The short-term outlook for Europe and the CIS is for economic growth to continue in 2005, albeit at significantly different rates in the major subregions. The euro area will continue to lag behind the other major regions of the world economy. Within Europe, central and eastern Europe will continue to perform significantly better than the euro area. Economic growth will weaken somewhat in the CIS, but average rates will remain well above the European average.
A favourable global context in 2005
The international economic context is expected to remain favourable for Europe and the CIS in 2005. The average annual rate of expansion of the global economy is forecast to be some 4¼ per cent in 2005, down from 5 per cent in 2004, which was the fastest growth in three decades. World merchandise trade will increase in volume terms by 8 per cent in 2005, strong but below the 10.5 per cent achieved in 2004.
The United States and China will remain the principal engines of global growth. Rapid growth rates are also expected to continue in other Asian emerging markets and Latin America.
In the United States, real GDP is forecast to increase by some 3.5 per cent in 2005, down from 4.4 per cent in 2004 (table 1). Overall, economic activity will be supported by the continued, albeit moderating strength of domestic demand. Exports should be stimulated by the depreciation of the dollar and by strong external demand in the USA’s major markets in Asia and the Americas. The Federal Reserve is expected to continue gradually raising short-term interest rates to move monetary policy closer to a neutral stance during 2005. But monetary policy is expected to be still accommodative during 2005. Fiscal policy will be slightly restrictive in 2005.
A moderate rate of recovery in the euro area
For the euro area, real GDP is forecast to increase on average by 1.8 per cent in 2005 (table 1). Positive growth in the rest of the world will continue to support exports, which remain the mainstay of growth. This moderate rate of economic expansion will be associated with only small gains in employment. The average annual unemployment rate in the euro area will be 8.9 per cent in 2005, unchanged from 2004. Inflation is expected to fall slightly below the ECB’s 2 per cent threshold.
The stance of fiscal policy is expected to be broadly neutral (possibly even slightly restrictive) both for the euro area and western Europe as a whole in 2005. In view of the fragility of factors of domestic growth and the dampening effects of the stronger euro on domestic economic activity and inflation, monetary policy in the euro area is likely to continue to “wait-and-see”. The ECB is expected to leave interest rates unchanged in 2005, but there is scope for countering a possible weakening of the recovery by lowering interest rates, particularly as the stronger euro will dampen imported inflation.
For western Europe as a whole, the annual rate of economic growth will be some 2¼ per cent, reflecting the slightly stronger growth momentum in countries outside the euro area. Among the four major west European economies, average annual growth will remain significantly below 2 per cent in Germany and Italy. Economic activity is expected to be stronger in France and the United Kingdom, with real GDP increasing by nearly 2 per cent and by 2.5 per cent, respectively.
The average annual rate of economic expansion in the European Union (EU-25) will be 2.2 per cent in 2005, masking significantly stronger growth in the aggregate of the ten new member States compared to the EU-15.
Continued strong growth in central Europe and the Baltics
Economic growth should remain strong in central Europe and the Baltic States (EU-8). Although GDP growth has started to decelerate in the EU-8 countries, recent economic sentiment indicators suggest a favourable short-term outlook. In 2005, the average rate of growth in the EU-8 may slow down somewhat compared with 2004 but, at some 4½ per cent, will remain considerably above the average of western Europe (table 1). A noticeable surge in greenfield FDI projects should accelerate the ongoing process of restructuring and boost exports. Further fiscal consolidation is envisaged in some countries in 2005 but its dampening effect on domestic demand should be marginal.
…and in south-east Europe
Most of the south-east European economies are also set to maintain strong rates of growth in 2005 but the unusually high rates achieved in some countries in 2004 will be difficult to sustain. Overall, domestic demand is set to remain buoyant, and should provide solid support to economic activity in these countries. Better financial intermediation and rapid credit expansion will continue to fuel demand and output growth. In the event, real GDP is forecast to increase by somewhat more than 5 per cent in 2005 compared with the preceding year (table 2). If Turkey is excluded from the regional aggregate then the average annual growth rate will be slightly lower. However, given the ongoing enterprise restructuring in many parts of the region the increases in employment are likely to be small.
CIS maintains dynamic growth
Economic activity in the CIS as a whole may lose some steam in 2005, but aggregate GDP is nevertheless expected to expand by some 6.5 per cent (table 2). Decelerating growth rates will prevail in all the large CIS economies – Belarus, Kazakhstan, Russia and Ukraine – following the evolution of external factors such as commodity prices and demand in the region’s main markets. Domestic demand in the CIS should generally remain buoyant but its effect on domestic economic activity will depend on the responsiveness of domestic supply. The macroeconomic policy stance should remain broadly neutral in the large economies, with the possible exception of Ukraine where some fiscal tightening can be expected. While in the short run there may be some further improvement in the labour markets, many CIS economies still have to address the challenge of restructuring as labour adjustment has in general been lagging behind that in output.
Downside risks are dominating
The baseline short-term outlook for the global economy is relatively favourable. But the global outlook is surrounded by risks, which continue to be predominantly on the downside.
- A major uncertainty is the likely development of the international oil markets. Oil prices remain subject to potential upward pressure from actual or threats of supply disruptions.
- The fact that the global economy continues to rely so much on the United States as a major engine of growth evidently makes the outlook very vulnerable to a more pronounced slowdown of the United States economy. This is all the more so, because the necessary correction of the large fiscal and current account imbalances that have developed in the United States economy will hardly be possible without a more or less pronounced slowdown of domestic demand and output growth.
- The huge United States current account deficit has been an important downside risk for the global economy for several years, given that it could trigger sudden and sharp changes in the direction of international capital flows, which would adversely affect economic activity. The orderly reversal of the deficit is a major challenge for policy makers both in the United States and other major economies.
- Downside risks are also related to uncertainty about the strength of personal consumption spending in the United States, given that the savings rate fell to a very low level in 2004 and that the wealth effects from rising house prices may start to wane in 2005. To this adds the uncertainty about the outlook for the labour market.
- Long-term interest rates in the international capital markets have remained at unusually low levels in the recovery so far, reflecting, inter alia, the persistence of moderate inflationary expectations, a weak supply of corporate bonds (a reflection of balance sheet consolidation) and the massive purchase of United States treasury bills by Asian central banks. A stronger than expected rise in long-term interest rates could be caused by the fading of these factors but also by increasing concerns in financial markets about large fiscal deficits, with a consequent dampening effect on economic growth.
- Other risks to the outlook include a possible hard landing in China, which has become an important source of demand for goods and services produced in the rest of Asia and other regions of the world economy.
Euro area recovery remains vulnerable to adverse external shocks
In the euro area, given its present strong reliance on export growth, the recovery is very vulnerable to a more pronounced weakening of global growth than is currently forecast. A further sharp appreciation of the euro could considerably dampen growth prospects with even the risk of economic growth stalling in 2005.
A potential upside risk is that business investment may respond more favourably than anticipated due to the continuation of favourable financing conditions and improved profitability. But the probability of this occurring is not very high given the overall moderate rate of economic expansion.
High house prices are a matter of concern
In some west European countries (France, Ireland, Spain, United Kingdom), the downside risks also include a possible sudden and pronounced reversal of the rise in house prices, with consequent negative wealth effects and, in turn, severe repercussions on private household consumption and the overall rate of economic growth.
Central and eastern Europe: external and internal imbalances pose risks
The main external risks to the outlook for central and eastern Europe include a possible sharp deceleration of economic growth in major western European markets and significantly higher than expected energy prices. If imported inflation continues to rise, this may prompt a more restrictive policy stance, with negative implications for economic activity.
A number of economies in this region still face important macroeconomic policy challenges such as large fiscal and current account deficits. Forthcoming elections in several countries carry the risk of pre-election increases in public spending, which could undermine policy credibility and probably result in monetary tightening, lower inflows of FDI and reduced competitiveness. The most pressing policy challenges facing the new EU member States are to achieve sustainable fiscal consolidation and implement structural reforms for job-rich growth.
CIS: vulnerabilities stemming from the strong reliance on commodity exports
The short-term outlook for the CIS will be strongly influenced by developments in the markets for oil and other primary commodities. On current forecasts, commodity prices will remain at high levels in 2005. But any sharp fall would have adverse effects on export revenues and overall economic activity. The main structural weakness of the CIS economies remains their high dependence on exports of natural resources and low value added products, implying a high degree of vulnerability to external shocks. In addition, there are already signs, especially in Russia, that the loss of competitiveness associated with real exchange rate appreciation (the “Dutch Disease”) is becoming a burden on local producers and is choking off aggregate domestic economic activity. The capacity of macroeconomic policy to address these negative developments is fairly limited. Unless local producers manage to counteract them at the micro level through further restructuring, there are likely to be negative repercussions on output growth in the affected countries, especially in their manufacturing industries. The long-term growth prospects of the CIS economies thus hinge on their success in diversifying their economies and implementing key reforms in product and financial markets.
Despite the overall relatively favourable short-term growth prospects for Europe and the CIS, there are a number of important issues that need to be addressed by economic policy to ensure that the basic conditions are in place for sustained and robust growth in the medium- and longer term (see Press Release ECE/GEN/05/P05).
For further information please contact:
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