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| April 21, 2003 | Monday | Safar 18, 1424 |
World economic report
The global economic recovery will remain slow and uncertain even after the war with Iraq. In its twice-yearly world economic outlook, the IMF cut its global growth forecast by half a per centage point to 3.2 per cent this year, barely higher than last year’s feeble 3 per cent expansion.
The forecast for the euro-zone, which has suffered from massive corporate debt burdens and weak prospects for investment, was cut by more than half to just 1.1 per cent, driven largely by a huge 1.5 per centage point reduction in projected German growth. The risks remained weighted towards the global economy under-performing the IMF’s forecast. The IMF also warned of rising risks of deflation, follows a string of downward revisions to economic growth by governments and private forecasters and increasing concern that current signs of economic weakness will persist after the Iraq war.
A number of other risks weigh on the outlook. The aftermath of the equity bubble, the emerging risk of a house price bubble and the patently unsustainable pattern of current accounts were all risks to growth. The heightened geopolitical risk that began with the 9/11 attacks could persist for decades. Globalization could affect trade and migration and take a quarter point off the world’s 4 per cent “normal” growth rate. Improving communication strategies to head off the threat of deflation could be more important than further cuts in interest rates. The Federal Reserve and the Bank of Japan should consider adopting numerical inflation targets, and the ECB should change its target from the current 2 per cent to a symmetrical 2.5 per cent target.
The ECB should also consider cutting interest rates again, and the Bank of Japan should adopt even more aggressive monetary easing, in association with the corporate and banking restructuring in Japan. Meanwhile, the IMF chief economist criticized the US administration’s plans for tax cuts, saying they were “awkwardly timed” and risked driving up deficits and interest rates in the medium term — a criticism frequently levelled by domestic critics and rejected by the administration officials. The US, whose forecast for this year cut by 0.4 per centage points to 2.2 per cent, would probably emerge from its “soft spot” only gradually, despite likely continued strong productivity growth.
The euro-zone economy has contracted in the first quarter of the year as the European Commission trimmed its estimates because of sluggish demand and uncertainty linked to the Iraq war, forecasting first quarter growth of minus 0.2 to 0.2 per cent and second quarter growth at 0.1 to 0.4 per cent. The European Central Bank warned that the economic outlook was uncertain. It expected “only a modest rate of economic growth for 2003” after recent data and surveys suggested the euro-zone economy “remained weak” in the early part of this year. Economists signalled continued concern about the downward risks to growth and suggested the ECB was keeping the door open to another rate cut in coming months. The bank opted to keep rates on hold at 3.75 per cent despite a deterioration in business and consumer confidence, although economists predicted a further cut soon. It last cut rates in February
Earlier, the Commission had slashed its 2003 growth forecast for the 12-nation bloc to 1.0 per cent from 1.8 per cent and warned of recession if geopolitical tensions continued to depress business and consumer confidence. The ECB, which kept interest rates steady at 2.5 per cent last week, said its main scenario remained one of moderate economic recovery in the second half of the year as uncertainty started to fade. Most economists believe the ECB will cut rates again by the end of the first half of the year in a bid to kick-start sagging growth in the euro-zone. But a quick end to the war in Iraq could delay the next move for a further month while the bank assessed the impact on oil prices and the global economic outlook.
The downbeat forecast by the European Commission suggests a third year of minimal growth, with a risk that Italy will join Germany, France and Portugal in breaching the EU’s budget rules. Europe needed to pursue tough policies to “inspire confidence” in the markets and with the public. The EU’s weakness in the face of a global downturn has underlined the need to further strengthen the economy’s growth capacity and resilience to shocks.
But under a more gloomy scenario, with a prolonged crisis in Iraq, and falling confidence, there could be a 2003 recession in the EU and US, with two successive quarters of falling output. The forecasts were unremittingly downbeat, with the EU unemployment expected to rise by 100,000 in 2003, the first rise since 1994, with joblessness at 8 per cent. While the Commission accepts that many of Europe’s problems are home grown, it also points a finger of blame at Washington, arguing that the twin US budget and current account deficits create instability.
German economy is forecast to grow by only 0.4 per cent this year, a sluggish performance which is dragging its trading partners down. Europe’s biggest economy is in breach of the stability pact, and it told to cut the cyclically adjusted deficit by 1 per cent of gross domestic product per year between the end of 2003 and 2005. It is urged to introduce further reforms to its “heavily regulated” labour markets, and to its costly health and pensions systems. The concern about long-term sustainability of public finances is all the more pressing as Germany’s debt-to-GDP ratio remains above the 60 per cent threshold, and a clear downward trend has not yet been established.
Germany seems certain to flout European Union fiscal rules for the second year in a row after a number of tax rises and subsidy cuts planned for this year’s budget were scrapped. An attempt by finance minister, to prevent Germany exceeding the 3 per cent budget deficit ceiling has been undermined by a deal between the ruling Social Democrats and Greens and opposition Christian Democrats
A supplementary budget might now be needed later in the year, particularly if growth remains weak. The government has continued to forecast a 2.85 per cent deficit this year. But the European commission forecast a 3.4 per cent deficit, while the International Monetary Fund expects 3.5 per cent.
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