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S. Venkitaramanan

THE International Monetary Fund brings out its World Economic Outlook (WEO) twice every year, once in April and the second time in September. These coincide with the semi-annual meetings of Finance Ministers and central bankers, hosted by the Bretton Woods institutions, the World Bank and the IMF.

The latest Outlook is professionally competent, keeping up the traditions of its predecessors. It offers the most authoritative forecast of global economic conditions, to be put out by a multilateral agency.

The latest WEO 2003 estimates the global economy to grow at 3.2 per cent in 2003 and 4.1 per cent in 2004. Advanced economies, which include the US, EU and Japan, are expected to grow at 1.8 per cent in 2003 and 2.9 per cent in 2004. The US, in particular, is estimated to clock a rate of growth of 2.6 per cent in 2003 and 3.9 per cent in 2004. Japan's estimated rate of growth is only 2.0 per cent and 1.4 per cent in 2003 and 2004 respectively.

Against these low figures, the rates of growth of China and India are, indeed, impressive. India is estimated to grow at 5.6 per cent in 2003 and 5.9 per cent in 2004 and China is expected to record a rate of growth at 7.5 per cent in each of the years. The growth of the global economy is propped up by these two emerging economies.

The IMF calculates the rate of growth of the world economy, based on exchange rates calculated on purchasing power parity basis and not on market exchange rates. On market exchange rates, the global growth rate is significantly lower, at 2.3 per cent for 2003 and 3.2 per cent for the year 2004.

The WEO 2003 notes that the US dollar has continued to depreciate through end May 2003. It also notes that private capital outflows on a global basis have reached a high of $110 billion, the highest since 1990. One important aspect of the global economy has been the swings in the oil prices, contributed by geopolitical developments.

Crude peaked to $34 a barrel before the Iraq war and then fell back sharply. In early September 2003, they fell further. The WEO expects oil prices to fall sharply to a level of nearly $25.5 in 2004. The Outlook estimates oil prices to fall, accompanied by a rise in non-oil commodity prices. This will be a boon for many developing countries.

Referring to the need for the US to adjust its economy to reduce its high current account deficit (5 per cent of GDP), the WEO 2003 hypothesises that the decline in the US dollar has so far been relatively orderly and generally welcome.

Resultant financial conditions in EU were offset largely by the ECB's interest rate cuts. WTO does not rule out further substantial dollar depreciation, which would have significant implications of the outlook, especially if it continues to be focused on the Euro area more than others.

Overall, global economic growth is expected to go up, underpinned by reduced geopolitical uncertainties — policy stimulus in the pipeline, a decline in oil prices and gradual diminution of the impact of the equity bubble. The WEO expects monetary policies to remain accommodative — a relaxed interest rate stance and credit policies — with only a gradual withdrawal of the stimulus, to begin in 2004, meaning thereby that interest rates may, however, rise in 2004.

Recovery will continue to be led by the US despite a weak labour market and considerable excess capacity. Current data show signs of improvement, with fiscal policy stimulus still in the pipeline — further budget deficits forecast as a result of the Bush administration's decisions.

Japan also seems to be on the return trajectory, given the stronger than expected second quarter outturn. Japan's revival is crucial, if the US is not to carry the entire burden of supporting global economic growth. But that will, in turn, depend on the US' growth since Japan is also highly export-dependent.

For a change, the WEO now rates the risks of deflation as slight. "The risk of a global deflationary spiral appears remote and inflationary expectations have recently edged up, reflecting increasing expectations of recovery and recent policy measures". However, the Outlook does not rule out the possibility of a temporary period of price decline, in the event of an adverse shock.

Most importantl, it cites Germany as a candidate for such an occurrence. Germany should practise an accommodative monetary and fiscal stance. It is, however, caught in the tentacles of the Growth and Stability Pact, which deny room for any fiscal adjustment to stimulate its stumbling economy.

The WEO administers a note of caution to developing countries, which depend heavily on debt financing from external markets. In its view, the recent improvement in financing conditions owes much to the temporary cyclical factors and could be reversed if industrial country interest rates rise.

This underscores the need to use the current window of opportunity for developing countries to press ahead their plans to address significant medium-term vulnerability.

The report devotes a special section to analysing the high level of public debt in emerging market economies. On an average, as a percentage of GDP, they are high in these countries and mostly well above the sustainable level. The Outlook cautions developing countries on the need to take steps to bring their fiscal situation under balance.

The report, however, notes that a few of the emerging market economies have not experienced debt crisis or have high inflationary rates in spite of their high debt-GDP ratio.

For instance, India and Malaysia have managed to maintain high debt/GDP ratios for a long period without a default, mainly because of the comparatively closed nature of their capital account. Further, these countries did not have resort much to large external debt.

The WEO notes that debt ratios prior to Asian crisis were held down by over-valued exchange rates reflecting the importance of foreign currency denominated debt in such countries. Perhaps, this is yet another reason why emerging markets should not be pressed unduly to revalue their currencies, especially when they have external debts denominated in foreign currency.

The general thrust of the report in favour of a cautious policy in regard to public debt is to be welcomed. The WEO stresses that ratios of revenue to GDP for emerging markets are low. On an average, the ratio of tax revenue to GDP is about 27 per cent of GDP for emerging markets compared with 44 per cent of GDP of industrial countries.

Further, effective tax rates for emerging market economies are generally lower than those of industrial countries. For instance, direct tax rates for industrial economies are 30 per cent or more, whereas for emerging markets outside Eastern Europe, they are often only 10 per cent. The need for effecting tax reform on the broad lines suggested by Dr Vijay Kelkar is re-emphasised in the light of these observations.

The fiscal situation of the emerging market economies is dictated, particularly by the pressure on the Government to maintain a high level of State intervention in investment activity. Such a demand does not operate in advanced economies. The recent experience of Brazil and Argentina in negotiating IMF aid is relevant in this context.

Argentina has been able to negotiate a substantially attractive deal with IMF. The new credit is on relatively easy terms. Further, their private creditors have followed a write down in the value of debt on which Argentina had defaulted in 2001. It is also significant that international lenders have had to adjust to the demand of the country for a high write-down of their principal. "Scandalous" as the proposed 75 per cent write-down appears to some lenders, there are chances that international lenders may have to accept this demand of Argentina.

An indication of softening of lenders' term is in respect of Brazil wherein IMF has agreed that the debt of the public sector oil giant Petrobras will not be taken into account in calculating the public debt to GDP burden. This shows that IMF is increasingly inclined to be more pragmatic in reckoning ceilings of public debt, obviously with a view to allowing elbowroom for economies, such as Brazil, which depend on public sector investment for infrastructural development.

In spite of these developments, the cautionary note of the WEO on the levels of public debt for developing countries is, indeed, rational. One should not, however, carry it beyond a limit.

Public debt in developing countries incurred for infrastructural investment — which is undertaken in advanced economies by the private sector — should not be considered as an evil to be avoided. One should be careful not to stifle economic growth in countries which depend on the state to fill the gaps in private sector financing for infrastructure. This is, in fact, the secret of Chinese growth miracle.

While the WEO stresses a number of lessons to be drawn from market economies, it does not draw the obvious conclusions from the instances of marked success in economic growth for developing economies, namely China and India, which have managed higher growth without inflation.

Is it because the West spurns the lessons offered by the Eastern countries, however striking the success?

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