VII	International Economic Developments

Following the global slowdown which started in the middle of 2000 and the adverse shock from the 11 September 2001 terrorist attacks on the United States, there had been increasing signs of a global economic recovery. However, recent economic data put out by major advanced countries would tend to suggest that the pace of economic recovery so far remains modest and vulnerable.

The recovery in most regions began in the first quarter of 2002, with the United States in the lead, but the nature and pace varied depending on the depth of the preceding downturn, the openness of the economy as well as country specific factors and constraints. The recovery was being underpinned by a number of factors, namely the substantial easing of macroeconomic policies in advanced countries over the past year, the completion of ongoing inventory cycles and the gradual abatement of oil prices. After growing by 4.7 per cent in 2000, world economic activity slowed down markedly to 2.5 per cent in 2001. It is expected to pick up to 2.8 per cent in 2002 and 4.0 per cent in 2003. In the first quarter of 2002, leading indicators pointed to a strengthening of consumer and business confidence while industrial production levelled off particularly in the US and the euro area. In Japan, the recovery was weaker and more fragile. Growth in Africa held up relatively well in 2001 and is likely to be sustained in 2002.

Growth of output of major advanced economies declined significantly from 3.5 per cent in 2000 to 1.1 per cent in 2001 but is expected to rise slightly to 1.5 per cent in 2002. In the US, activity remained weak during the second half of 2001. The September 11 events further set back an already fragile economy, heightening uncertainty and badly shaking confidence. However, the economy initially proved more resilient than expected and among the advanced economies, the upturn was the strongest in the United States, driven initially by the completion of the inventory cycle and a moderate pickup in final domestic demand, underpinned by the substantial reductions in interest rates and the previous fall in oil prices. On the fiscal side, the combination of the June 2001 tax cuts and emergency spending measures passed in the aftermath of the terrorist attacks, along with the operation of the automatic stabilisers, provided substantial support to the economy. Following an expansion of 4.1 per cent in 2000, economic growth declined to 1.2 per cent in 2001 but is expected to pick up to 2.3 per cent in 2002. In the first quarter of 2002, household spending remained strong and manufacturing output stabilised, pointing to a recovery in the US economy. However, a sharp slowdown in economic activity has been recorded in the second quarter of 2002. The US economy grew by 1.1 per cent in the second quarter of 2002 as compared to 5.0 per cent in the first quarter of 2002 mainly due to weakness in financial markets and heightened uncertainty related to problems in corporate reporting and governance. The high current account deficit, the low personal savings rate, the relatively high level of corporate debt and the overvaluation of asset prices are also weighing on the US economy.

Economic conditions and prospects in Japan remain a source of serious concern, with the economy experiencing its third and most severe recession of the past decade, confidence and activity remaining weak and the banking sector experiencing severe strains. However, some signs of a possible bottoming out in the fall of activity have been noted due to recent initiatives taken by Japan. Japan’s real output is expected to fall by 1.0 per cent in 2002 after a decline of 0.4 per cent in 2001, as the pronounced weakness of private demand continued through the first half of 2002. The fall in activity has been driven by both domestic and external factors, notably, deflation, rising unemployment, falling consumer confidence, declining exports in the face of the global slowdown and the rapid fall in demand for Information Technology goods. However, the inability to achieve sustained growth over the past decade reflects rather the failure to deal decisively with structural weaknesses, especially in the banking system. An important step is for the Bank of Japan to engage in an aggressive policy to end deflation as soon as possible. Given the high public debt, rising long-term interest rates and falling household confidence, a clear and credible commitment to medium-term fiscal consolidation is required, backed up by reforms to the tax system, public enterprises and the health sector.

Europe experienced a slowing down in growth as from the middle of 2000 and after a temporary rebound in late 2000 and early 2001, GDP growth continued to weaken in the remainder of the year. The extent of the slowdown has differed considerably across countries, being particularly marked in Germany, Belgium, the Netherlands and Italy. In contrast, growth in France and UK has in general been better sustained. The differences in the depth of the slowdown reflect domestic rather than external factors. In particular, consumption spending remained strong in France and the UK, buoyed by relatively strong real wage growth and stronger labour market conditions, but weakened elsewhere. Signs of recovery begun to emerge in the first quarter of 2002, spurred by a turn-around in the inventory cycle, monetary policy easing, the strengthening external environment and the decline in oil prices. Also, business confidence and to a lesser degree consumer confidence improved. However, with the recent slowdown of the US economy, the recovery that was underway in Europe has somewhat lost its momentum.

Real GDP in the euro area is expected to grow by 1.4 per cent in 2002, slightly lower than the growth of 1.5 per cent in 2001. Fiscal policy in most countries in the euro area has been supportive during the slowdown, through the operation of automatic stabilisers but at the cost of a widening deficit in the short term. Once the recovery gathers pace, those countries with significant structural deficits will have to resume their consolidation efforts and move towards positions which are compatible with the medium-term challenges associated with ageing populations. The main risks to the outlook in the region include a weaker than expected upturn in Germany, given its size and close links with other euro area countries, structural weaknesses particularly in labour markets and a further rise in oil prices.

The growth rate in the United Kingdom in 2001 was the strongest among the G-7 economies. However, there are significant disparities in the various sectors of the economy. While private consumption remained strong, external demand weakened which, along with the continued strength of sterling and weakening confidence in the aftermath of the September 11 events, contributed to a sharp decline in manufacturing output. Output in the United Kingdom is expected to grow by 2.0 per cent in 2002, slightly lower that the growth rate of 2.2 per cent in 2001.

In Asia, after being hard hit by the global slowdown, a number of countries showed clear signs of a pickup in activity in the first quarter of 2002, aided by a nascent strengthening in the electronics sector and accommodating macroeconomic policies. With the strengthening of activity in the advanced economies, production picked up in a number of countries including Korea, Malaysia and Thailand, as has consumer and business confidence although increases in unemployment across the region muted the pickup in household spending. However, economic activity in the South East Asian countries has slowed down again recently as a result of the slow pick-up in activity in advanced economies.

In Argentina, the situation remains extremely difficult and a substantial decline in output and acceleration of inflation during 2002 appear unavoidable. However, spillover effects from Argentina on other regional economies have been generally limited. The depth and duration of the downturn in Argentina will hinge primarily on the new government's economic program and on how effectively it is implemented. While Mexico and other countries in Central America were hit hard in 2001 by the US slowdown, the Caribbean nations suffered from a downturn in tourism after the September 11 events. In Venezuela, a substantial increase in government spending combined with lower oil output has led to fiscal pressures and a weakening of the external current account.

In the developing countries as a group, growth of output declined from 5.7 per cent in 2000 to 4.0 per cent in 2001 but is likely to pick up slightly to 4.3 per cent in 2002. In China, economic output remained relatively resilient, growing at the pace of 7.3 per cent in 2001 as compared to 8.0 per cent in 2000. Growth in China is expected to be about 7.0 per cent in 2002, supported by robust domestic demand. While China's vulnerability to weaknesses in external demand has been limited, given its high reserves, favourable debt indicators and rising FDI inflows, the stronger competition that is likely to arise from World Trade Organisation (WTO) membership will increase pressures for reform in sectors such as agriculture, manufacturing and banking. In India, robust service sector activity and a projected record level of agricultural output helping to offset lingering weaknesses in external demand and industrial production will result in the growth rate to pick up from 4.3 per cent in 2001 to 5.5 per cent in 2002. Growth in the Middle East is projected to weaken further in 2002 largely reflecting oil price volatility and the regional security situation. Growth of the region as a whole went down from 5.3 per cent in 2000 to 4.5 per cent in 2001 and is expected to decline further to 3.1 per cent in 2002. The slowdown in growth has generally been limited by the use of more prudent macroeconomic policies. The main policy priority, however, remains the need to diversify production into sectors other than energy, to make these economies less dependent on oil revenues.

Following an economic expansion of 3.0 per cent in 2000 and 3.7 per cent in 2001, growth in Africa is projected to slow down slightly to 3.4 per cent in 2002. Although conditions and prospects vary widely across individual countries, the key influence on the outlook for much of the region continues to depend on commodity market developments, the conduct of economic policies and the extent of armed conflict and other sources of civil tension. Further trade liberalisation by the advanced economies would provide a major boost to the region's export performance and hence to prospects for sustained growth and poverty reduction. In a number of economies such as Botswana, Cameroon, Senegal, Tanzania and Uganda, sound economic policies have enabled them to offset the effects of export price weaknesses and the global slowdown and thus sustain strong rates of growth.

Growth in the transition economies declined from 6.6 per cent in 2000 to 5.0 per cent in 2001 and is expected to decline further to 3.9 per cent in 2002. Growth amongst the countries in central and eastern Europe, with the exception of Poland and Turkey, has been generally well sustained during the global slowdown with robust domestic demand offsetting weaker export performance and is expected to pick up further as the global recovery takes hold. Growth in the Commonwealth of Independent States has also remained remarkably resilient to the global slowdown, underpinned by continued solid growth in Russia and Ukraine. However, the pace of activity is likely to weaken in 2002 mainly as a result of slowing demand in the region’s oil exporting countries. The central challenge facing the region is the acceleration of structural reforms, notably institutional building and governance, enterprise and financial sector restructuring and transforming the role of the state.

Inflationary pressures have continued to ease, reflecting weaker global activity. In advanced economies, inflation declined slightly from 2.3 per cent in 2000 to 2.2 per cent in 2001 and is projected to fall significantly to 1.3 per cent in 2002, the lowest level on record. In the US, in view of a moderate underlying inflation and declining economic activity, worsened by the September 11 attacks, the Federal Reserve eased monetary policy aggressively on five occasions in the second half of 2001, reducing the federal funds rate from 3.75 per cent to 1.75 per cent. In the UK, the Bank of England brought down interest rates on four occasions in the fiscal year ended June 2002 but may soon consider a policy tightening given the potential imbalances in its economy, notably the high levels of household and corporate debt. In the euro area, inflationary pressures have eased due to the slowdown in growth as well as wage growth remaining reasonably subdued. The inflation rate in the euro area is expected to fall from 2.6 per cent in 2001 to 1.9 per cent in 2002. However, there are upside risks to inflation emanating from oil price developments. Since the middle of 2001, the European Central Bank reduced interest rates by 125 basis points. Monetary policy stance has been kept on hold until the recovery becomes established. In the face of a weakening Japanese economy and deflationary pressures that would not abate, the Bank of Japan carried out an aggressive quantitative easing by injecting liquidity in the banking system. Should deflationary forces persist, monetary policy would have to continue providing liquidity through the use of a broader range of instruments, although a further easing might weaken the yen. In emerging and developing countries, inflation is projected to fall but it remains a concern in the Commonwealth of Independent States, some central and eastern European countries and a few countries in Latin America and Africa. In the developing countries as a whole, inflation is expected to be at a low of 5.8 per cent in 2002, slightly above the level of 5.7 per cent recorded in 2001 and it is projected to drop to a record low of 5.1 per cent in 2003. Long-term inflationary risks remain generally limited, given the past fall in commodity prices, the substantial excess capacity in most industrial countries and increasing evidence that the improvement in central bank credibility in recent years is helping to anchor inflationary expectations.

The dollar weakened in the third quarter of 2001, amid increased expectations for a more protracted economic slowdown in the US. During the same period, the euro strengthened as shifting expectations for relative growth differentials between the US and the euro area economies, prompted investors to expand their long euro positions. Meanwhile, the yen also strengthened against a wide range of currencies as investors bought yen to cover their short positions amid expectations that Japanese firms would repatriate funds from overseas investments ahead of the economy's fiscal half-year end. Despite lingering uncertainty about the economic impact of the September 11 events, the dollar started to strengthen around mid October 2001. As for the euro, it weakened with growing expectations that the US economic activity would outpace that of the euro area, given that economic data from the countries in the euro region were increasingly pointing to deteriorating conditions. In Japan, the worsening economic and financial outlook shifted the balance of risks towards a weaker yen which depreciated significantly, particularly against the dollar. As signs of recovery began to emerge in the US in early 2002, market expectations regarding the prospects for economic growth further strengthened the dollar. The introduction of euro notes and coins on 1 January 2002, has been a historic step and has been accomplished remarkably smoothly. By increasing price transparency and reducing transaction costs, the euro currency is expected to promote greater economic integration. Notwithstanding the introduction of euro notes and coins that supported the euro at the start of the year, renewed focus on growth differentials led to its weakness. In the second quarter of 2002, concerns over the Middle East tensions and expectations that a US-led global recovery would diversify portfolio assets out of the US started weighing on the dollar and contributed to the strengthening of the euro.

Crude oil prices weakened during 2001 in reaction to the slowing world economy. Despite a short-lived spike immediately following the September 11 events, prices tumbled to less than US$19 a barrel at the end of 2001. The softening in world oil markets during 2001 occurred despite efforts by OPEC to maintain prices within the target range of US$22-28 a barrel. In December 2001, after negotiating commitments to cuts of close to half a million barrels a day with major non-OPEC producers, OPEC announced further cuts of 1.5 million barrels a day to start in the beginning of 2002 for a period of six months. Against the background of these cuts and with signs of recovery in US activity, oil prices firmed in early 2002 to close at US$23 a barrel. Prices went up even higher in March and April 2002, induced by fears of disruptions in supply due to the growing tensions in the Middle East; oil prices rose to about US$27 a barrel before falling subsequently as fears of significant disruptions of supply eroded.

Weak demand and declining exports in the face of slowing global activity led to a decline in the volume of world trade in 2001. The growth rate of world trade in goods and services declined markedly from 12.4 per cent in 2000 to a negative rate of 0.2 per cent in 2001. The volume of world trade is expected to pick up by 2.5 per cent in 2002 and further by 6.6 per cent in 2003. In the advanced economies, the rate of growth of the volume of exports fell from 11.7 per cent in 2000 to a negative rate of 1.3 per cent in 2001 but is expected to pick up to 0.9 per cent in 2002. Developing countries’ exports fell from 15.0 per cent in 2000 to 3.0 per cent in 2001. However, trade liberalisation giving greater access to exports from developing countries in world markets may contribute to a pickup in the volume of exports of developing countries, which is projected to grow by 4.8 per cent in 2002.

Current account imbalances, especially the persistent current account deficit in the US and surpluses in many other advanced countries, remain a serious risk to economic stability. They have been driven in large part by the relatively rapid growth in the US as compared to other countries. The current account deficit in the US declined only slightly from 4.5 per cent of GDP in 2000 to 4.1 per cent of GDP in 2001. It is expected to remain at the same level in 2002. In the UK, the current account deficit stood at 1.8 per cent of GDP both in 2000 and 2001; it is, however, expected to deteriorate to 2.1 per cent of GDP in 2002. The current account surplus in Japan fell from 2.5 per cent of GDP in 2000 to 2.1 per cent of GDP in 2001. However, it is projected to rise to 2.9 per cent of GDP in 2002. After registering a current account deficit of 0.2 per cent of GDP in 2000, the euro area recorded a current account surplus equivalent to 0.7 per cent of GDP in 2001. This surplus is expected to rise slightly to 0.8 per cent of GDP in 2002. Little progress has been made in reducing these persistent imbalances in the global economy due to the synchronous slowdown. However, decisive actions to reinvigorate activity in Japan, continued structural reforms to encourage growth in the euro area and ongoing corporate and financial sector reforms in some Asian emerging markets with large current account surpluses, have become a priority from both national and international perspectives and may contribute towards containing the imbalances in the medium term.

Total external debt of developing countries declined from US$2,208 billion in 2000 to US$2,190 billion in 2001 but is expected to rise to US$2,232 billion in 2002. However, the ratio of debt to GDP, which stood at 40.8 per cent in 2000 and 2001, is expected to remain at the same level in 2002 due to the prospective strength in activity in the developing countries as the global economy recovers.