[Index]
Persistent economic weakness in euro
area contrasts with robust expansion
in eastern Europe and the CIS
UNECE launches its Economic Survey
of Europe 2005 No. 2
Geneva, 21
July 2005 - This issue of the
Survey provides an assessment of the macroeconomic
situation and the short-term outlook in
the summer 2005. It updates the assessment
made in the Economic Survey of Europe
2005 No. 1, which was finalized in late
January this year. In addition, this Survey
contains a study on the issue how to sustain
growth in a resource-based economy using
the specific case of Russia, which was
prepared for the UNECE Spring Seminar
held in February.
A balancing act
– global recovery continues …
In mid-2005, the consensus
of forecasters is for continued robust
global economic expansion in 2005, albeit
at a somewhat lower rate than in 2004.
World output is expected to increase by
4 per cent. The continued expansion will
be supported by favourable financing conditions,
with long-term interest rates expected
to rise only slightly. The difference
between growth in the United States and
in the other major industrialized economies,
however, will widen in 2005. Modest growth
prospects in western Europe continue to
contrast with the persistent economic
dynamism of eastern Europe and the CIS.
In the United States,
real GDP is forecast to increase on average
by 3.5 per cent in 2005, about a percentage
point less than in 2004. With the United
States continuing to act as a “locomotive”
for the world economy (given weak domestic
demand in the other major advanced economies),
the large current account deficit is set
to deteriorate further. The expansion
remains very dependent on household consumption
spending, which will be supported by rising
real incomes, a stronger demand for labour,
and increased net wealth resulting from
the surge in house prices. The Federal
Reserve is expected to continue its gradual
tightening of monetary policy towards
a neutral stance, which will tend to dampen
economic growth. The expansion is currently
expected to continue at a rate close to
trend in 2006 as well.
… but important
global downside risks have not diminished.
The pattern of downside
risks to this overall favourable global
outlook has, however, changed for the
worse during the first half of 2005 in
comparison with the assessment made at
the beginning of the year. These risks
centre around the developments in the
oil markets; the further widening of global
external imbalances; a sudden and sharp
reversal of the rise in house prices in
many countries, where they have reached
levels regarded as out of line with “fundamentals”;
and a stronger than anticipated rise in
long-term interest rates from their current
unusually low levels.
Although the adverse economic impact of
higher oil prices has so far been relatively
small, the large cumulative increase over
the past two years must inevitably bring
them closer to a point at which the economic
pain for households and end-users in industry
will be increasingly felt. In any case,
further rises in oil prices will increase
the risk of dampening and even choking
off economic growth in the oil importing
countries.
A persistent challenge
remains the orderly reversal of the unprecedented
global imbalances, with rising current
account deficits in the United States
mirrored in rising surpluses in the rest
of the world, notably Asia. There is still
a risk that a change in financial market
sentiment could suddenly trigger a sharp
and sustained decline of the dollar, with
concomitant upward pressures on inflation
and interest rates in the United States
and adverse spillover effects on other
asset markets and regions in the global
economy.
The strength of the dollar
from the second quarter of 2005 means
that exchange rates are moving in the
opposite direction required for dealing
with the global imbalances, which means
that the risk of a sharp adjustment at
a later stage could be increasing.
Euro area: The
lean years
In the euro area, growth
forecasts have again been lowered. Real
GDP is now expected to increase by only
1.3 per cent in 2005. (In January of this
year the consensus was for a growth rate
of 1.7 per cent.) The continued rise of
oil prices in 2005 has curbed the purchasing
power of private households, at a time
when consumer confidence was already low
due to uncertainties about employment
and the impact of intensified international
competition. Exports have been held back
by the lagged effects of the strong euro
and the slower growth of global demand.
The recent weakening
of the euro has only partially offset
the large appreciation against the dollar
since early 2002 and, if not reversed,
will have a positive effect on economic
activity.
The persistent sluggishness
of aggregate domestic demand, which now
has spread to all three major economies,
remains the key problem of the euro area.
On current forecasts, economic activity
might gain slightly more momentum in 2006,
but this will depend on the development
of the global economy and on the price
of oil.
Growth rates are set
to continue to diverge significantly among
the twelve economies in 2005, with the
average for the euro area being pulled
down by the weakness of the three major
economies. Real GDP is forecast to (at
best) stagnate in Italy and to increase
only moderately in Germany (0.9 per cent)
and France (1.6 per cent). Among the smaller
economies, sluggish activity in the Netherlands
and Portugal contrasts with continued
solid growth in most of the other countries.
Finding the appropriate
policy mix
The persistent sluggishness
of economic activity in the euro area,
in combination with a widening output
gap and persistently high rates of unemployment
point to the need for a cut in the ECB’s
main official interest rate, which has
been at 2 per cent since June 2003. On
current forecasts, moreover, inflation
will fall below the ECB’s 2 per
cent ceiling in 2005 and 2006. But the
euro area may now well be on the edge
of a Keynesian liquidity trap.
While lower interest
rates may be desirable they are unlikely
to provide much of a boost to economic
growth given that such a move would hardly
lead to a further significant lowering
of long-term interest rates, which are
already at exceptionally low levels. Nevertheless,
even if the additional monetary stimulus
were small, it would send a signal to
economic agents that the ECB is also concerned
about raising growth and employment, as
in fact it should be, as mandated by the
Treaty of Amsterdam. There has been progress
in structural reforms in recent years
and much more will undoubtedly have to
be done – but it is in the very
nature of these reforms that their growth
effects will generally appear only with
a relatively long lag. Finding an appropriate
macroeconomic policy mix, with a supportive
role to be played by fiscal policy, is
now the major challenge.
The economies
of new EU member states preserve their
dynamism
The short-term outlook
for the new EU member states from central
Europe and the Baltic region remains generally
favourable. Both in 2005 and 2006 the
average rate of growth of these subregions,
as well as the GDP growth rates in most
countries are likely to remain significantly
higher that those of the old EU member
states (table
1).
Restructuring and economic
modernization (on the supply side) together
with strong investor and consumer confidence
(on the demand side) will remain the principal
engines of growth in the short run. Macroeconomic
policy in the new EU member states is
set to remain moderately supportive of
economic growth, and will benefit from
the recent changes in the rules of the
EU’s Stability and Growth Pact,
which provide for increased policy flexibility.
On the downside, the forecasts of GDP
growth are subject to the risk of weakening
external demand, especially in western
Europe that absorbs the bulk of regional
exports.
The re-appearance of
high rates of inflation is unlikely in
any of the EU-10 countries, but their
rates are still generally higher than
in the old EU member states. Large fiscal
deficits are another problem, especially
in the central European economies. Regardless
of the desired timing of their accession
to the EMU, these issues will remain the
focus of macroeconomic policy in the EU-10
in the short- to medium term.
South-east Europe:
the large current account deficits are
in the focus of macroeconomic policy
With
domestic demand outpacing aggregate output
throughout south-east Europe, the external
imbalances of many countries are escalating.
These large current account deficits are
risky for immature market economies that
are susceptible to external shocks. Policy
makers in south-east Europe have undertaken
various measures to curb the growth of
domestic demand in an effort to halt the
further expansion of these deficits. However,
the ongoing general tightening of macroeconomic
policies may have adverse effects on the
growth of domestic output in the short
run.
Nevertheless, in most
parts of south-east Europe, economic growth
is expected to remain relatively strong,
but at a slightly lower rate than in 2004.
The fact that the region’s aggregate
GDP growth rate in 2005 will be more than
2½ percentage points lower than
in 2004 mainly reflects the slowdown from
exceptionally high rates in the two largest
economies, Turkey and Romania. GDP in
most of south-east Europe is expected
to grow at rates between 4 and 6 per cent
through 2006.
Despite some
slowdown, strong economic performance
will prevail in the CIS
Economic growth in the
CIS region is generally set to remain
relatively strong through 2005 but its
pace is slowing down in some economies
(table
2). Commodity exporters (especially
those specialized in hydrocarbons) continue
to benefit from high world market prices
and robust demand in some of their main
markets. Current trends suggest a continuing
rise in real disposable incomes, which
are underpinning buoyant domestic demand.
Macroeconomic policies are generally set
to remain expansionary, providing further
support to the growth of the output and
real incomes. This, however, is also a
source of downside risk, as the loosening
of macroeconomic policy (which in some
cases has been under way for several years)
is not sustainable and has already led
to rising inflationary pressures in a
number of countries.
The outlook for the
Russian economy hinges on the balance
of divergent trends in some key industries.
Thus, while rapid growth continues in
some sectors of the economy, particularly
in market services (underpinned by strong
consumer spending), other industries,
such as manufacturing, have slowed down
considerably (partly as a result of the
losses in competitiveness due to the persistent
appreciation of the rouble’s real
exchange rate). As to domestic demand,
Russian consumers continue to be the mainstay
of the economic expansion, whereas investment
activity has weakened markedly. Macroeconomic
policy in Russia remains beset with consistency
problems: the monetary authorities in
fact face a trilemma, as they are not
only struggling to balance the mutually
exclusive goals of targeting both the
exchange rate and the inflation rate under
the pressure of sizeable inflows of foreign
exchange, but at the same time they are
having to cope with the inflationary consequences
of a continuing fiscal loosening.
The marked slowdown
in Ukraine’s economy in the early
months of 2005 will affect the average
performance for the year as a whole. As
the demand for Ukraine’s exports
is likely to deteriorate further (especially
for steel), this implies that net exports
will have a diminishing influence on output
growth. This shift in the sources of economic
growth is expected to lead to a further
deceleration in the rate of output growth
for the year as a whole. As a result of
the drastic deterioration in the government’s
financial balance, which was associated
with the 2004 presidential election campaign
and has led to a resurgence of inflation,
Ukraine now faces the need for a major
effort at fiscal consolidation.
In contrast, economic
growth is likely to maintain its momentum
in the two other large CIS economies,
Kazakhstan and Belarus. In Kazakhstan,
strong domestic demand should continue
to provide the main impetus for economic
activity and GDP is forecast to grow by
some 8 per cent in 2005. One of the downside
risks arises from the pre-election fiscal
loosening (reflected in a sizeable increase
in social spending), which may lead to
higher inflation and prompt a tightening
of monetary policy. Rapid economic growth
is also expected to continue in Belarus,
with GDP forecast to grow by close to
10 per cent in 2005. Accommodative monetary
policies and strong import demand in its
main export market, Russia, should continue
to support activity, at least in the short
run.
In the Caucasian Rim,
economic growth should remain strong in
Armenia and, especially, in Azerbaijan,
where the new Baku-Ceyhan-Tbilisi pipeline
should start operating at full capacity
before the end of 2005. A rapid economic
recovery is expected to continue in Tajikistan,
but some moderation of output growth is
expected in the other central Asian CIS
economies. The downside risks to the economic
outlook in Kyrgyzstan have increased considerably
since the beginning of 2005 due to the
political turmoil in the country and newly
emerging problems with gold production.
A gradual economic slowdown
is likely to continue in 2006 in the CIS
as a whole, as well as in some of the
largest economies. While total output
in the region will continue to grow at
relatively high rates, sustaining these
in the medium and longer run will require
an acceleration in the process of systemic
and structural reform.
For further information please contact:
UNECE Economic Analysis Division
Palais des Nations
CH - 1211 Geneva 10, Switzerland
Phone: +41(0)22 917 24 92
Fax: +41(0)22 917 03 09
E-mail: [email protected]
Website: http://www.unece.org/ead/ead_ese_new.htm
Ref: ECE/GEN/05/P08