The Hindu Business Line : IMF on world economy: Will the recovery `spring' eternal?

The world economy is on the recovery path and the IMF has forecast for the next two years a growth rate that is the best in over a decade. S. Sethuraman looks at how the turnaround came about, and the risks that lie ahead.

THE International Monetary Fund (IMF) has delivered the most upbeat assessment for the world economy, projecting a 4.5 per cent average growth for 2004-05, the best two-year period in over a decade. Finance Ministers of industrial and developing nations who gathered in Washington in April celebrated the "springtime of recovery" after a somewhat prolonged downturn, with calls for more "pro-growth" reforms to sustain the resurgence despite serious risks to overcome.

Standard rhetoric apart, there was no commitment on the part of the major players — the US, the EU and Japan — to any co-ordinated strategy for bringing about an orderly resolution of global imbalances or achieve a smooth transition to higher interest rates, which would eventually be required as growth strengthens globally.

But there remains uncertainty about the timing and speed of future moves in the realm of monetary policies. Dutifully, the ministers called for early progress to the stalled Doha Round and reduction of trade-distorting subsidies in agriculture, but stressed that successful completion was a "shared responsibility" of all WTO member-countries.

The large fiscal and current deficits of the US are at the core of concerns, though sustained growth would also be imperilled if the EU, which gets expanded on May 1 with ten more countries of central and eastern Europe, balks at accelerating the ordained reforms of product and labour markets, and Japan's rise out of deflation is not fortified with banking and corporate reforms.

All that the communiqué of the International Monetary and Financial Committee (IMFC) said was that the priority now was to implement macro-economic and structural policy measures that would help to achieve a "robust, balanced and sustainable recovery," and it called on "all countries and regions to play their part and co-operate in addressing global imbalances."

How has the turnaround in the global economy come about, and what are the risks ahead? IMF's Economic Counsellor, Mr Raghuram Rajan, cites the impressive rebound in world trade, the robust US recovery (growth at above 3 per cent and 4 per cent in the last two quarters of 2003 with signs of job additions), exceptionally high growth in emerging Asia, especially China (9.1 per cent), and the strongest showing for Japan's economy since l996.

The other contributory factors have been rising business confidence, as reflected in pick-up in investment and industrial production, low inflation and interest rates, abundant liquidity and stable financial markets, helped in part by the gradual adjustment of the falling dollar vis-à-vis other major currencies.

Competitive exchange rates and revival of the IT sector have also fuelled growth in developing Asia. Based on the continuance of this benign environment and a sharp rise in global trade to 6.8 per cent (IMF) and 7.5 per cent (WTO) in 2004, the Fund estimates the world economy to grow to 4.6 per cent this year and 4.4 per cent in 2005 with the US registering a growth of 4.6 per cent and 3.9 per cent respectively for the two years.

Growth will be faster in developing Asia, 7.4 per cent and 7 per cent in 2004 and 2005, respectively, largely due to the booming economies of China (8.5 and 8 per cent) and India (6.8 and 6 per cent). A solid recovery is under way in Latin America, notably Brazil and Argentina.

The risks to short-term outlook are, apart from large global imbalances of countries (in deficits and surpluses) and the implications of transition to a higher interest rate environment, the surge in oil prices and continuing geo-political uncertainties, including likely terrorist attacks.

Fiscal consolidation has to take place not only in the US but also in Europe (in countries such as Germany, France and Italy) and Japan as well as in some of the emerging economies, including India.

In its World Economic Outlook, the IMF says that further progress in addressing India's "large" fiscal imbalances is urgent because recovery would increase private sector's demand for financing, putting upward pressure on interest rates.

What the IMF looks at is the overall public sector deficit (of the Centre's, the States' and public undertakings) which, Mr Rajan says, is sizeable, and, if it had not any serious impact so far, it is because private investment had remained subdued. The expectation is that private sector investment would pick up in India as well.

China and India have been lauded for their strong performance, aided by macroeconomic fundamentals and rebound in private capital flows. Emerging economies, in general, are urged to take advantage of the current favourable global environment to press ahead with structural reforms needed to strengthen the growth potential and fiscal position and improve flexibility and resilience and to resist protectionist pressures.

Exchange rate flexibility has been enjoined upon Asian surplus countries, particularly China. Indeed, the dynamism in emerging Asia with its rapid growth, bulging reserves (which increased by $250 billion in 2003), current account surplus and capital inflows is raising the question whether the region is becoming less dependent on the world economy. Emerging Asia's current share in world output is 25 per cent and in trade, 19 per cent.

China has increasingly become the engine for regional growth with its growing imports from its neighbours and is turning into a regional reprocessing and manufacturing hub for re-exports. China's rising demand for primary products and metals is boosting world commodity prices. Intra-regional trade now accounts for 40 per cent of total exports of the countries within. However, advanced economies remain the largest export market for final goods.

The IMF says the region will need to nurture domestic demand growth, strengthen its financial markets and improve governance, and increase competition.

If China tackles its financial and enterprise sector reform challenges forcefully, its growing weight and influence in the world economy would continue for much longer, according to the IMF.

Indications were clear in Washington that the US would now want China, with its larger and critical role in the world economy, to be a dialogue partner for G-7. Finance Ministers of G-7 countries, dominating the Bretton Woods institutions by their voting power, called for more exchange rate flexibility, having China in mind, and for more "pro-growth" reforms in major countries and "economic areas that lack such flexibility."

Of late, Beijing has also been giving indications that over time it would let renminbi exchange rate develop in the direction of increased flexibility.

For India, the RBI Governor, Dr Y. V. Reddy, pointed out that accumulation of reserves in emerging market economies in Asia were not only linked to exchange rate policies and related trade and employment implications but also the lack of confidence in the existing international financial architecture which needed to be redesigned.

He called for bold leadership at the international level to make the institutions effective and transparent and ensure that resource flows were adequate to meet social goals and that protectionist measures, particularly in the agriculture and textile sectors, were shed at a time when developing countries had been opening up their markets.

Predictably, the G-7 and the IMFC communiqué, which reflects the majority view of richer nations, did not attach any sense of urgency to key issues of concern to developing countries, resource transfers in the context of the Millennium Development Goals on poverty reduction and other social targets or the "democratic deficit" in the international financial institutions, as Dr Reddy put it.

All these and the criteria for quota revision so as to reflect the economic weight of different countries were all remitted back to the IMF for further reviews to be considered at the Fund-Bank annual meetings in October next.

Meanwhile, the Bush Administration wants to cut the IMF to size and plans to redefine the role of the Fund and the World Bank, now in the 60th year of their founding in 1944.

The US Treasury Secretary, Mr John Snow, made no secret of his administration's plan to trim the sails of the IMF and suggested it should limit lending for balance of payments support and that low-income countries, with fundamentals in place, should move beyond concessional borrowing (under the poverty reduction and growth strategy) to attract capital.

(The author, a former Chief Editor of PTI, is a freelance journalist.)

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