The Hindu Business Line : IMF's World Economic Outlook 2004 — For better fiscal consolidation in developed countries

JUST last week, we reviewed the World Bank's Global Finance and Development Report. Soon after has come the time to survey the IMF's World Economic Outlook (WEO) 2004, produced in time for the semi-annual meeting of the world's Finance Ministers and central bankers.

Time was when these meetings were occasions for the big finance boys of the world to offer their courtesies to the Finance Ministers. As we have seen, the tables have been reversed, with erstwhile borrowers becoming lenders and investors. The fizz and glamour must have waned with the role change.

The World Economic Outlook offered by IMF more or less covers the same ground as IBRD's report, but with a greater touch of professional assurance. It conveys the message that the global economy has been on a path of growth. It has revised its earlier September 2003 forecasts upwards by a 0.5-0.6 per cent.

In particular, for the US economy, it projects a rate of growth of 4.6 per cent in 2004 and 3.9 per cent in 2005, while for the world as a whole, the rates projected are 4.6 per cent and 4.4 per cent. The other main engine of growth (China) is expected to grow at 8.5 per cent and 8.0 per cent respectively. India follows closely behind with an estimate of 6.8 per cent and 6.0 per cent respectively. (These are in line with our own authorities' latest estimates.)

Insofar as the commodity prices go, the report suggests that a hardening is on the cards. Especially in respect of crude, the expected improvement in Iraq supplies hangs on the security situation, which is still fragile. Further, the depreciation of the US dollar means the oil exporters expect a higher price in dollar terms.

Taking this and the anticipated robust demand globally, the estimate is that crude price will not decline. Indeed, they will be on a rising trend, with considerable volatility.

Similarly, non-energy commodity prices are also leading to firm up, thanks to the growing demand, especially from China.

This has to be factored in our calculations of inflation in India over the coming years. This also has implications for policy in the petroleum sector. How long can the Government afford to support low prices to the consumer when import parity prices increase? The fisc will be under great pressure.

The IMF's World Economic Outlook 2004 contains the usual observations on the non-sustainability of the twin deficits of the US. While it notes the recent depreciation of the greenback, it points out that it has not yet led to an improvement of the current account deficit.

In a perceptive "box", WEO 2004 points out that the depreciation of the dollar has some unintended benefits for the US. Its assets denominated in foreign currencies increase in value, while its liabilities denominated in dollars decline in real value. The US' net asset position improves when the dollar depreciates — a consequence of the currency composition of its assets and liabilities. It pays the US to have its debt denominated in a declining currency, albeit its own.

On interest rates, the WEO gives the same cautionary advice that the World Bank's Global Development Finance report offers. It observes that the world's soft interest rate regime is likely to come to an end. The US Fed will surely have to raise rates in the not distant future.

This will definitely spell problems for countries with high foreign borrowing with rates linked to the prevalent rates in New York. The honeymoon with soft rates is surely about to end.

This implies risks of various kinds, including effects on stock markets and financial markets. There can be serious repercussions on capital flows also.

The WEO notes that not only in the US, in other countries also, soft monetary policy needs to change. "Interest rates in almost all countries will need to rise as the recovery continues, although the near-term situation varies significantly depending importantly on the evolving pace and nature of the recovery. In some countries, notably the UK and Australia, the tightening cycle is under-way already. In others, especially those that have experienced exchange rate appreciation, further easing could be required".

But, by and large, the WEO is of the view that tightening of monetary policy is on the cards for the world as a whole.

A key challenge for the central banks will be to communicate their intention as clearly as possible to markets, thereby reducing the risk of abrupt changes and expectations later on. This is obviously a tall order. But regulators are expected to be familiar with such challenges.

Turning to Japan, the WEO pointedly remarks that recovery had continued and substantially exceeded expectations with GDP growth in 2003 estimated at 2.7 per cent, about 0.7 per cent higher than projected last September.

Despite the appreciation of the yen, notwithstanding the record official foreign exchange intervention, the recovery has been driven by exports, particularly to Asia and by redounding private investments, either by raising corporate profitability and recovery in equity markets.

The WEO is silent on the positive contribution made by Japan's deliberate policy of monetary expansion and keeping the yen lower than what it would have been otherwise.

The WEO touches on the prospects of increasing reserves in emerging economies. It points out that India and China will continue to have large capital inflows and current account surpluses leading to higher reserves. The problems that these reserves represent — high cost of investment, likely impact on money supply — are touched on only briefly.

Obviously, the focus of the WEO is on more fundamental issues, such as the US's structural imbalance and how to correct them. Asia's reserves are needed to support it.

The WEO 2004 is, as usual, a professionally well-done job. It has high credibility, coming as it does from the best economic brains housed in any single institution in the world. In particular, it focusses on the importance of enhancing the ability of economies to cope with adversity.

It points out the existence of geopolitical and other risks in the recent past, which had the potential to destroy confidence and thereby economic activity.

The fact that 9/11 and the Sars epidemic did not destroy the ability of the global economy to survive was due to the expansionary policies followed both in the US and China. These expansionary policies restored life to these economies and are, in turn, now driving world economic growth.

The WEO is right to emphasise that the source of resilience is the ability to use "policy". The US could respond to the events of September 11 with expansionary policies precisely because "it had a fundamentally sound fiscal house and had room for monetary expansion. But these policy bullets are now largely spent".

The best way to insure against future shocks is to restore the ability to use policy in a similar way. WEO naturally plugs for more solid fiscal consolidation in the developed countries precisely for this reason. It will also be good for long-term growth for the US as it has to meet the long-run fiscal costs of an aging population. It will also help growth in the rest of the world. The latest WEO 2004 is noteworthy for its lack of hectoring to developing countries on exchange rate policy. Unlike its predecessor, it has not devoted too much attention to the need for countries, like China, to have a floating exchange rate.

While there is no doubt about the obvious pressure on the part of the US trying to persuade Asian economies to have their currencies appreciate, the WEO merely notes the fact that the central bankers are intervening.

The WEO 2004 does not devote too much attention to themes, which are within the purview of its counterpart, the World Bank, especially policies relating to poverty alleviation. These are matters on which in the 1990s the IMF devoted considerable attention with the consequence that its energies were too thinly spread.

Similarly, apart from a reference to the uncomfortable situation in regard to Doha Round, the WEO does not also devote too much attention to questions of trade issues.

This is a subject on which much can be written. The WEO is reticent for obvious reasons. The US and the EU, the principal shareholders of IMF, are primarily responsible for the current stand-off in WTO negotiations.

All in all, WEO 2004 incorporates good counsel coming from the gurus of the Potomac. It is to be hoped that the imperial power of the US will be able to take the advice offered, at least after the Presidential elections. As the report states succinctly, its suggestions leave much work for policy-makers. It says: "In putting together the World Economic Outlook, we have the luxury of being able to offer advice without having to carry it out".

This observation typifies the wholesome lack of intellectual arrogance that characterises the latest WEO 2004. How one wishes the same spirit of humility extends to all those in the IMF who proffer advice to the poorer countries of the world that are struggling with their complex economic problems.