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World Economic Outlook — September 2002: Strong on trade and financial linkages

S. Venkitaramanan

The IMF's World Economic Outlook is an eagerly-awaited document, although it does not often say anything new. While the WEO is strong on linkages between trade and financial integration and advocacy in trade liberalisation, it is weak on suggestions for restructuring global finance.

It is that time of year when Finance Ministers of the world and central bankers gather to discuss the world economic prospects under the auspices of the World Bank and the IMF. The latest such Conference is just over, preceded, of course, by the usual demonstrations of NGO activists protesting — in vain — against the Bank and the Fund. The fact that the latest Conference has invited very little media reaction in India is indicative of our comparative insulation from major problems, thanks to the 1991 reforms.

Notwithstanding the latest downgrading by Standard & Poor of India's internal debt, we continue to hold our head high as one of the few countries that have a respectable rate of economic growth, low inflation and comfortable BoP position. Compare our position with a decade or so earlier when every whisper in the galleries in the Bank and the Fund used to be carefully reported. Liberalisation and reforms have definitely enabled us to gain relative independence from the gurus on the Potomac.

The IMF's World Economic Outlook (WEO) is an eagerly-awaited document, although it does not often say anything new. WEO September 2002 concentrates on interlinkages between trade and finance. The WEO notes that since late 2001, a global recovery has been under way. However, after a strong first quarter, concerns about the pace and sustainability of the recovery have risen significantly. Financial markets have weakened markedly with equity markets falling sharply since end March, accompanied by a depreciation of the US dollar. The Outlook notes that financial conditions in emerging markets have deteriorated, particularly in South America and Turkey. The recovery is, however, expected to continue in the second half of 2002, and in 2003, the growth is estimated to be weaker than earlier expected.

Risks to the global outlook are primarily on the downside. Since inflationary pressures remain generally subdued, macro-economic policies in advanced countries will now need to remain accommodative for longer than had earlier been rejected. The report cautions that it is necessary to reduce dependence on the US as the global engine of growth.

The WEO returns to the theme of global imbalances, which it had addressed in April 2002. The growing imbalance, especially on the part of the US' current account is highlighted as an important issue.

The WEO faces frontally the criticism that "current account deficit" is becoming an outmoded concept — a view lately restated by the US Treasury Secretary, Mr Paul O'Neil. The IMF believes that current account deficit still matters if only for the reason that external adjustments across countries imply significant changes in the tradable goods sector and in real exchange rates. The Fund cautions against rapid movements in exchange rates, which can lead to disruptive changes in the global macro economy. Any instability as a result of unsustainable current account deficits can translate into a critical situation and can have adverse impact on the international financial system. The Outlook points out that historically the international financial system has been most stable when the external position of the leader country has been strong. However, the recent deterioration of the US, the current financial leader of the world, causes concern.

The WEO emphasises the seriousness of the situation. There is now a gap of 2.5 per cent of global GDP between the current account surpluses of Continental Europe and East Asia and the deficits of deficit countries dominated by the United States. Reviewing historical data, WEO cautions that adjustments of such large imbalances would require not only policy changes in the deficit countries but also structural changes in the surplus countries, which should include relaxation of various policies and boosting of growth. It is doubtful whether this policy advice will find ready acceptance amongst the currently surplus countries such as China, Japan and other East Asian economies. Japan is already struggling with the consequences of this current stagnation. It is easy to advise, but difficult to implement a structural change.

The latest WEO incorporates two essays on trade and financial integration. It points out, in particular, that trade and financial integration typically go hand-in-hand. Financial openness in industrial countries has increased sharply, especially during the 1980s and 1990s. The rise in financial flows among industrial countries has enabled the US to become both the world's largest creditor and its largest debtor. Trade openness has also increased, but less so than financial openness in industrial countries.

The WEO devotes particular attention to the fact that industrial countries are increasingly subsidising their agricultural production. These subsidies are distorting both domestic farm production and international trade. The total transfers from consumer and tax-payers to farmers of these countries averaged about 30 per cent of farmers' gross income in 2001. In absolute terms, these subsidies cost over $300 billion. This alone amounted to six times the overseas development aid. Support to agriculture by industrial countries is definitely at a unsustainable level. It is also provided in a manner, which is admittedly highly inefficient, although politically-driven. The WEO argues that these support programmes should be reviewed keeping in view that there is better use for money so saved and also the fact that the present structure of agricultural support distorts the pattern of global agricultural production. Whether this sane advice will be heeded is, however, very much in doubt, especially as it is the richer countries that have to act.

The WEO notes that, in India, a cyclical recovery is now under way, although agriculture has been negatively affected by a poor monsoon and the regional security situation and higher oil prices are sources of risk. The Outlook also notes that inflation remains moderate and the external position is comfortable. It highlights the fiscal deficit as among the highest in the world, making fiscal consolidation an urgent necessity.

The Outlook makes a special comment on India's relative slowness in trade liberalisation. It quotes the RBI Governor, Mr Bimal Jalan, as having stated that "Despite all the talk, we are nowhere even close to being globalised in terms of any commonly used indicator of globalisation. In fact, we (India) are still one of the least globalised among major countries — however we look at it." The WEO notes that while some reforms had taken place in the 1990s, India's trade regime remains one of the most restrictive. India's average tariff also remains one of the highest in the world. In addition, a range of non-tariff barriers continues to be in use, including some import bans, import restrictions in state trading and stringent standards of certification requirements.

The Outlook also highlights the fact that India has become one of the major users of anti-dumping measures. Measured by the IMF's trade restrictiveness index, India stands at 8 (on a scale of one to 10) compared with 5 for China and 4-5 for other countries in East Asia. Trade development has been further restrained by various domestic impediments to investment and growth. Between 1980 and 2000, India's trade openness increased by about 50 per cent while that of China surged by 150 per cent. While India's share of world merchandise exports increased from 0.5 per cent to less than 0.7 per cent over the last 20 years, China's share more than tripled to almost 4 per cent. Perhaps, as a result, FDI flows to India also remain very low in comparison to China and some other emerging countries.


While the WEO is strong on linkages between trade and financial integration and advocacy in trade liberalisation, it is weak on suggestions for restructuring global finance. It is particularly intriguing considering the heavy attack mounted on the IMF by distinguished critics, including Mr Joseph Stiglitz, the Nobel Laureate. The WEO has consciously avoided any reference to suggestions for restructuring global financial architecture. There is no specific reference to the initiative launched at the behest of Ms Anne Krueger for global debt restructuring and sovereign bankruptcy procedures. The fact is that in spite of continuing bailouts, countries in Latin America continue to be chronic borrowers subject to international investors' volatility. IMF has not found a way-out of its own problems.

Whether the recent events will encourage it to think out of the box remains to be seen. But, in the jamboree atmosphere of the World Bank-Fund Conference, there would have been very little scope for evolving any constructive suggestions. These will have to await a careful and considered consultation amongst bankers and professionals of the multilateral institutions together with the concerned Finance Ministers, particularly from developing countries. The global financial situation will continue to remain clouded so long as the basic financial architecture remains unchanged. The question is whether IMF, which advocates reforms for every one else, will reform itself and if so, how soon. Till then, we will continue to see the world moving from one reluctant but inevitable bailout to another.

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