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Press Conference of Michael Mussa, Economic Counsellor and Director, Research Department
December 19, 1997
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The Interim Assessment of the World Economic Outlook was undertaken in November and December of this year. The focus is primarily on Asian countries affected by recent turmoil. The report, of course, is the product of a comprehensive interdepartmental review of world economic developments that is based on information that the IMF staff has gathered in consultations and discussions with member countries. The analysis in the World Economic Outlook is coordinated by the Research Department under the direction of Mr. Mussa.
Although the World Economic Outlook document has been discussed by the IMF's Executive Board, I would note that the projections and policy considerations contained in the document are those of the IMF staff and should not be attributed to executive directors or to their national authorities. With that, I would like to invite Mr. Mussa and then Mr. Larsen to make some opening remarks before we turn to your questions. Mr. Mussa.
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In comparison with the projections published in the October WEO, which were based on information available through early September, the Interim WEO now forecasts slower growth for the world economy with the main effect seen in Asia. As you may see by turning to Table 3 on page 52 of the Interim WEO, on a year over year basis for 1997, the downward revision for world growth is only a tenth of a percent. A slightly higher projected growth in the larger economies of Europe counterbalances significant further write-downs of growth forecast for some much smaller emerging market economies in Asia and a couple of others around the world.
For 1998, the downward revision to projected world growth is a significant eight tenths of one percent with substantial further write-downs of the forecast for a number of Asian emerging market economies and a significant one percent write-down in the forecast for Japan to a projected growth rate of just 1.1 percent for 1998.
The crisis in emerging market Asia and the domestic slowdown in Japan were already partly apparent by late summer and were reflected to some degree in the projections published in the October WEO. To gauge the extent to which developments since late spring have forced downward revisions to growth projections for key Asian economies, therefore, it is useful to go back to the projections published in the May WEO and compare them to those in the interim WEO. Please see Table 4 which is on page 53 of the Interim WEO where these comparisons are made.
The countries most affected by the present crisis are the ASEAN-4--that is Thailand, Indonesia, Malaysia and the Philippines--and more recently Korea. Since the crisis began about the middle of this year, its effects are seen on growth both for 1997 and for 1998. For Thailand, the May projections--before we saw any crisis--were for 6.8 percent growth in 1997 and 7.0 percent growth in 1998. As of early December, those projections had been cut to just six tenths of one percent for 1997 and a flat zero for 1998. Combining the two years, therefore, growth combined of 13.8 percent was projected for Thailand in May. That two-year growth projection has now been cut by 13.2 percent to only 0.6 percent for the two years combined. Although not shown in the table, I might add that the cut in the two-year projection for growth of domestic demand in Thailand rather than of GDP is a fair bit greater than 13.2 percent.
For Indonesia, the reduction to projected GDP growth over the two years, 1997 and 1998, is 8.5 percent. For Malaysia, it is 6.4 percent. And for the Philippines, it is 3.6 percent for the two years combined. As with Thailand, downward revisions to projections of domestic demand growth must surely be larger than these figures for real GDP growth. As for all of these countries, projections of current account deficits have been revised significantly downward in the face of diminished capital inflows.
For Korea, surprisingly, projected GDP growth for 1997 has been revised up since May from 5.6 to 6.0 percent. For 1998, however, projected growth more sensibly has been cut by almost four percent from 6.3 percent to just 2.5 percent. I should add that this projection of much slower growth of the Korean economy next year has been misinterpreted in some of the media--in some cases, I believe, perniciously misinterpreted--as a demand by the International Monetary Fund that Korea must cut its economic growth rate as a condition for IMF support.
Such an interpretation is, of course, utter nonsense. Korea's growth rate will slow very dramatically because of the problems presently besetting the Korean economy and to some degree because of policies needed to deal with those problems and to restore Korea to the pace of economic advance that has characterized its past accomplishment and that reflects its longer term future potential. As a forecast for near-term growth for 1998, my personal view is that 2.5 percent is decidedly on the optimistic side.
For Japan, the May WEO projections were for 2.2 percent growth in 1997, followed by 2.9 percent in 1998. These were cut considerably by the time of the October WEO, and have now been further reduced to just one percent and 1.1 percent respectively. Despite the weakness revealed in the just released TANKAN survey and other recent negative data, fiscal measures and support for the financial sector just announced by the Japanese authorities in the past couple of days provide increased assurance that these diminished growth expectations, at least, have a reasonable prospect of being realized.
The downward revisions to the projections for world growth since the May WEO are from 4.4 percent for both 1997 and 1998 only slightly to 4.1 percent now for this year and more substantially to 3.5 percent for next year, with most of the revision to 1998 projected growth coming since the October WEO. The key reason for the modest revision to projected growth this year, despite the large downward revisions for much of Asia, is that projections for the United States and to a lesser extent Canada, Italy and United Kingdom, have been revised up since May, and are revised down only slightly since October. This reflects stronger than expected growth of domestic demand within these large economies. Because domestic demand in North America and to some extent Western Europe is expected to remain strong in 1998--indeed to be a little bit stronger than was expected at least in May--the downward revisions to projections for these large industrial economies and for the world as a whole are smaller than the negative impact that is coming out of Asia and some other emerging market countries.
On balance, the industrial countries of North America and Europe will probably need to absorb the effects of something like a $50 billion deterioration in their combined current account positions as emerging market countries adjust to a significant downturn of capital inflows. Mr. Larsen will say a little bit more about this. Taking account of the somewhat larger adjustment of real net exports associated with this correction in the current accounts, the impact effect on North America and Europe would normally be expected to be about one-half of one percentage point of growth for 1998. The revisions to the growth forecast for these countries since October, however, are down only two tenths of a percent for the United States, three tenths for Canada, and only one tenth for the European Union. It is fortunate not to have all parts of the world economy face the prospects of a mutually reinforcing slowdown of growth simultaneously.
MR. LARSEN: When a financial cataclysm occurs like the one we have seen in Asia, it is being transmitted throughout the world economy through a number of a different channels. One key channel will be the change we are likely to see in the availability of net private capital flows to the emerging market countries. As shown in Table 6 of the document, these capital flows, the private capital flows, developing countries, transition countries, and the newly industrialized economies of Asia, averaged a mere $15 billion per year in the second half of the 1980s. They then ballooned in the course of the first half of the 1990s to reach $260 billion in 1996. In the early part of 1997, we estimate that these capital inflows were running at an average annual rate well above $300 billion before then beginning to fall off in the second quarter of 1997.
As we show in the table, our assumption is based on an estimate of net capital inflows into these three groups of countries of $180 billion in 1997. That is a reduction of $80 billion compared to the record level of 1996. A key issue in the forecast and in constructing the forecast has been what is going to happen to these capital inflows during the period ahead. It seems very unlikely that they will come back very quickly to the level we saw in 1996, even though we are assuming in the baseline projection that confidence will begin to recover gradually in the course of 1998.
Of course, to some extent the drop off in private capital inflows is being offset by a reduced accumulation of reserves or even a decline in reserves in some cases, and also by some temporary increase in official financing for some countries. Nevertheless, it is clear that the decline in total net private capital flows to the emerging market countries will need to be matched to a large degree by a correction of current account imbalances.
And as we show in Table 7, we are projecting at present that the current account deficits of the emerging market countries, would continue to amount to well over 80 billion in the developing countries and 26 billion in the countries in transition in 1998. Given the availability of capital inflows, that may well be an overly optimistic projection in terms of what it implies about the availability of financing.
Chances are, therefore, that we are likely to see a greater degree of current account adjustment in the emerging market countries than shown in these projections. Indeed, to some extent one could regard these interim revisions to the projections as being work in progress and in a few months time we probably will have a firm idea about what is likely to happen to capital inflows and current account positions in 1998.
QUESTION: Now this crisis in Southeast Asia has led to several of the currencies being practically devalued. Now that will affect the export competitiveness of other countries like say India and Pakistan. Now do you think that will eventually lead to a sort of contagion effect in countries that are not now affected?
MR. MUSSA: Well, of course, we've seen a considerable spread of contagion among the Southeast Asian economies and more broadly. I think it is reasonable to anticipate that these large shifts in competitive positions will certainly affect the trade competitiveness and therefore to some degree the trade flows, that is exports and imports, from other emerging market countries in Asia and also elsewhere. How large those effects will be is another matter. The extent of trade, for example, between India and Southeast Asia, while significant, is not large as a total component of India's trade and trade for India as a whole is not a particularly large component of national product for India. So I would expect the impacts on the general performance of the economy to be relatively limited.
QUESTION: Would you discuss what you see as the biggest downside risk to this forecast not coming true and how confident you are given how rapidly things are changing now that we won't be back in a few weeks with a revised forecast?
MR. MUSSA: Well, we'll be back in a few months with a revised forecast in accord with the spring WEO, and a survey of past WEOs indicates that the forecasts do indeed change between one WEO and the next, and I think it's reasonable to anticipate there will be some change. Direction is not absolutely certain. Probably given recent events, the balance of risk at the present moment is a little bit on the downside from our present forecast. But there is upside clearly also. Certainly in the United States and in Western Europe, Canada, Latin America, growth could turn out to be stronger than what's presently in the forecast.
I would say for Asia it looks as if the risks balance more to the downside, and that is, I think, one of the key areas of concern looking forward: how long this turbulence in financial markets will go on and whether additional emerging market countries will get pulled in to the turmoil to a greater extent than has happened so far. So that's a major source of uncertainty. As Mr. Larsen indicated, there's a considerable uncertainty about the extent of private capital flows to emerging market countries generally and how the adjustment will occur to what will apparently be a significant slowdown in such flows.
There are obviously other risks in the industrial countries that stock markets could move sharply downward or the other sort of normal business cycle risk in North America and in Europe in addition to the uncertainties for the Japanese economy.
QUESTION: I'm a little perplexed here. From the 1998 projections for Southeast Asia and Korea, for the countries most directly affected, you don't have any of them in what by U.S. standards would be a recession. There isn't a single one of those countries that's showing negative growth. Isn't that phenomenally optimistic, not just decidedly optimistic?
MR. MUSSA: I wouldn't say phenomenally optimistic. I think a proper way to think about a recession in a country is how much growth slows relative to the normal trend rate of growth. In the United States, we believe potential growth of the economy is a little over two percent, and that, in fact, has been the average growth rate over the past decade and a half. So if growth in the United States is moving at potential and then suddenly slows by three percentage points, it's minus one percent, and we have a recession. All right. That's basically what happened in 1990-91.
These Southeast Asian economies over the past 15 or 20 years have had, leaving aside the Philippines which has had more difficulty, but Thailand, Indonesia, and Malaysia, have been growing on average a little above seven percent for two decades. For Thailand to slow down to zero is a drop of 14 percent over two years from its normal trend rate of growth. That will be like and feel like a very deep recession in the United States. Now that doesn't say that real GDP growth will not turn negative because this is a forecast and there is uncertainty around that forecast.
Moreover, as I indicated in my opening statement, the projections for growth of domestic demand are significantly weaker than they are for gross domestic product because we are projecting that the current account deficit in Thailand, which was running at eight percent through the first half of this year is going to correct downward to two or three percent by the time you get to the second half of next year. That says that the growth of domestic demand has to absorb, in fact, somewhat more than that difference. So for the two years combined, it's another five to seven percentage points off over the two years combined growth of domestic demand below the normal trend rate and substantially below the very rapid growth that was experienced in 1994 and 1995. So we're talking about an 18 or 20 percent slowdown of the growth of domestic demand over two years relative to trend, and that's a pretty severe recession by any standards.
QUESTION: If we look at page 52, Table 3, regarding newly industrialized Asian countries, which I think are the four Asian Tigers, the forecast for 1997 actually is revised upward by 0.3 percent. I wonder the reason for that.
Second question: President Jiang Zemin of People's Republic of China recently guaranteed to Asian countries that the remnimbi will not depreciate, but the problem is that he didn't specify for how long. So in your forecast, how strong, in your opinion, is the pressure for remnimbi to depreciate?
The third question is that Fred Bergsten, the former Assistant Secretary for Treasury, recently testified in Congress saying that Taiwan is to blame for the second stage of Asian financial crisis. He said that for the economic fundamental, especially as a percentage to GDP of the current account surplus, Taiwan has no reason to depreciate its currency, and he thinks that Taiwan has to be blamed for the Hong Kong financial turmoil. What's your evaluation of that?
MR. MUSSA: Well, first, regarding the forecast for the newly industrialized Asian economies, that is Korea, Singapore, Hong Kong SAR, and Taiwan Province of China, it's relevant to note that economic growth for those four newly industrialized economies in 1995 was 7.3 percent, and then it slowed significantly, not only on a one-year basis but relative to previous experience as well, to 6.4 percent in 1996. And that was part of the global slowdown in exports that affected many of these economies in 1996 and which we've discussed in previous WEOs.
Then, there has been a pick up of export growth through the first half of this year, and indeed Korea was showing recovery through the first half of this year, after a slowdown. The crisis which we're seeing now is coming late for these economies, late in 1997, which means the year over year 1997 growth figure is very marginally affected. The annualized growth rate in the final quarter of 1997, in terms of its weighted effect, is about six percent in terms of the overall growth forecast year over year.
So what's happening is there was some recovery in the first part of this year of growth in these economies. The crisis is going to impact them, but very little of that shows up in the 1997 year over year number. But the 1998 number shows more of a slowdown. I suspect that for Korea, as I indicated, that our forecast is a bit on the high side, a little bit probably for this year and I fear more so for next year.
With respect to the exchange rate of the remnimbi and the position of China, of course, we forecast here in this document through 1998, and I am not anticipating any problems that would induce very strong pressures on the remnimbi looking out a year or a little longer. One wants to remember that China is running a current account surplus at present, not a deficit. It has a huge volume of reserves. It will clearly suffer some loss of competitive trading position vis-a-vis other East Asian economies. And I think we can anticipate that, therefore, export growth will slow somewhat. But the Chinese economy is in a relatively good position to absorb that effect. It has a large volume of reserves and it has a surplus at present.
With respect to the contribution of Taiwan Province of China to Asian exchange market turmoil, it is true that in mid-October they stopped intervening to support the exchange rate and the currency depreciated at that stage, and the next Monday the assault began on the Hong Kong currency. But what happened in Taiwan Province of China was not dissimilar qualitatively or quantitatively to what we saw also in Singapore, which is another economy that has a very, very strong balance of payments position. The exchange rate had been allowed to depreciate in the midst of depreciations of most of its other close neighbors and trading partners. So I wouldn't want to read an enormous amount of significance into the depreciation of the currency of Taiwan Province of China. But it clearly was not a helpful event in terms of developments for other countries.
QUESTION: I would like to know if you could share with us the latest projections for growth and for the current account in Brazil? Secondly, on page 83 of "Policy Responses," you compare the responses of Brazil and the Asian countries. The assumption in Brazil is that the government will be able to lower interest rates in the first half of 1998. Now, given the uncertainties of capital flows, private capital flows, and the continuing volatility of the Asian markets and markets worldwide, how realistic is that expectation of lowering interest rates?
MR. MUSSA: I don't think we produce a specific number for Brazil in the WEO. My recollection is we've reduced the growth forecast by two or 2.5 percentage points. So we're talking about growth in 1998 of around 1.5 percent, something like that. And we've also reduced a fair bit the projected current account deficit, which was running up to around 4.5 percent at an annual rate this year, and I think there is already some evidence that it's beginning to shrink.
Now, the Brazilian authorities, when pressures arose against the Real, acted very strongly, first in tightening monetary policy quite aggressively, raising the interest rate to over 40 percent in an economy where the inflation rate is now running at an annual rate of 4 percent. So we're talking about nearly 40 percent real interest rates. It was possible to ease that back to something in the 1930s particularly after the very strong package of fiscal measures was announced by the government because those fiscal measures are going to help more directly to reduce the current account imbalance and have taken some of the burden off monetary policy in demonstrating to the market the necessary resolve to lessen the magnitude of the financing need that is associated with the current account deficit.
Interest rates, however, remain quite high in real terms. And in addition, we're seeing some significant fiscal tightening. The overall impact of which is going to be to slow domestic demand growth in the Brazilian economy rather smartly. And some of the figures for industrial production and employment and so forth are already showing the effect of those developments. I believe that as we see more of that effect and more evidence of the improvement in the current account position, the market will become increasingly confident that Brazil's economy and its economic policies will be able to successfully manage their way through the present situation, and in those circumstances it will be possible prudently and reasonably to reduce the level of interest rates.
But what's very important is to not try and drive that process ahead too rapidly or one can undermine the essential element of market confidence. So I would share the expectation that it will be possible as one moves into 1998 to reduce--probably fairly significantly--the level of interest rates as the Brazilian economy slows down somewhat, as the current account deficit comes down, and as market confidence is therefore undergirded by these developments. But it's important not try and force the pace of that adjustment ahead of the willingness of the market to recognize the accomplishment.
QUESTION: Mr. Larsen, I'm wondering if you can explain why it is that you're expecting a reduction in private capital investment, specially in the Asian region, and I'm wondering if you can also kind of walk through how that will be offset, if you can sort of illustrate what you're talking about when that investment would be offset by other factors?
MR. LARSEN: There are a number of reasons to expect a somewhat lower level of capital flows overall to Asia and to the emerging market countries in general, certainly in 1998 and maybe also in 1999. The large level of capital flows we saw in the first half of the 1990s reflected a large number of positive elements in the countries concerned, which are explained in Chapter II of the paper: their excellent growth performance; their very rapid levels of export growth during a period in which a number of industrial countries were experiencing substantial recessions; and, of course, also an element of over-exuberance on the part of international investors, which in the end, in our view, led to an excessive compression of yield spreads on the emerging market debt instruments.
What we have seen recently have been signs of a general reassessment of emerging market risk. In other words, at least in the near term, these countries can expect to face somewhat higher risk premia in international capital markets--some of them maybe even significantly higher risk premia. This will tend to slow the overall flow both on the supply side and on the demand side for funds.
We've also seen signs of continued rapid economic growth in the United States and growing signs of recovery also in Europe, which means that rates of return and investment opportunities in general have continued to improve in North America and in Europe. This will also mean that there will be greater competition in international capital markets for international investments, which will also tend to slow the flow of capital to emerging market countries.
A more positive aspect is the continuing excellent long-run growth potential of the emerging market countries which I think in the longer-run will continue to provide a substantial incentive for international investors to invest in these countries--especially if these countries now begin to tackle some of the weaknesses, especially in their financial systems, that have been exposed in the crisis. We can probably also expect in the longer-run to see a continued trend toward increasing international portfolio diversification whereby international investors gradually may want to increase the share of emerging market investments in their overall portfolios.
QUESTION: Could you analyze the crisis and whether it was due to lack of transparency? Secondly, when do you think the tigers will get back their stripes and go back to eight percent, ten percent growth rates? And last, are they going to get it at all or is it over? And further, beyond the statistics which are given, what does the crisis mean in terms of employment, jobs, and for the people? Does the IMF also concern itself as well with the impact on the people and take measures to assuage those problems?
MR. MUSSA: The WEO does have a very extensive discussion of what we see as the principal factors lying behind the crisis at the start. I may ask Mr. Hacche to summarize that briefly. In terms of the impact on the people, the type of growth slowdown that we're going to see in Southeast Asia is going to have a decidedly negative short-term impact. You know when I say domestic demand is going to turn negative and be 18 to 20 percent below trend, that means consumption and investment is going to be very adversely affected in some of these economies. So undoubtedly, people are going to feel the pain of this adjustment.
The issue is how long might that go on. The answer to that, of course, depends on things we can't know for certain. But what I think is relevant is if we look back at the "tequila crisis" in Mexico and Argentina, which were very hard hit, that crisis produced very sharp downturns in the growth rates of GDP and of domestic demand in both of those economies for about a year and then as the basis for recovery and confidence was established, the upturn came, led by exports, then investment and more recently recovery of consumption. The performance of both Mexico and Argentina this year has really been quite spectacular in terms of their economic growth rate, and we're expecting both of those economies to continue to do quite well in 1999.
With respect to the longer-term growth prospects of the Southeast Asian and East Asian economies, I think there is every reason to believe that they can return after a period of adjustment of a year or so to the type of longer-run average performance that has characterized the past two decades or so. Now, Korea, which is more mature, than the economies of Southeast Asia and which has achieved a per capita income of between a third and half the level of that in the United States, is unlikely to see its growth rate over the medium term return to eight or ten percent. It's more likely to be growing in the five/six percent range over the next decade or so, well above the growth rate of the advanced industrial economies including, of course, very importantly its close neighbor Japan, but probably somewhat below the spectacular performance during Korea's catch-up period beginning in the 1960s and extending through the 1970s and 1980s and into this decade.
Similarly, Singapore has had a very strong growth record. It has even higher per capita income than Korea, and it will, I think, continue to growth quite strongly but probably more in the five/six percent range than in the eight, nine, ten percent range. The other economies which have a considerable distance to go yet with their catch-ups can, I think, expect growth more on the order of seven, perhaps eight percent as a longer term average looking forth over a decade after a period of recovery.
There are, of course, no guarantees and it requires continued high levels of savings, high investment that's directed towards productive activities, improved education of the labor force and all the other factors that contribute to sustained growth over the longer term. I don't know, Graham, whether you want to add something on the factors.
MR. HACCHE: Yes. There are two sections in the report dealing essentially with what lay behind these crises. Section II of the report discusses what led to the build up to the present difficulties, as we refer to them, and the third section discusses the contagion from one country to another and developments as crisis spread from Thailand to the other countries in Southeast Asia. If I can just briefly summarize Section II, Section II says that were essentially four sets of factors that led up to the difficulties that have been experienced in Southeast Asia.
The first factor is the unusually successful macroeconomic performance in many respects of the countries in Southeast Asia which both attracted large-scale capital inflows through the 1990s and managed to hide some of the problems that were accumulating in some cases.
The second set of factors are a series of external developments, some of which were helpful, at least initially in 1994-95 or in the early 1990s. For example, unusually low interest rates in the industrial countries encouraged capital inflows into the region. Movements in exchange rates--the depreciation of the U.S. dollar in 1993, 1994, 1995--initially helped countries in Southeast Asia which had currencies that were formally or informally pegged to the dollar. It helped their competitiveness. Subsequently when the dollar/yen rate turned around in mid-1995, their competitiveness was damaged and that hit their export performance in 1996 especially. Also, there was a slowdown of exports in the region in 1996 which originated partly from attempts by countries to deal with overheating which was building up in their economies.
That leads to the third factor which is complications that arose with macroeconomic policies, especially given the exchange rate arrangements that a number of these countries, Korea being the main exception, had, the problems they had in dealing with overheating, given their exchange rate arrangements.
And then the fourth, and what some regard as the most important set of factors in the case of some of these countries are various structural problems, especially in the financial sectors--problems which were exposed when the crisis erupted.
QUESTION: In the report, you show Japan still growing one percent next year. My impression is that this is more optimistic than most private forecasters. You also show its current account surplus actually increasing slightly which implies, at least on a global basis, that it's not going to be helping any of the other countries in trouble ease their trouble by increasing demand for their goods and services. Can you talk about what the risks of Japan doing worse than your forecast are? And what you regard as the bottom range of plausible forecasts? And secondly, the implications of a worse forecast on Japan's part for the other countries in Southeast Asia or in Asia?
MR. MUSSA: I was just checking here to see what The Economist's poll of forecasters shows for Japan. As of early December, which is essentially the time of our forecast, they were at 1.5 for 1997 and 0.9 for 1998. That's obviously an average. We're at 1.0 for 1997 so we're half a percent below them for 1997 and we're 1.1, or two tenths of one percent above them for 1998. I don't have the consensus forecast numbers with me, but my impression is that we're not very different from the average of outside forecasts.
Now, since early December, obviously a number of things have changed, and some of them are clearly negative. We have the TANKAN survey come out; developments in Korea have not looked particularly reassuring as far as Japan is concerned; there has been increased nervousness with bankruptcies in Japan itself. On the other hand, the Japanese government this week announced significant new measures. Now, one can argue about how big the macroeconomic effect is of the tax cuts that they announced. Most estimates put the magnitude of those fiscal policy changes vis-a-vis where we were before the announcement on the order of one percent of GDP or thereabouts.
Now, whether the multiplier is above unity or below unity is an arguable question for a temporary income tax cut. For a permanent cut in corporate taxes and some other measures and probably some action on the public investment side as well, there is probably a stronger case for expecting the impact to be a little bit larger than unity.
So while it's not an enormously stimulative fiscal package, it's something that is worth a fair bit and I would be reasonably confident that it at least outweighs the other negative factors that we've seen in the last few days. Accordingly, I wouldn't be pushing the forecast of one percent down at this stage given the information we've presently got. I don't think I'd be pushing it up very much either. As best one can judge, it looks to be a slow year for Japan after another slow year in 1997.
Now, with respect to the current account, we forecast that year over year, the current account surplus of Japan will be a few billion bigger in 1998 than in 1997. Most of that has sort of already happened in the numbers that we've seen on a monthly basis, so there's effectively no change from where we are now. Fundamentally, the way we see the situation is that Japanese exports to the rest of Asia are going to slow down a fair bit; and imports from the rest of Asia, which are going to become a fair bit cheaper from many sources, are perhaps going to pick up some. That's going to tend to worsen the Japanese trade and current account position. On the other hand, domestic demand has been very weak in Japan. Import growth from other industrial countries in North America and Europe has been slowing and we think will probably slow further. So the Japanese current account and trade position is going to improve vis-a-vis the industrial countries of North America and Western Europe and, on balance, that's going to about offset the weakness vis-a-vis Asia.
That means, as I indicated in my opening remarks, that while Japan will feel the shock of the adjustment of the current account position of the emerging market countries, it will mainly pass it on, and most of it will need to be absorbed in the industrial economies of North America and Europe.
Are there risks to the Japanese forecasts? Obviously, yes. There are clearly risks internally within Japan. Should the downward spiral of confidence continue and consumers decide to save even more and spend even less, then that would be a problem. Difficulties in the financial sector would also affect the economy probably largely through that mechanism if they come about. On the other side, Japanese industry is quite competitive vis-a-vis most other industrial countries. Japanese automobile companies, for example, are making very handsome profits on their exports to Europe and the United States. And investments to expand capacity for some of those industries do make sense. So I think that the external sector vis-a-vis other industrial countries will be helping the Japanese.
There was a very large drop of consumption in the second quarter of this year following the consumption tax increase. I think it's plausible to suppose that some of that will come back at some point, and we're not predicting a gangbusters recovery. So I would say there certainly are risks on the downside, but there's a little bit of potential on the upside as well. Moreover, despite all of the complaints that the Japanese authorities never do anything, the fact of the matter is that they have used fiscal policy quite actively over the course of this decade when they have felt the pressing need to do so. And I wouldn't want to rule out the possibility that if the situation looks worse than we are now expecting to a significant degree that further actions will be considered.
QUESTION: My question concerns the relationship between the exchange rate and export revenue growth for the charts on pages 13, 14, and 17. What kind of increase do you expect in export revenue growth from the ASEAN countries and Korea given these big devaluations? And I'm puzzled by the China figures. You have that big devaluation you show on page 13 at the beginning of 1994 and then the sharp fall off in export revenue growth from China in 1995, 1996, 1997. Could you explain that?
MR. MUSSA: Well, some of it is not always easy to explain. But part of what's going on is also the sheer rate of export revenue growth in terms of U.S. dollars initially. At over 60 percent at the end of 1994, that is not a pace that can last. What the chart for China is showing is the growth rate of export revenue, not the level. If we showed the level, we would see an enormous amount added to the level of Chinese exports. That's what we would expect a devaluation to do, to produce a big increase in the level of exports. That increase in the level of exports comes through a temporary acceleration in the rate of growth of export earnings, but once you've felt that effect, then you don't continue to get the same high level of growth.
The other thing which is going on here--and we don't have the chart in this WEO, but we did it in a previous one--is an enormous falloff in export growth of many emerging market countries to the industrial countries, and China is experiencing some of that along with others. It may also be we made a mistake.
MR. HACCHE: Perhaps I could just add that there's a footnote on page 15 that explains why the devaluation shown in Figure 5 on page 13 exaggerates the true devaluation of the Chinese currency.
QUESTION: Did the recent election in Korea figure into your reasoning at all? How do you think that affects the outlook for Korea in general in terms of its recovery for 1998?
MR. MUSSA: Korea is experiencing a severe liquidity crisis and crisis of confidence at the present with an enormous depreciation of the won. Now depreciation makes you more competitive, but there are also very severe problems in terms of what's happened to consumer confidence and probably also business confidence and a lot of disruption in the financial sector. It's difficult to believe that, in that type of environment, the economy is not going to suffer a very large slowdown. I don't happen to believe that the personality of who gets elected is a particularly important factor in determining the future likely course of events in Korea.
What will matter is what are the policies that are put in place by the Korean government and what confidence, most particularly at home and also abroad, people have in the consistency and determination of those policies to face up to the very real structural difficulties that do exist in the Korean economy. So it is to an important extent a panic that is creating the current difficulties in Korea, but there is a substance to the problems in the financial structure of the Korean economy and in the financial sector itself in Korea, and other structural problems that need to be addressed to rationalize Korean industry. Those are difficult adjustments to make in any economy and they'll be difficult in Korea, and it will require the determination of the government to face up to those problems, some of which are going to be quite painful to resolve for many Koreans.
QUESTION: On Japan, first, if I could, you mentioned the stimulus package. I was wondering what your view is on the banking portion of that package? Do you believe that ten trillion is enough? Do you believe the package the way it's currently set out meets your test of transparency? Then, too, on the U.S., if I could ask, does the baseline forecast assume the Fed will raise rates at some point in 1998 and, two, how plausible is it to assume that the U.S. takes the overwhelming bulk of the adjustment in the current account that you're forecasting? I mean it looks like the U.S. takes almost 90 or 95 percent of that and Europe takes a very small part of it.
MR. MUSSA: In terms of Japan and the financial sector package, I believe the managing director characterized it as a step in the right direction, and I would go further than that. I think it's an important step. There is a lot of skepticism that it is a step that is big enough to get one all the way where one needs to be. In terms of the quantity of support from the public sector that may ultimately be necessary to deal with some of the problems in the Japanese financial sector, the true answer, I think, is no one really knows how much money will be required. The key reason for that is that the quality and viability of a lot of the loans on the portfolios of Japanese banks depend on how well the Japanese economy performs. So if the Japanese economy begins to recover again as it did in 1995-96, then loans that now look problematical will look a lot better. On the other hand, if the Japanese economy remains in a situation of stagnation, not only into 1998 but well beyond, then some loans that now don't look so bad are going to begin to look worse. There is no way to know how that situation will evolve unless one has an absolutely rock solid economic forecast; and while our forecasting record has some relationship to rocks, rock solid is not exactly the way I would seek to describe it. So there is uncertainty, I think, about how much is going to be required.
And I think it's a fact that the Japanese authorities have not made terribly clear precisely how it is that those funds are going to be utilized and for precisely what purposes, and they're going to need to be considerably more specific about that over the course of coming days and weeks. But after being forced (after the Jusen debacle) to back away from any notion that the public sector would provide funds to deal with these problems and instead try and do it through an exceedingly nontransparent method of getting strong institutions to bail out weak ones, it is, I think, very positive that the politicians are prepared now to step forward and say, yes, we're going to need a significant amount of public money to deal with these problems even if they can't at this stage quite bring themselves to say precisely how it is that that money is, in fact, going to be used.
With respect to the United States, I think we may still be assuming a small increase in the federal funds rate toward the end of the year. Yes, we're up about 40 basis points between 1997 and 1998. What significance to attach to that? Not much. What the Federal Reserve is doing is quite sensibly they're sitting back and watching developments.
Undoubtedly in my view, if it were not for the weakness in Asia and its expected impact on the U.S. economy, both in terms of slowing down U.S. exports and slowing down U.S. output growth and slowing down U.S. employment growth from what has clearly been an unsustainable pace over the past year and a half, were it not for those effects and for the help of a strong dollar in keeping inflation low, the Federal Reserve would have tightened U.S. monetary policy in November and tightened it again in December. That would have been reasonable and prudent in those circumstances. Instead it has been reasonable and prudent for the Federal Reserve to sit back and wait--in the quite reasonable expectation, given the evidence, that there is no immediate threat of an upsurge of inflation. They will, as they do, watch developments and they will need to make a judgment as 1998 proceeds whether, in fact, inflationary pressures remain in abeyance and are unlikely to pick up over the course of 1998 and 1999 without a further tightening of monetary policy or whether some further tightening is, in fact, needed to guard against the risk of higher inflation. Or if things look a fair bit weaker than we are now expecting and they are now expecting, whether in fact it may be appropriate to make monetary conditions in the United States a little easier.
Well do I recall that in early 1995 when the dollar became very, very weak, I suggested the Federal Reserve should participate in an effort to stabilize exchange rates to some extent by firming its monetary policy another 25 basis points as the Bundesbank cut and the Bank of Japan also cut their interest rates. It turned out that with a very, very sharp slowdown in Mexico in the first half of 1995 which cut about a percentage point off the annualized growth rate of the U.S. economy in the first half of that year, that the Fed, I think quite wisely, did not raise interest rates in the winter or early spring of 1995 and instead by the summer was actually cutting interest rates. That's a sensible management of monetary policy and I assume that the general characteristics which have governed the conduct of U.S. monetary policy will continue to be operative and that they will tighten if it appears that inflation is legitimately a concern. They'll sit where they are most likely so long as it appears the economy is slowing down and inflation is not a problem, and one should not rule out the possibility that they would ease monetary policy if the world economy and the U.S. economy in particular turns out to be a good deal more sluggish than we expect.
That is, I think, an important reason why we should be concerned about the prospects for the world economy but we shouldn't be excessively worried at this stage. The world's dominant central bank has plenty of positive leverage both to slow the economy down if that's needed or to give it a boost if that is called for. I think similarly in Western Europe, those economies seem to be recovering more strongly now. Evidence is that domestic demand is picking up more firmly, perhaps a little bit less in Germany than elsewhere in Europe. While I think the best expectation is that monetary policy in Europe will become somewhat less accommodative by the end of this year than it is now, it has the capacity to move in either direction as the circumstances may call for by evolution of the conditions in the world economy, and especially in Europe.
As regards current account prospects, let me say if you read the earlier annex to the WEO in which we evaluated the WEO forecast, you will know that our capacity to forecast developments in current accounts is truly terrible. I think it actually has slightly negative predictive value. Nevertheless, I think that it is a fair and reasonable expectation that the U.S. current account deficit is going to grow significantly between 1997 and 1998, largely reflecting developments in Asia, including Japan. What will happen for Europe, I'm a little less confident about, but I think they will feel some significant impact from Asian developments also. So it will not only be the United States and Canada, who will take the strain, though probably more here than there in terms of the overall quantitative effect.
I do not believe at the present moment that that should be regarded as a troubling prospect, that the growth rate of domestic demand in the United States is really quite rapid, and the fact that it's not fully reflected in GDP is one of the things that has helped keep inflationary pressures better contained. It looks like domestic demand growth is going to hold up pretty well in the United States and so a widening of the current account deficit is not likely to be associated, in the near term at least, with a slowing of the growth rate of the economy to a greater extent than is really desirable in present circumstances.
However, while that may be--indeed, very likely is--a favorable prospect for the near term, a current account deficit of the United States pushing up to say $250 billion is not so salutary for the medium and longer term. So at some point the current account deficit in the United States will need to come down. And it will not be healthy either for the United States or the rest of the world for that to be accomplished by a big recession in the United States that cuts dramatically into U.S. domestic demand growth. Probably more likely at some point the very strong dollar that we presently see in foreign exchange markets will become somewhat less strong and hopefully that will occur on a schedule such that a slowing of domestic demand growth in the United States will correspond to improvements in the U.S. competitive position which enable the current account position to shift away from deficit and towards surplus in a way that can be accommodated within the growth capacity of the United States without generating inflationary pressures in this economy.
So over the near term, I think on the whole a salutary prospect; but over the medium term, the deficit cannot continue to grow and grow and grow. At some point, there is going to need to be a turn in the other direction.
[Edited transcript]
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