UNECE releases the Economic Survey of Europe, 2002 No. 2
The global recovery has become increasingly fragile
"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: info.ead.@unece.org, Web site: http://www.unece.org/ead/ead_h.htm
1 UNECE, Economic Survey of Europe, 2002 No. 1, pp.7-10.
United Nations Economic Commission for Europe
Palais des Nations,
CH-1211 Geneva 10, Switzerland
Tel.: +41 (0) 22 917 44 44
Fax: +41 (0) 22 917 05 05
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