-product—make a major contribution to the reduction of global imbalances. The key economic priority for many MENA oil exporters is to upgrade infrastructure and create jobs at home. The large surpluses now accumulating provide the chance to press ahead with this objective.

An appropriate policy response

Modest inflationary pressures, taken together with the prospect of a significantly higher long-term oil-export related incomes, imply scope for a significant policy adjustment in the oil exporting countries in the MENA region.

A policy decision to use a greater proportion of the revenues for current spending is only the first step. It is important to ensure that extra spending is focused on projects that have high social or private rates of return. The aim should be to target spending in a way that helps the private sector create jobs, boosts long-term growth potential and increases the flexibility of economies. Spending on high-quality infrastructure, education and social reform would all contribute significantly to these objectives and help ensure that the benefits of the higher oil revenues endure.

And by raising domestic demand and increasing imports the additional spending will also contribute directly to helping resolve global imbalances. This in turn should help mitigate the downside risks that global imbalances pose for global growth prospects. And reducing global imbalances strengthens the growth prospects for the world economy as a whole and for individual regions, including the MENA region.

Making economies more flexible is particularly important in order for the main oil-exporting countries to maximize the gains from the large increases in oil revenues they are now experiencing. This includes exchange rate flexibility. Although this is less of an issue for economies that are highly open to trade and labor flows, such as the GCC countries, experience has shown that flexible exchange rate regimes enable countries to respond to shocks and changes in the domestic or external environment with less risk of a negative impact on growth. The large foreign exchange flows that increased revenues represent can fuel rapid money and credit growth, and make inflation more difficult to avoid unless exchange rate regimes are flexible.

Oil-importers, too, need flexibility both in their exchange rate regimes and elsewhere in the economy if they are to minimize the impact of oil price rises on their economies.

The impact of higher oil revenues on regional financial markets further strengthens the case for continuing reforms in the financial sector. Experience in the 1990s reminded us of the importance of a strong, well-regulated financial system. As economies grow, they need increasing breadth and depth in their financial markets if credit allocation is properly to reflect risks and returns and so ensure the most effective use of resources.

Conclusion

The world economy is at a critical juncture. The period of expansion we have experienced over the past several years has been remarkable because it has been evident in every region; because of its pace; and because of its length. In the short-term there is good reason to expect continuing buoyancy.

But there are downside risks: and these could increase if global imbalances are not resolved, and resolved on a multilateral basis.

This is also an important juncture for the MENA countries, especially the oil exporters. The large increase in oil revenues offers the chance to tackle important domestic problems—above all the creation of new jobs to meet the needs of growing populations. Spending on high-quality infrastructure, human development, and social reform will bring long-term benefits for these economies by developing the private sector and raising their growth potential. Accompanied by the appropriate monetary and fiscal policies, increases in spending need not undermine inflationary control and increased exchange rate flexibility can also enable economies more readily adjust to shocks.

Pushing ahead with financial sector reforms will also strengthen the capacity of the oil exporters to adjust to higher revenues.

And there is an important, and welcome, international dimension to policies aimed at using higher oil revenues to tackle domestic economic challenges. Increasing demand in the oil exporting countries in the MENA region will help reduce global imbalances and so could make a direct and significant contribution to strengthening the growth prospects of the global economy.

This is, in other words, a situation where, given the appropriate policy response, everyone can gain. As such it is an opportunity we should seize.

Thank you.