Transcript of a Press Conference on the Analytical Chapters 3 and 4 of the World Economic Outlook

April 7, 2011

Washington, D.C.
Thursday, April 7, 2011

MS LOTZE: Good morning, and welcome to this press conference on the Analytical Chapters of the World Economic Outlook, Chapter 3 on oil and Chapter 4 on capital flows.

Let me introduce our speakers who are all from the Research Department. To my immediate right is Jörg Decressin, Assistant Director of the department. To his right is Thomas Helbling, Team Leader of the chapter on oil scarcity and Adviser in the department. All the way at the end is Rupa Duttagupta, Team Leader of the chapter on capital flows and Deputy Chief of the World Economic Studies Division. Jörg will start out with some overview remarks and then the two team leaders will have opening remarks on their chapters. Let me turn it over to Jörg, please.

MR. DECRESSIN: Ladies and gentlemen, welcome to the press conference for Chapters 3 and 4 of the World Economic Outlook. Chapters 1 and 2 which discuss the global outlook and the global policy challenges will be presented to you on Monday.

Chapter 3 discusses the medium-term oil market outlook and analyzes the implications of unexpected changes in the availability of oil on the global economy. In recent weeks the focus has shifted to near-term oil supply risk, but medium-term oil issues remain important for global economic prospects. Thomas Helbling, who is sitting to my right, will provide a short synopsis of this chapter. Afterwards we'll discuss Chapter 4 which presents an analysis of international capital flows.

As you know, following the collapse during the global crisis, capital flows have recovered in many economies especially in emerging markets. Against this backdrop, Chapter 4 analyzes international capital flows over the past 30 years to understand their predictability and how they are likely to respond to a changing global economic environment. Rupa Duttagupta will provide a summary of this chapter after Thomas. Thomas, the floor is yours.

MR. HELBLING: Thank you, Jörg. Good morning. Chapter 3 reconsiders oil scarcity and its possible impact on the global economy. The motivation of the chapter is of course the persistent increase in oil prices observed over the past 10 years. This trend increase suggests that the global oil market has entered a period of increased scarcity as it has on earlier occasions. We argue that the two main defining elements of the current period will likely remain present over the medium-term. First, as we expect strong growth in major, emerging and developing economies to continue, oil demand in these economies will be catching up with demand of advanced economies. Second, after stagnating in recent years, oil supply will not return to the growth trends of the 1980s and 1990s.

We also note that scarcity is reinforced by the low responsiveness of both oil demand and supply to price changes especially in the short- and medium-term. Current high oil prices already reflect a downshift in oil supply trends. However, there is still considerable uncertainty about future trends. For example, it might be more difficult than expected to manage decline rates in maturing fields. Against such oil-scarcity risks, we analyze various scenarios of unexpected changes in oil scarcity and their impact on the global economy from moderate to more severe.

The focus on persistent or medium-term adverse oil supply shocks differs from some current concerns when center on short-term disruptions to oil supply.

Our first main message is that it would be premature to conclude that oil scarcity will inevitably be a strong constraint on medium-term global growth. Our simulation analysis shows that if unexpected increases in oil scarcity are gradual and moderate, the cost in terms of global economic growth could be small. Specifically, an unexpected downshift in people supply trend growth of 1 percentage point would slow annual global growth by less than a quarter percent over the medium- and long-term. Improving possibilities for substituting oil with other sources of energy would also moderate the costs in terms of losses in economic growth.

Nevertheless, and that is our second message, one should not underestimate the risks either. Scarcity and its growth effects could be more significant. It is also uncertain whether the world economy could adjust to increased scarcity as smoothly as we assume in our analysis.

The third main message is that adverse medium-term oil supply shocks would imply a surge in global capital flows from oil exporters to importers and the widening of global current-account imbalances. This suggests that the need to reduce the risk associated with growing current-account imbalances and large capital flows will be present.

There are two main policy implications. First, policymakers should review whether current policy frameworks facilitate the adjustment to changes in oil scarcity. This would include reviewing structural policies to see whether a stronger role for price signals will be desirable. Second, consideration should be given to policies aimed at lowering the risk of oil scarcity including through the development of sustainable alternative sources of energy. Thank you.

MS. DUTTAGUPTA: Thank you. This paper on capital flows looks at the experience with international capital flows for the last 30 years. The main focus is emerging-market economies, but we also look at advanced economies and developing economies as comparators.

As Jörg mentioned in his introductory remarks, the motivation is the sharp recovery in capital flows to a number of economies after the global crisis, especially in emerging-market economies. On the one hand, this is good news because for example capital flows can provide needed financing to boost domestic demand. But at the same time, policymakers have also been concerned about whether flows are occurring at a pace very fast or are driven by factors that are outside the control of domestic policymakers, for example, the ultra-low global interest rates. Consequently, one concern is how net flows will be affected when global financing conditions start to reverse.

The chapter tries to shed light on this debate by asking four key questions. The first one is sort of a scene setter, it looks at the recent recovery and compares it with the previous trends in capital flows’ previous surges and asks how the recent recovery is different in terms of the level, pace, and composition of flows. Next it looks at the nature of flows. Are they variable? Are they volatile? These are the kinds of questions it tries to answer. Third, it then looks at historical data and asks whether history can provide guidance as to how net flows to emerging markets behaved in periods similar to today's where global interest rates were very low or when investor risk appetite was increasing. A final section then looks at how a country’s direct U.S. financial exposure determines to what extent it is sensitive to changes in U.S. interest rates and how this sensitivity differs from countries that do not have such U.S. direct financial exposure.

In terms of answers, the recent recovery is remarkable in the sense that capital flows recovered in an extraordinarily short span of time. However, the levels of flows are very much in line with averages experienced in previous surges and are definitely below historical peaks. Also, the composition of net flows is slightly different. Our data ends at the third quarter of 2010 and until then we see that most of the recent recovery was led by portfolio debt flows followed by bank and other private flows. If this trend continues, it would be somewhat of a departure from what we have seen in the 1990s and the 2000s when there is a clear gradual fall in the share of these—what we call debt-creating flows.

Next, moving on to the nature of flows, we find that volatility of net flows have increased in emerging as well as advanced economies and net flows exhibit low persistence—that is a high level of flows in one year does not predict a high level the next year. In terms of the composition, debt-creating flows are somewhat more volatile and less persistent than other types of flow.

Then looking at history we find that indeed net flows to emerging-market economies temporarily rose when global financing conditions were easy—that is periods when global interest rates were generally low and investor risk appetite was generally high. The dynamics in flows was generally driven by bank and other private flows.

A final set of findings relate to the sensitivity of countries to changes in global monetary conditions. In particular, countries with U.S. direct financial exposure seem to be more sensitive to changes in U.S. interest rate policies compared to countries that do not have such U.S. direct financial exposure. This negative additional effect of a U.S. rate hike on a financially exposed economy is generally deeper when the U.S. rate increase is unanticipated and when it happens in an environment that is characterized by easy global conditions. However, for financially exposed economies with strong growth performance or deep domestic financial markets, the sensitivity to changes in U.S. monetary policy is much less.

To wrap it up, the chapter concludes that variable capital flows is a fact or life, not just with emerging markets but also for advanced economies. The key therefore is to make sure that this variability does not translate into macroeconomic volatility. Countries therefore need to adopt the right mix of macroeconomic and prudential policies to take advantage of capital flows and cope better with their restive nature. Thank you.

QUESTIONER: I have a question on the oil study. It's mainly to double-check numbers because sometimes it says percentage and I want to make sure it's percentage points and not percentage, and in particular for your main scenario if production calls by 1 percentage point under the average, how much it would affect GDP. It would affect it by a quarter point of GDP growth as I assume not as of the total right?


QUESTIONER: I wanted to make sure. Is it 1 percentage point decrease per year? I saw in the hypothesis that after 2025 it comes back to its original production and if you could explain the hypothesis.

QUESTIONER: The benchmark scenario is a reduction in trend growth of oil supply. In the baseline or in what we call the control, the trend growth rate is 1.8 percent. That's annual growth in the supply. In the benchmark in the alternative scenario we now analyzed that the annual growth rate is 0.8 percent.

QUESTIONER: During 20 years?

MR. HELBLING: Yes. Twenty-five years.

QUESTIONER: Twenty-five. The decrease would be 25 basis points per year on GDP annual growth?

MR. HELBLING: Yes, a little bit less than 25 basis points in annual GDP growth.

QUESTIONER: Why do you expect it to go back up to its annual trend after 25 years?

MR. HELBLING: We wanted to have a persistent medium-term shock. I think the idea is that in the very long-term it is more difficult to predict oil supply. In the short-term you have all kinds of rigidities, changes in the supply process and bringing in alternative sources of energy takes a long time. So it is appropriate to focus on oil only. We believe that over a 25- or 30-year horizon, it would be much more difficult to do. Our analysis then would have to widen up to energy supply more generally and also energy demand more generally because oil demand and oil supply are just part of a bigger picture.

QUESTIONER: When you mentioned price in the report, it's over 20 years so I'm not sure when I read the story whether I should say 20 or 25. What's the most relevant in light of the report?

MR. HELBLING: Twenty years.

QUESTIONER: You mentioned in the oil chapter about China's demand of the overall world oil supply rising from 6 percent to 11 percent in 2010. Do you have any projections for where China will be 10 years from now or 5 years from now in terms of total oil demand? Also I'm trying to understand where the OECD countries will be over the next several years in terms of their oil demand and if I understand it right, oil demand in the OECD countries has actually been on the decline.

MR. HELBLING: Our chapter is about sensitivity analysis so we don't make specific predictions about the levels. What you can see if current trends will continue, clearly the share of China would increase and the share of OECD economies would decline further. In the analysis we had to make a number of simplifying assumptions including that in the end countries will grow at similar rates which is just a technical assumption for the simulation analysis.

QUESTIONER: My question is about oil. I want to ask about the impact of the Japanese earthquake and the Japanese nuclear power plant accident on oil prices and oil demand. The Japanese government and the power company have to rely on oil and natural gas to produce electricity and some countries have reviewed their plans to build nuclear plants. What will be the effect on oil prices and oil markets in the medium-term?

MR. HELBLING: In the chapter we look at at the medium term, that is, broad supply trends. So that the Japanese earthquake does not figure in Chapter 3. It is discussed in Chapter 1, which will be presented next week.

But in the shorter term, clearly the replacement of nuclear power with thermal power will affect oil and gas markets. Some very rough calculations suggest though that the impact should be relatively minor. A bigger issue that I think shows again that our chapter has a medium-term focus, where of course the role of nuclear power in total energy supply and energy demand over a very longer horizon will be an important factor and regarding the impact of the events in Japan, it remains to be seen what it means for the future of nuclear power.

QUESTIONER: I have a question about oil scarcity associated with imbalances. The wells will be transferred from import countries to oil exporting countries. After that capital flow will increase from exporting countries to other emerging countries and you mean imbalances will increase? I want to ask what is that mechanism to increasing—

MR. HELBLING: The basic mechanism is that when oil is more expensive you pay more for your oil, that is a wealth transfer to the oil exporters. Oil exporters respond to increases in wealth and initially there are two main responses. On the one hand, there is an increase in savings that feed back into the global economy in the form of lower real interest rates. Second, with higher wealth they will spend more and part of that spending will not go domestic production, but it will result in higher imports and it will have offsetting effects on the rest of the world. In other words, higher expenditures will partly fall on goods and services produced elsewhere. These are the two main channels.

QUESTIONER: You mean in the context of the oil chapter, imbalance means between people exporting countries and oil importing countries and also emerging and advanced countries?

MR. HELBLING: The change in imbalances is mainly between oil importers and oil exporters to begin with in the sense that the offsetting effects that we have in our global model will differ a bit by region. Because part of how the other regions will be affected by the feeding-back of the increase in wealth to oil exporters will depend on the strength of their trade linkages so that countries that are more closely linked to oil exporters will benefit more from increased domestic demand from oil exporters. Secondly, countries with higher investment ratios will benefit more from the lowering of global real interest rates because of higher savings in oil exporters.

MS. LOTZE: One more question on oil online and then I have two questions on capital flows. On oil:

“What are the challenges and opportunities for new oil producers like Brazil?”

MR. HELBLING: For the new oil producers like Brazil, I think the opportunities are enormous. The challenge for them is that the developing of some oil reserves are at the technological frontier as they're deep-sea so that they involve high costs and they involve new technologies. I think there are still technological challenges in the extraction of such deep-water oil. But overall, the effect is clear. Brazil will benefit from oil scarcity as do other oil exporters.

MS. LOTZE: Should we move to capital flows? I have two questions here online. The first is:

“Is there any relation between the increase of capital inflows and soaring inflation in emerging countries like China and Vietnam? If any, what should the authorities do?”

MS. DUTTAGUPTA: I think I'm going to defer this question for next week when we discuss macroeconomic policies in specific countries—that is the outlook and what countries should do.

QUESTIONER: I was curious about the rebalancing that's going to take place in the oil story, that oil importers like the Eurozone or the U.S. would not be more affected since you mentioned that it's goods exporters like Japan and Asia that would benefit from demand. How could they not be more affected than this?

MR. HELBLING: They will be affected in the sense that their oil trade balance will worsen. And in the end if there is the initial effect that changes in wealth will lead to changes in spending and savings, but in the longer term the effects—if you look at the charts—are very clear in the sense that oil exporters have higher current-account surpluses and oil importers depending on their initial position have worse current-account positions.

QUESTIONER: So you say that the effect is limited at 0.15 to 0.2?

MR. HELBLING: No, that's on growth.

QUESTIONER: Right. That's what I mean, the impact at the end of the day.

MR. HELBLING: That's the average impact and the average impact in the longer-term doesn't differ that much by country. In fact, there the key element is the oil factor share or the importance of oil in consumption and production and there the differences across regions in the global economy are not that big. In the chapter, the shares vary between 2 to 5 percent. What is different though is the initial growth response which depends in part on how much regions benefit from lower global real interest rates and trade linkages with oil exporters and there are more significant differences both in the importance or the role of investment in these regions and in the strength of trade linkages with oil exporters.

MS. LOTZE: A very quick question on oil:

“Does the oil scarcity outlook include unconventional petroleum, oil sands, tars and shale gas?”

MR. HELBLING: Yes, in the sense that our measure of petroleum products includes products from unconventional sources, and if you look at the model simulations, our set-up sort of mimics a world in which a greater share of unconventional oil resources can be accessed at a higher price and that's still the picture, that unconventional oil resources still involve much higher extraction costs.

MS. LOTZE: Thank you. One more question online on capital flows:

“How sensitive is Brazil to changes in U.S. monetary policy? Does Brazil use the right mix of macro policies?”

MS. DUTTAGUPTA: What we find is that countries with greater U.S. direct financial exposure are more sensitive to changes in U.S. interest rates. Brazil, in terms of U.S. direct exposure is in the top quartile of the sample so that it would be more sensitive than a country that is at the bottom quartile, for example Morocco which has relatively low U.S. direct financial exposure.

At the same time it's important to remember that any country that has U.S. direct financial exposure is more sensitive than a country that does not. Therefore, all emerging market and advanced economies are subject to this variability. At the end of the day, the main thing to make sure of is that this variability in capital flows does not lead to excessive macroeconomic volatility, and there the entire gamut of policies that are appropriate—including macroeconomic and prudential policies—are useful. In terms of Brazilian-specific policies, again you'll have to wait for WEO's Chapters 1 and 2 next week.

QUESTIONER: I'm having trouble understanding what your definition of oil scarcity is exactly. Do oil prices have to rise a certain percentage for the resource to be deemed scarce? What exactly do you mean by scarcity?

MR. HELBLING: Scarcity in the way we define it, or let me put it this way, oil prices can be high for a number of reasons, but traditionally when you talk about scarcity, you look at the long-term availability of resources and there the key measure is in our chapter the trend component in prices. So the hypothesis is if a resource is scarce, it means it involves higher opportunity costs of bringing the resource to the market that can involve a number of reasons, in particular extraction costs. If the resource is scarce typically it means that you have to tap higher-cost deposits or reserves.

That's one. And if the resource is also scarce, it involves more tradeoffs between using it now or in the future so that user cost of oil increases, in a sense, if you consume it today you give up an opportunity of consuming it tomorrow. In that sense our measure is the trend component in oil prices.

MS. LOTZE: Are there any other questions? We have no more questions online. If there are no more questions in the room then we'll conclude this press conference. Let me remind you of the launch of Chapters 1 and 2 next Monday, April 11 at 10 o'clock here in at the IMF. Also for broadcasters the reminder that news clips of this event and from the chapters are on News Market and Unifeed for downloading. Thank you very much for coming and participating.

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