The Hindu Business Line : World Economic Outlook, September 2005

APRIL and September are the months when Finance Ministers and central bank Governors gather in Washington or some other location to attend the semi-annual Fund-Bank meetings. These are also occasions for a review of global economic trends and problems.

The diminishing role of the IMF and the IBRD in the wake of massive private capital flows has robbed them of much of their importance. . The IMF's World Economic Outlook (WEO), released to coincide with the latest IMF-World Bank Conference, represents that institution's current assessment of global economic prospects, problems and constraints. It has brought to bear the considered judgment of its army of experts, conceded highly competent.

Its general conclusion is that world economic expansion will remain on track despite the rising oil price and a consequent worsening of global economic imbalances. The IMF has forecast a global economic growth of 4.3 per cent this year, virtually the same as forecast in its April 2005 report. It notes with some surprise that the impact of crude price increases on growth and inflation has been "surprisingly moderate".

But, in the words of Dr Raghuram Rajan, IMF's Chief Economist, the high oil price remains a clear and potent danger for growth and inflation. High energy prices could hurt consumer confidence and lead to accelerating inflation.

The IMF report noted that the growth of the global economy demonstrated sufficient momentum to withstand a rise in market-determined interest rates from very low levels, but indicated that rising inflation expectations could lead to a sharp tightening of financial market conditions.

"The days of easy money are over", seems to be the message of the IMF's latest Outlook. The report also highlights the continuing high dependence of world growth on the US and China and the dangers presented by growing imbalances in the global economy.

Its view is that these imbalances could aggravate protectionist pressures in the US as they have already done in respect of textile imports and outsourcing of services. This trend would be particularly strengthened by the emergence of competitive forces resulting from the success of China's manufacturing industries on the global scene.

The Outlook notes that financial market conditions continue to remain benign. Long-term interest rates, while volatile, remain universally low around the world. Global equity markets remain resilient, supported by strong corporate results and increasingly solid balance-sheets.

The report notes that credit spreads remain moderate. Emerging market financing conditions are very favourable, in part reflecting improved economic fundamentals and the increased presence of long-term investors. The report notes that, in general, in the current low interest rate scenario, market participants have tried to boost yield on their investments through increasingly complex and leveraged strategies. This contains a warning to be heeded by regulators in countries such as India, which is witnessing an unprecedented stock-market boom.

The WEO 2005 also notes that such "trades" have resulted in material losses incurred by a number of hedge funds when General Motors and Ford's debt paper was downgraded, though the impact was relatively contained and turbulence did not spread into global markets.

The WEO notes the perceptive comment of the Fed Chairman, Mr Alan Greenspan, that continuance of low interest rates in the long end of the debt markets in the face of rising short-term rates remains a conundrum.

The WEO comments that the situation is difficult to reconcile with economic fundamentals, including rising public debt in countries, in general. It admits the reasons for this contradiction are obviously global in nature, including the rising trends in global savings, particularly in countries, like China.

The WEO reiterates the usual admonitions in respect of global economic imbalances — the need for the US to adjust its consumption, its fiscal stance, as well as the imperative urgency of China moving to flexible exchange rate regimes, and for Japan to restructure its economy and the Euro Zone to reactivate its industries by undertaking structural reforms.

The recommendations are couched, as usual, in persuasive language, but how far the countries for which the advice is intended will heed the sensible macroeconomic lessons remains uncertain. Turning to India, the latest WEO has a special Box entitled "Is India becoming an engine of global growth?" It notes that India experienced 7.7 per cent growth in 2003-2004, higher than growth in all other Asian countries, except China and well above its own trend growth since the early 1990s.

India's share in world output in purchasing power parity adjusted exchange rates has increased from about 4.3 per cent in 1990 to 5.8 per cent in 2004. One question is whether India has become an engine for world growth.

The WEO notes that over the past 10 years, India has accounted for just under one-fifth of Asian growth and about 10 per cent of world growth, compared to 53 per cent and 28 per cent respectively for China. It is obvious that spill-overs from India's growth (on the global economy) remain limited compared to China.

India's limited role to-date as a growth engine in the global economy reflects the fact that it remains a relatively closed economy.

The report states that various factors have hindered India's integration. India remains relatively protected, says the report, with tariffs averaging 22 per cent or 18 per cent in trade-weighted terms above the average trend in emerging Asia and global tariff rates of 9.5 per cent and 11.5 per cent respectively. Significant non-tariff barriers also remain. Moreover, structural impediments, including labour laws and onerous red tape, have retarded the growth of manufacturing, which has been the driver of growth in the rest of emerging Asia.

The WEO notes that foreign direct investment in India has been hindered by a difficult business climate as well as by caps on FDI in certain sectors.

According to the WEO, infrastructure investment has to rise to 7-8 per cent of GDP — an increase of 3 per cent — if India is to maintain its current trend rate of growth. But progress in addressing this bottleneck has been constrained by persistent large fiscal deficits, which, though decreasing in recent years, remain high.

The report shows the potential that India has and the opportunities it has been missing.

To sum up, the WEO September 2005offers a bouquet of cogent and well-considered comments on the global economy. Whether the policy-makers in the important countries of the world will listen depends on the extent to which they have to lean on IMF to subserve their political ends.

This seems unlikely at present, as long as the IMF is itself not provided with a tool with which to serve the various member-countries, including, in particular, the surplus nations. The suggestions in the Outlook are bound to be a case of whistling in the dark. Policy-makers a la Mr George Bush, Mr Tony Blair, Mr Hu Jintao, and perhaps Dr Manmohan Singh, will read its the lucid paragraphs but, in all likelihood, pass on, unable to act.

If there is a message in the WEO-2005, it is this and it is crystal clear. "The world is doing well, but it is on risky track, what with its gaping global imbalances in terms of current account deficits and fiscal gaps, as well as rising crude prices."

The WEO has obviously done its job adequately by sounding the note of warning that the world should take corrective steps. Unless the different nations of the world — the rich as well as the poor — seriously take up the challenge of adjusting the imbalances, there could be a hard landing. But, so far, the auguries have not been too bad.

The world seems to be muddling along, thanks, but no thanks, to accommodative monetary policies and obliging central bankers in emerging Asia and in West Asia, who invest their riches in the West. But the World Economic Outlook gives no guesstimate as to when the cookie will crumble. And if, or when, it does, we cannot say we have not been warned.

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