[Index]
2003 - Western Europe and North America:
A postponed recovery
Eastern Europe, the Baltic States and the CIS: Moderate growth
UNECE releases the Economic Survey
of Europe, 2002 No. 2
The global recovery has become increasingly fragile
Geneva, 14 November 2002
"At the beginning of the final quarter of 2002, the economic situation in
the world economy was looking increasingly fragile" stresses Mrs. Brigita
Schmögnerová, Executive Secretary of the United Nations Economic
Commission for Europe (UNECE) commenting on the latest issue of the Economic
Survey for Europe just released by the UNECE. The consensus of forecasters
is now that the recovery has been postponed until the second half of 2003.
"But this appears to be merely a mechanical rescheduling of the upswing, which
ignores the restraints on growth and the considerable downside risks associated
with the persistent imbalances in the global economy."
2003 growth forecasts for North America and western Europe have been
cut
In the United States, real GDP is now forecast to increase by somewhat less
than 2.5 per cent in 2002 as a whole. The expected outcome for 2003 is only
slightly better at 2.6 per cent (table 1),
but nearly 1 percentage point less than forecast in the spring of 2002. Consumer
confidence fell sharply in October, adding to the general uncertainty about
the future direction of economic activity, against the background of the sharp
fall in equity prices, persistent labour market weakness and heightened geopolitical
risks.
The recent decision of the Federal Reserve to lower its target for the federal
funds rate by half a percentage point to 1¼ per cent was therefore
timely and adequate. But the economic stimulus provided by the further easing
of monetary policy may be reduced in an environment dominated by high levels
of debt and considerable underutilization of production capacities. In the
euro area, real GDP is now forecast to increase by 0.9 per cent in 2002, about
a quarter of a percentage point less than was expected in the spring of 2002.
This mainly reflects the persistent weakness of domestic demand, which is
being accentuated by the negative wealth effects of the sharp drop in share
prices. A major factor restraining growth in the euro area (and western Europe
at large) remains the sluggishness of the German economy, where real GDP is
forecast to increase by only 0.5 per cent in 2002.
On the basis of an expected strengthening of the international business
cycle, led by the United States, the rate of economic growth in the euro area
is also forecast to pick up in the course of 2003. The consensus of forecasters
is currently for an increase in real GDP of only some 2 per cent in the euro
area in 2003. The expected outcome is broadly the same for the European Union
and western Europe as a whole (see table 1).
Significant downside risks remain
The short-term economic outlook is subject to a number of important downside
risks and uncertainties, which are partly the legacy of the boom years in
the United States in the second half of the 1990s. The high levels of debt
accumulated in the United States private sector during the second half of
the 1990s will have to be reduced sooner or later. Households may be compelled
to make a larger increase in their savings than is currently assumed by forecasters,
with concomitant adverse effects on consumer demand, business profits and
fixed investment.
There are, moreover, persistent concerns about the financing of the United
States current account deficit and which is projected to remain very high
in 2003. Much will depend on the confidence of foreign investors as to whether
the United States corporate sector will be able to generate relatively high
rates of return.
Another question is to what extent business investment will be limited because
of the necessity to make provisions for their pension fund obligations, which
are now insufficiently covered as a result of the sharp decline in equity
markets.
The bad loans problem of the banks in Japan remains severe and, moreover,
a priority concern for international financial stability. Also, the upward
pressure on the oil price associated with a potential military conflict in
Iraq, is likely to have adverse effects on purchasing power and business and
consumer confidence in the oil importing countries.
Moreover, inflation, at the global level has fallen to relatively low levels,
reflecting the significant growth in potential supply capacities in recent
years, which has tended to outpace demand. The associated (albeit moderate)
deflationary tendencies will be strengthened by the collapse of financial
asset prices since the first quarter of 2000 and they risk being accentuated
by the prolonged weakness of economic activity in the United States, which
has been the major importer of last resort for the global economy over the
last few years. This constellation of factors constitutes a major policy challenge,
given that interest rates are already very low in the United States, and that
in a context of low and falling inflation, the room for manoeuvre of monetary
policy is narrowly circumscribed. This points to the complementary role of
fiscal policy in stimulating economic activity.
"In view of the domestic and external imbalances in the United States economy,
there is the dilemma that any domestic demand-led recovery would risk being
short-lived because of the adverse implications for the external deficit and
increased risk that foreign investors would be unwilling to continue financing
it. The longer the external adjustment is delayed the greater the possibility
of disruptive changes in capital flows" says Mrs. Schmögnerová.
The subdued outlook calls for a more supportive policy mix in Europe
For the inevitable adjustment process in the United States to occur more
or less smoothly, a more conducive environment of domestic demand growth is
required in the rest of the world, and especially in western Europe. This
can certainly be helped by policies aimed at structural reforms in product
and labour markets. But it will also require a reconsideration of the macroeconomic
policy framework in the euro area in order to achieve a better coordination
between fiscal and monetary policy1. More generally, the low inflation target
pursued by the ECB, in combination with the procyclical policies triggered
by the rules of the Stability and Growth Pact, introduce a deflationary bias
to economic policy which is particularly dangerous in the present economic
context. The intended revision of the Stability and Growth Pact in the euro
area needs to provide a more conducive framework for the operation of the
automatic stabilizers in the event of a cyclical slowdown by putting the focus
of fiscal discipline on structural budget deficits and levels of government
debt. The current economic outlook also calls for a more expansionary stance
of monetary policy, not least to better offset the dampening economic effects
of the appreciation of the euro and the fall in equity values.
Eastern Europe, the Baltic States and the CIS: Economic activity
bolstered by resilient domestic demand
"Despite the unfavourable external conditions, most economies in the region
managed to preserve some of their dynamism during the first half of 2002 but
there was a general moderation of the pace of growth," says Mrs. Schmögnerová.
The adverse impact of the global slowdown has been strongest on central Europe,
where GDP growth dropped to 1.8 per cent in the first half of 2002, making
it the slowest growing subregion among the transition economies (table
2). However, this was largely due to the weak performance of the Polish
economy, which has been in a state of near stagnation since the second quarter
of 2001. By contrast, the Baltic states were the fastest growing subregion
with aggregate GDP increasing by 5.2 per cent over the first half of 2001.
Although growth in the CIS economies was significantly weaker than a year
ago, the average GDP growth rate was still 4.3 per cent. GDP in south-east
Europe increased by 4.1 per cent year-on-year, a rate which was broadly similar
to that of a year ago.
One of the factors that contributed to these relatively positive outcomes
was the shift towards domestically driven growth, which started already in
2001 and strengthened in the first half of 2002. In one large group of economies
(Croatia, Hungary, Russia and Slovakia, as well as most of the other CIS countries),
the main impetus came from booming private consumption. In other countries
(Bulgaria, Romania and the Baltic states) both private consumption and fixed
investment made a positive contribution to growth while in some cases (Armenia
and Azerbaijan), the surge in investment probably outweighed the other domestic
factors of growth.
Foreign trade activity generally lost some momentum in the first half of
the year, but the patterns were not uniform across the region. In eastern
Europe and the Baltic area, after a weak start, trade picked up somewhat in
the second quarter. A number of countries in this part of the continent benefited
from improvements in terms of trade, with a beneficial effect on their trade
balances. In contrast, lower commodity prices impacted negatively on export
earnings in the CIS region despite some increases in shipments. On the other
hand, the continuing recovery of domestic demand in many CIS countries gave
a boost to imports, particularly from non-CIS area (table
3).
Despite the general weakening of foreign trade, net exports still made a
positive contribution to growth in some countries (notably in Romania and
Slovakia but also in the Czech Republic and Slovenia). However, even in cases
where exports were generally subdued, exporters managed to divert some sales
from traditional to new markets or redirected them to the local markets, benefiting
from the strong domestic demand. One of the important positive messages of
these recent developments is that local producers have demonstrated an increasing
responsiveness to market opportunities, behaving more and more like genuine
market agents.
The majority of the transition economies made further progress in disinflation
in the first half of 2002, and the most advanced among them have already achieved
a large degree of macroeconomic stability. However, the persistently high
unemployment rates remain one of the major sources of strain in many transition
economies. Due to the ongoing painful labour market adjustments, output growth
in the first half of the year had a positive effect on unemployment rates
in only a limited number of countries; in general, these rates increased in
most countries, in some cases reaching record levels.
While capital flows to emerging markets on a global scale generally weakened
in the first half of 2002, most transition economies were not subject to external
financing constraints: current account deficits were easily financed and capital
inflows were on the rise. The increasing tendency for international investors
to differentiate among countries has clearly been beneficial for those transition
economies that have made the most progress in the process of market reforms.
In particular, FDI, largely a non-debt creating inflow, has remained a major
source of finance. On average, net FDI inflows in 2000-2001 exceeded the current
account deficits of the east European countries (table
4), suggesting a relatively low vulnerability of current account financing
to potential disruptions in capital markets.
A stronger external impetus is needed to sustain a high rate of economic
expansion
The shift away from export-led growth, however, places the transition economies
in a somewhat vulnerable position. Most of these economies have chronically
large current account deficits and a further weakening of their trade performance
may pose certain risks for the sustainability of these deficits. In addition
the surge in domestic demand in some economies was underpinned by a notable
fiscal loosening (often related to election cycles), a policy that is clearly
unsustainable. "Thus, it is unlikely that these economies - especially the
countries in eastern Europe and the Baltic region - will be able to escape
for long the negative effects of a protracted weakness in the global and west
European economies" says Mrs. Schmögnerová. Moreover, given the
risks stemming from the widening fiscal and current account deficits, a policy
reversal may be needed in some of these economies in order to curb the growth
of domestic demand and bring about the needed macroeconomic adjustment. As
for the commodity exporting CIS countries, their short-term prospects have
improved somewhat due to the U-turn in some commodity prices (particularly
oil and gold) in the course of 2002.
According to the latest available forecasts, aggregate GDP in the transition
economies as a whole is expected to increase by some 3¾ per cent in
2002 and some 4 per cent in 2003. With average rates of GDP growth of 5 per
cent in 2002 and 5¼ per cent in 2003, the Baltic states are expected
to be the fastest growing subregion in the short run. Aggregate GDP in the
CIS is forecast to increase by 4½ per cent in 2002 and by slightly
less, 4¼ per cent, in 2003. The average rate of GDP growth in eastern
Europe - which is heavily influenced by Poland - is expected to be 2½
per cent in 2002, improving to 3¾ per cent in 2003 (see table
2).
For further information please contact: UNECE Economic Analysis Division,
Palais des Nations,
CH - 1211 Geneva 10, Switzerland, Tel: +41(0)22 917 24 79, Fax: +41(0)22 917
03 09,
E-mail: [email protected], Web
site: http://www.unece.org/ead/ead_h.htm
__________
1 UNECE, Economic Survey of Europe, 2002 No.
1, pp.7-10.