Transcript of a Press Teleconference Call on the World Economic Outlook's Chapters II, III and IV, Raghuram Rajan, Economic Counsellor and Director of Research, Research Department, IMF

April 7, 2005

With Raghuram Rajan, Economic Counsellor and Director of Research,
David J. Robinson, Deputy Director of Research, and Timothy Callen, Chief, World Economic Outlook Studies Division, Research Department
International Monetary Fund
Washington, DC, April 7, 2005

MR. MURRAY: Good day. I'm William Murray, Deputy Chief of Media Relations. Thanks for joining us. Before we get into the World Economic Outlook analytic chapters, let me go over the ground rules briefly.

This is an on-the-record conference call. The contents of the conference call are embargoed, as are the analytic chapters, until 1900 GMT today, that's 3:00 p.m., Washington, D.C. time. So again, 1900 GMT.

I just want to also point out that after this conference call concludes on the Media Briefing Center we will also post under the same embargo a paper on oil markets and a Public Information Notice covering the discussion by the Executive Board of the oil markets during a seminar a few weeks ago. So you will have some additional paper after this conference call concludes on oil-related issues.

Let me introduce the three principals.

Raghu Rajan, Economic Counsellor and Director of the Research Department of the IMF, is with me today. David Robinson, Deputy Director of the Research Department, and Timothy Callen, the chief of the World Economic Outlook Studies Division, is also with us. As are all of the lead authors of the essays in the four chapters of the latest World Economic Outlook.

I encourage you to ask as many questions as possible. Take advantage of this conference call and this opportunity to speak with Mr. Rajan and the other principals. Raghu?

MR. RAJAN: Thank you very much. Good morning, everyone. Let me talk about the chapters in reverse order starting first with the chapter on oil markets. This is somewhat different from the stuff that you've been seeing coming out recently in that it's not just short-term, but medium-term and long-term projections for the oil market.

What we find is that the oil market will remain tight in coming years and we should expect to live with high and volatile oil prices which will continue to pose a risk to the global economy. The reasons for this are fairly straightforward. Spare production capacity which is currently very low will continue to remain low because projections of oil demand and supply that are presented in this chapter suggest they will continue to remain fairly in balance going forward which means that any supply disruptions or unexpected movements in demand can cause sharp changes in the price of oil.

Obviously, part of the reason for the tightness is we expect oil demand to continue to grow robustly. This will especially be so because of the improvement in standards of living in developing countries. For example, if you base China's experience on the experience of other countries at similar stages of growth, it is reaching the stage where transport demand will explode and more and more people will buy cars, and this will have a significant effect on demand for oil going forward, and you can make the same case for other developing countries.

Also another reason for tightness is that investment has been subdued in the past. Not only are there long lags in current investment coming on stream, but because of high expected volatility in prices and also regulatory impediments to investment, the investment response has not been overwhelming. So in short, it's going to be a rocky ride going forward with a wide band of uncertainty surrounding high expected prices.

That's a quick summary of Chapter 4. There are details which we'd be happy to answer questions on.

Chapter 3 asks if globalization makes the U.S.'s current account deficit more or less of a cause for concern. Essentially, it's taking a long-run view in asking if developments in the world economy ought to last a few decades will actually make large current account deficits more or less sustainable.

The central message is that while it has reduced the potential cost of adjustment, made it more easy to sustain current account deficits for a long period, it has also increased the risk that such current account deficits could unwind in an abrupt fashion.

Let me give you some details. First, the reason it has become more sustainable is that we have had an increase in trade, and we've also have an increase in growth in the areas of the world economy that used to be small before; for example, emerging Asia. Both of these essentially offer a wider canvas for the whole current account adjustment to take place over and, therefore, concentrate the costs of adjustment much less than used to be the case in the past. It spreads it over a wider canvas, so to speak, and that's a good thing.

Second, investors become more willing to hold foreign financial assets which allow large deficits to be financed more easily, giving more time for the real adjustments to take place and, therefore, make the real adjustments less disruptive by giving them time to adjust.

However, the problem with this is that it in a sense forces countries to do less over the long period. In particular, the essay refers to the fact that globalization has not necessarily caused countries to undertake fiscal adjustments. And so the extent that policies are less constrained, adjustments need not take place when they have to take place, they are financed more easily, which implies that the risks of abrupt adjustments also go up and that is why globalization is not an unmixed blessing, it is possible that it could unwind in a unhappy way which is why we at the IMF have been suggesting for some time that we take policy steps to reduce the extent of global imbalances that exist currently.

One special point I'd like to point out in the chapter is that it focuses on what is known as valuation effects. Essentially, the fact is that the U.S., for example, holds foreign assets denominated in foreign currencies, but the liabilities of the United States are denominated in U.S. dollars which means that if the dollar depreciates, the U.S.'s assets, its claims on other countries increase in value, but its liabilities do not.

So one positive effect of the dollar depreciation thus far, even though it has not had an effect on the trade balance as much as one might expect, it has had a significant effect on the U.S.'s net foreign asset position, increasing it or, in other words, reducing the extent to which the net foreign liability position would have deteriorated as a result of the large current account deficit.

In fact, if you think about it in that way, approximately three-quarters of the current account deficit over the last 2 years has been "financed" through an improvement in the net asset position as a result of valuation changes. This is a part of the chapter that you might want to look at because it has some interesting new implications.

Finally, the chapter on low-income countries looks at two interesting aspects. One is that the effects of volatility have been less focused on in the past, and they are very important. Fluctuations on output growth, that is what we mean by output volatility, are nearly three times as large in developing countries as they are in industrial countries. Apart from the fact that volatility is harmful in its own right, everyone would prefer a steady diet rather than swinging between feast and famine, it also seems to have a significant impact on growth.

Indeed, for countries in sub-Saharan Africa, if output volatility in those countries had been at the same level as in industrial countries in 2003, growth in these economies would have been about a third higher which is a significant impact on growth.

A key finding in this essay is that a large share of output volatility in developing countries is attributable to things that the country itself controls, country-specific events and, therefore, there is a lot of room for domestic policy to improve and reduce the volatility of these countries.

The kinds of policies that are advocated in this chapter, more stable fiscal policies don't increase expenditure in booms and cut it sharply in busts, creating financial systems and reforms in that diversifying the production base for these economies, that tend to be too focused on particular commodities, and also diversify their export base. All these could help reduce volatility and as a collateral effect enhance growth. In this year when we're looking at the effects of aid and growth in these very poor countries, it makes sense to also look at volatility.

The second essay deals with worker remittances, something which has been little studied in the past. This is a key source of foreign exchange for developing countries and the essay makes clear how key.

In 2003, remittance inflows from 90 developing countries analyzed in this essay amount to about $100 billion which is approximately 50 percent of total capital inflows. For a number of developing countries, remittances are the single largest source of foreign exchange, exceeding export revenues, official aid, FBI and other private capital inflows. As an example, Mexico receives about $15 million in remittances per year, and this is probably an underestimate because we don't measure remittances that well.

The United States still remains the main source of remittances, over $30 billion in 2003, and the outflows from the U.S. have almost quadrupled in the last 15 years. So this is a big and growing source of external financing for a number of countries.

What is most important about remittances which the essay highlights is their stability. They're sent in good times as well as bad times and so they play a role in cushioning adverse shocks such as wars and natural disasters. In fact, they lower the volatility of GDP growth which I just told you from the other essay was so harmful.

They also are very well targeted at the poorest people, so in that sense they contribute significantly to reducing poverty which again the essay demonstrates.

So given these benefits, we need to find ways to encourage remittances. For example, by reducing the cost of sending them as well as to impediments to their flow, and the essay makes clear what kinds of policies might make sense.

So that is a quick roundup of what we've done in this World Economic Outlook, and we would be very happy to answer questions on this.

MR. MURRAY: Thanks very much, Raghu. Please weigh in with any question you may have.

QUESTION: Good morning. I have a question about the oil market chapter. There is some discussion about the transparency of the market and the way countries report their reserves. I was wondering if this is something the IMF is thinking about doing some work on or maybe making this part of what you do in collecting this data.

MR. RAJAN: It's still premature for us to go into collecting the data, but we have certainly been in conversations with the people who collect this data such as the JODI initiative, we've been in contact with the International Energy Agency, and a number of people who are involved in data collection and dissemination with the idea of trying to see what we can do to make the process more timely and more informative.

So we are certainly very much involved in this process. Whether we eventually participate in data collection is yet to be determined.

MR. ROBINSON: Just to add a little bit to what Raghu said, there is a box on data quality in the oil market in the chapter, Box 4.2, and if you look at the last paragraph of that you'll see a discussion of some of the things that we think can be done to help improve transparency. As Raghu says, the role of the IMF is something that we're still thinking of areas in which we might be able to help, things like technical assistance, statistical legislation and organization, for example. And there are some others like fund's special dissemination standard and so on.

An underlying problem which is not something that perhaps we can directly help with but is important is that many statistical agencies don't in fact have enough human resources to put together this data, and that's one of those boring but important things that need to be dealt in order to improve the situation.

QUESTION: You gave an estimate for oil prices in real terms. I was wondering if you also have a figure for a nominal figure, what your assumptions on inflations are. Also you will have seen a recent report by Goldman Sachs mentioning the price of oil going possibly to $100 a barrel. Do you consider that outlandish or something that comes into a reasonable range?

MR. RAJAN: First, let me start with the common facts. Clearly, that is a short to medium projection and ours extends over a much longer period.

To the extent that there is some kind of a supply disruption, $100 a barrel does not seem outlandish. We in the essay, in the chapter itself, consider the effects of an $80-a-barrel spike. So it's not to say that it's outlandish. Is it the most likely scenario? I think not necessarily. It depends on how the market evolves.

The point that we want to make is that the market is tight, so large movements either in demand or in supply can have significant effects on price. Remember that even with the spike of the order of $80 to $100 a barrel, we are barely approaching the levels that we approached in 1979.

In terms of the first part of your question which is on oil prices—

MR. ROBINSON: I think on the underlying assumptions in the essay, I can tell you it assumes a global growth average of about 3-1/2 percent over the period. I don't actually have—unless one of my colleagues has at hand—the underlying inflation assumption, and I think that's something that we could perhaps provide you separately. I've just been told that it's 2 percent every year. So hopefully that will answer your question. Thank you.

QUESTION: You are now aware that there is an energy bill being discussed in the U.S. Senate and it is of course a long-term project applying methods to reduce the consumption of foreign oil in the United States which is the number-one oil consumer. Do you think if this is approved, passed and implemented, will it have any effects in the long-term?

MR. RAJAN: I have to say that what I know about is the last version of the energy bill which I thought focused a little more on incentives for production and less for incentives on conservation.

I think it would be important to also focus on incentives for conservation going forward which implies some consideration of whether the taxation regime for oil should be changed going forward.

I would think that a two-pronged approach would have a better chance of success in reducing dependence on oil than a single-handed approach.

QUESTION: I have a couple of questions. The first one is what is your recommendation on energy conservation from emerging countries around if you are thinking about cutting subsidies, increasing taxation of energy, what kind of measures emerging countries could take.

The second question is on refining. Basically you just say nothing on the role of refining in solving the energy problem. I was wondering if you see any problem with [inaudible] refining capacity.

Also on the question on the nominal prices, I just made the calculation and I want to be sure. With inflation of 2 percent yearly, I just assume a nominal translation of $34 in 2010 is going to be about $40, and that $56 in 2030 is going to translate about $90. But I want to be sure if you share these calculations.

MR. ROBINSON: Let me say something on each of those three items and then my colleague Martin Sommer will say something on the nominal price issue.

In terms of recommendations to emerging markets, I think that one important thing that you mentioned and that I just want to highlight is the need to pass through oil price increases to domestic prices. We're looking at a situation where we think that the shock that we've seen to prices is a permanent shock. It's going to continue at least according to futures markets and, correspondingly, countries need to adjust to that, and if you don't adjust to it, if you don't allow the oil price to pass through, you simply tend to boost demand, worsening the problem, and at the same time you end up with something of a fiscal problem as well. So I think that that is one key issue to look at.

In terms of the refining issue, I think you're right, that's an important issue. It's not one that we focused on very directly in this particular essay. But clearly the constraints on refining capacity as Mr. Greenspan said the other, for example, are important, and that's one of the things I think that governments need to look at to try and reduce volatility in the oil market looking forward.

On the basic policy challenges is to manage volatility and what we know is going to be a volatile environment, and that includes getting rid of bottlenecks and things like that in the refining industry.

Let me now ask Martin if he wants to comment on the nominal

prices issue.

MR. SUMMER: Good morning, I am Martin Summer. As David has mentioned, we assumed for the purposes of the projection that the average annual inflation would be 2 percent. In terms of the nominal prices for 2010, it would mean that our real price can be interpreted as a range of $45 to $64. So again this would be the equilibrium on nominal price of oil for 2010.

QUESTION: I have actually two questions. One is if you can just run over the oil prices again. What are you seeing for 2010 and then what are you seeing for 2030 in terms of real and nominal?

When we're talking about living standards being one of the factors feeding robust demand for oil in the years ago, if you could just talk a little bit more about that and what countries are we talking about, what do we mean by improved living standards.

MR. RAJAN: Let me start with the improving living standards and then hand over to the question on prices.

What we see in a number of emerging markets is that they're reaching the level of GDP where transport demand takes off. You have to go onto the streets of India to see how many cars and motorcycles are on the streets, but the same is true of China and a number of other emerging markets.

What we see is that around $2,500 per capita GDP people start moving to start buying automobiles, and this demand starts taking off in a tremendous way. Our sense is transport demand, the growth in transport demand, will account for a very, very big chunk of the growth in oil demand going forward and it is going to come from these developing countries and emerging markets where people finally have the purchasing power to actually buy cars for themselves. So this is where we think the improvement of living standards is.

It's not so much heating oil for the houses and so on, but really the fact that people need to move about and they're going to move about in a big way going forward in these countries which is going to account for a big chunk of the increase in demand.

We've taken into account in the essay the fact that you're going to have more improved cars, better technologies and so on. Yet despite the sheer number of people who will start moving about is going to account for a big chunk of the increase in oil demand.

On oil prices, let me turn it over to David.

MR. ROBINSON: I think what we should do on the oil prices is that we will put together a little table showing what the real and nominal are because I don't have the figures on the nominal prices through 2030 at hand, and maybe Bill can make sure that this is promulgated properly.

Essentially the projections show that in real terms the equilibrium price would end up between $39 and $56 for 2030, and that's the range where we are looking.


MR. ROBINSON: We don't really have a projection of the equilibrium price for 2010 because this is a long-term process, but it's just a matter of multiplying those numbers by 2 percent accumulated up for 30 years, and we'll provide them to you.

MR. MURRAY: Why don't we do that? What I'll do is if you want to follow-up on this number, drop me an Email at and I'll make sure that we get the appropriate data to you.

QUESTION: So by 2030 world oil prices adjusted for inflation would range anywhere from $39 a barrel to $56?


QUESTION: That's what I saw, but I just wanted to check. Thank you.

QUESTION: Just one more question on oil prices. For 2005 can you tell us what you are forecasting the average oil price to be?

MR. ROBINSON: I can tell you what futures markets as of yesterday forecast the oil price to be, and we tend to follow the futures markets fairly closely because experience has suggested that they are on the whole the best forward-looking forecast. They're not a very good one I'll say, and in fact, you will get next week an annex which looks at this in some more detail, but we based our forecasts on the futures markets.

As of yesterday, futures markets were projecting an average oil price of $52.23 for 2005. You have to remember that that is on the IMF oil price assumption which is the average of three types of crude. It is not comparable to the sort of headline that you normally see as west Texas crude.

MR. MURRAY: Dubai, WTI, and Brent.


QUESTION: But this is the figure I could compare to your September report where you forecast I think $37.25.

MR. ROBINSON: That's correct.

QUESTION: A question again about the oil price. If the upper end of your band for real prices is $56, it seems that that is not a whole lot higher than where we are now. Am I wrong to infer that you don't expect oil prices to restrain economic growth very much?

MR. ROBINSON: Let me try and answer that question. First, I think you have to compare it not with the price today, but where futures markets say the real oil price will be in the future. When we looked at this a couple of days ago, the figure was around $40 a barrel as of 2010 in real terms.

So I think that what has happened and what we're seeing is that as Raghu said, we're in a situation where there's a lot of volatility, prices have risen, and I guess that they're already at the bottom end of our long-term range.

MR. RAJAN: Put another way, the oil market is a commodity market and you expect in the long run supply responses to meet projections for demand. So I think the numbers that we put out are high given that it is that kind of market because you would expect that in the long run you would find both of them interacting together and the fact that we still come up with numbers in the long run which are so high suggests there are special factors working this market, the factors that the chapter references to.

QUESTION: [Inaudible] ...and what is the effect of a sharp devaluation of the dollar.

MR. RAJAN: The effect of a sharp devaluation of the dollar has more direct effects than indirect effects. The direct effects, of course, it tends to be disruptive for countries that, for example, tend to price their trade in dollars. It tends to be disruptive for people who hoard dollar assets. It tends to force them to start thinking about moving out of those assets, and so on.

Another effect, however, is what accompanies it. If in fact the dollar is expected to depreciate or is depreciating and you want investors to stay in the dollar because you need to finance the current account deficit, you have to do one of two things. One is increase interest rates so as to make the dollar more attractive where long rates have to go up to make dollar rates more attractive which is going to have an effect on output through the interest rate effect.

The other possibility is that expecting the dollar to keep depreciating, you may have an overshoot where the dollar has to depreciate much more than it would otherwise depreciate so that investors now can say it's down enough, now it's going to start going up and that gives us a reason to return to the dollar.

So both from the interest rate aspect as well as the dollar depreciation aspect you have a fairly large movement in the value of asset prices and effects on real activity, all of which can be disruptive.

So you could have, for example, on the disruption side some financial institutions coming under strain, some countries coming under some strain, and you could have real effects which would also subtract from global growth. So a whole bunch of effects which could be quite costly.

QUESTION: Do you see any of those happening?

MR. RAJAN: I think what we see is there is a risk it could happen. I wouldn't say it is a very high probability risk today, but that is assuming that countries undertake policies to narrow the imbalances in the medium term so that investors can feel confident there is an end game in sight.

If nothing happens, I think the risk actually starts increasing and one should start worrying about it. At this point, as I said, the risk is fairly small, but the cost of such a thing happening is so big that it makes sense to start paying attention to it.

QUESTION: I have a couple of questions, one about oil and one about remittances.

The first is, I don't quite understand when we were discussing this, given that demand is going to increase by about 60 percent I guess from now until 2030 why your forecasts aren't actually higher also given that you've said capacity is so tight right now.

Secondly, there was bit in the very beginning about the impact of higher oil prices on growth, and I know that you've made this point that if you adjust today's dollars, that the 1970s prices were actually much higher. But at the same time, the increase that we've had over the past 18 months has been almost double. So why can't we expect that to have a market impact on growth maybe in the next year or two since oil prices tend to have a lag effect?

MR. RAJAN: I'll start with the first point which is, yes, demand is increasing, but supply will also respond. Again, remember we're talking medium- to long-term forecasts, and even if you think the gestation period for oil investments is 5 years, that will be enough time for some investment to come on.

I think the point we're trying to make in the essay is it's not going to be enough to create the amount of excess capacity that we would need to reduce oil price volatility and to reduce the level of oil prices to what we've seen in the past.

So the point is not to say that supply will not respond, but it's not going to respond in such an enormous and overwhelming fashion as to completely overwhelm the effects of tight markets that we see now. So that is point number one.

As to the effects of oil prices, we are not saying that the higher oil prices will not have an effect on growth, and we have talked about how much of an effect it will have. What I will say is that the effect that our models have estimated recently seem lower than what they used to be in the past and this has to do with the fact that in developed countries there is a lot more credibility for monetary policy, there is a lot lower oil intensity, and the pass through of oil prices into general prices and then into inflation has remained relatively muted.

For a number of reasons we haven't had the enormous impact that one might have predicted in the past. But that said, it is not to say that it will have no impact.

Let me turn it over to David if he has anything to add on this.

MR. ROBINSON: I have very little to add what Raghu has said.

I think there's one other factor which also plays a role in explaining why oil prices had less of an impact and that's partly because the rise in oil prices is itself being generated by strong growth. So in a sense it's a response to higher growth and so, correspondingly clearly, the net impact on growth is less.

I think you said you had a question on remittances?

QUESTION: Yes. I wanted to know if there was a 2004 figure because the figures I think in the report were 2003. Do you have a figure for overall remittances in 2004?

MR. CALLEN: No, we don't have a figure yet. The latest one we have is in the essay for 2003.

QUESTION: I have a question on supply. You are forecasting a big surge in consumption and yet saying at the same time that non-OPEC countries are not going to increase their supply significantly. Nor even the OPEC countries are willing to do that given the big investments that are necessary. So how is the supply going to meet the demand?

MR. ROBINSON: Let me try and answer that question, and I think it's probably helpful if you look at Table 4.5 which sets out our projected oil demand non-OPEC supply and the core on OPEC.

I think if you look at the top line you see, yes, demand is increasing. Then as Raghu said, at the same time, supply is increasing. We do see some increase in non-OPEC supply and, indeed, higher prices can be expected to generate that.

Then of course the question is what happens in OPEC? One of the key conclusions from this projection I think that is as you look forward, the call on OPEC—by which we mean the amount that OPEC will be asked to produce to fill in the gap, so to speak—increases quite dramatically. Then the question is, will OPEC want to or indeed be able to fill that gap, and we have some discussion of that in the text.

Our basic conclusion is that while it's obviously very difficult to project exactly what OPEC is going to do, if we think of OPEC as acting as a sort of profit-maximizing entity, then it will want to increase production, at the same time it won't want to push prices down too much, and we find that the balance of those two things suggests that it will want to have around 41 percent, if I remember correctly, of the oil market.

That's what we've built into our projections looking forward, and if we assume that they increase production along those lines then that essentially is consistent with the $39 to $56 per barrel long-run equilibrium price that comes out of this analysis. But obviously one of the many uncertainties in these sums is how OPEC will react, particularly in the post-2010 period.

MR. MURRAY: Are there any additional questions?

Before we wrap up, let me just cover a couple of things. Raghu's opening remarks will be available. I will email them to you. I've received a few requests on the oil price forecast data which I'll certainly get back to you.

Again, the contents of this briefing are under embargo, as is the text, until 1900 GMT today. That's 3:00 p.m. Washington time. If you have any follow-up questions, certainly drop me a note and I'll try to get you an answer before the embargo expires.

Again, shortly after this briefing concludes we'll be posting some additional paper on the Media Briefing Center regarding oil issues.

Thanks for joining us today, and I look forward to seeing you in Washington next week for the World Economic Outlook Chapter I press conference on April 13th.


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