ECE/GEN/99/3
Embargo
Tuesday, 4 May 1999
00:01 hours GMT
Geneva, 27 April 1999
ECONOMIC
SLOWDOWN IN WESTERN MARKET ECONOMIES,
RECESSION
POSSIBLE IN TRANSITION ECONOMIES
UN/ECE releases its
latest 1999 Economic Survey of Europe
Western market
economies: outlook still weakening
In western Europe,
economic activity became increasingly sluggish in the final
months of 1998, according to the United Nations Economic
Commission for Europe (UN/ECE) 1999 Economic Survey to be released on 4 May 1999. Industrial output fell in the last
quarter and real GDP rose only slightly. Industrial confidence
has continued to fall in the first three months of 1999 against
the background of deteriorating order books and weaker production
expectations. The marked rise in consumer confidence in 1998
petered out in February 1999 and weakened in March.
The short-term economic outlook
deteriorated steadily in the second half of 1998 and current
forecasts now point to an increase in real GDP of slightly less
than 2 per cent in 1999, down from 2.7 per cent in 1998.
This reflects essentially a weakening in the growth of total
domestic demand. The deceleration in export growth is expected to
continue this year, but the adverse effect on overall output
growth will be partly offset by the weaker demand for imports. In
the euro area, aggregate economic growth is forecast to be
slightly above 2 per cent in 1999, down from 2.8 per cent in
previous year. These forecasts imply that economic activity will
strengthen in the second half of the year and pave the way for
further cyclical gains in 2000.
The slowdown in economic growth
in 1999 will mean smaller increases in employment and little, if
any, further progress in reducing high levels of unemployment.
Inflation is not a problem, even
if the deflationary effects of falling commodity prices will no
longer be present in 1999.
The lowering of official
interest rates decided by the European Central Bank (ECB) in
early April 1999 is in line with the analysis made in the Survey. But the response of the ECB to the worsening of economic
performance and growth prospects has come rather late and, given
the long lags involved, will have little impact on economic
activity in 1999. Although nominal interest rates are now quite
low, there will be a need for a further easing of monetary policy
if economic conditions fail to improve significantly in the euro
area as a whole. This might also stem from an appreciation of the
euro, which would be tantamount to a tightening of monetary
conditions.
The burden on monetary policy to
stabilize economic activity is increased by the fact that the
scope for supportive fiscal policies in the three major economies
of the euro area is virtually exhausted given the rules of the
Stability and Growth Pact, and the associated stability
programmes, which aim at achieving broadly balanced government
budgets by the year 2002.
In the United States, the
continuing buoyancy of domestic demand and output in late 1998
has persisted in the first few months of 1999. The unemployment
rate fell to 4.2 per cent in March, the lowest rate in nearly 30
years, but inflationary pressures remain remarkably low. Real GDP
is now forecast to increase by some 3 per cent in 1999, down from
3.9 per cent in 1998.
Altogether, real GDP in western
Europe and North America is forecast to increase by some 2.5 per
cent in 1999, down from 3.3 per cent in 1998.
This relatively benign scenario,
however, is surrounded by considerable downside risks, the
effects of which could be amplified because they are partly
interrelated. Outcomes could be worse than currently forecast if
the recession in Japan were to deepen in 1999 rather than
bottoming out as expected or if net private capital inflows to
emerging markets are significantly lower then projected, with
concomitant adverse effects on their activity levels and import
demand. Another important risk is the high level of share prices
in many industrialized countries, notably in the United States: a
major downward correction of share prices in the United States
could have large negative effects on both consumer spending and
business investment with significant financial spillover effects
on western Europe. The projected rise in the US current account
deficit to record levels and the concomitant rise in net foreign
indebtedness, moreover, could eventually weaken the confidence of
international investors and trigger a large-scale withdrawal from
dollar denominated assets. This, in turn, would lead to a sharp
depreciation of the dollar, which would affect activity in
western Europe and other regions of the world economy.
It is still too early to judge
the impact of the war in Yugoslavia on economic activity in the
western market economies. It will depend partly on the length of
the conflict and whether it can be contained. Apart from the
depressing impact on exports to south-east Europe, a prolonged
war would put upward pressures on government defence spending,
which in view of the budget deficit targets in the euro area
would need to be offset by savings elsewhere or by higher taxes.
It cannot be excluded that the conflict will eventually affect
consumer and industrial confidence and dampen private sector
spending.
Transition economies:
negative impact of strong external shocks
The overall trend of economic
activity in the ECE transition economies was abruptly reversed
towards the middle of 1998 when the negative impact of a strong
external demand shock dominated the second half of the year. This
shock resulted from the combined effect of the collapse of
Russian imports, the drop in global demand for primary and
intermediate products, and the weakening of west European import
demand. Virtually all transition economies were negatively
affected (albeit to varying degrees) by the fall in external
demand. The speed at which economic developments deteriorated in
the second half of the year presents a serious challenge to
policy makers in the transition economies.
The rate of growth of aggregate
GDP in eastern Europe in 1998 (2 per cent) was only half of what
had been expected and well below the average in 1997 (2.8 per
cent) which reflects a general weakening of economic activity
throughout most of eastern Europe. There was a similar
disappointment in the Baltic states: aggregate GDP growth in 1998
(around 4 per cent) was considerably below the impressive 7.6 per
cent of 1997. Economic performance in the Commonwealth of
Independent States worsened considerably in 1998: aggregate GDP
of the CIS fell by 2: per cent, wiping out the modest 1.1 per cent
recovery in 1997.
In 1998, output growth in the
transition economies continued to be highly differentiated across
countries and the growing disparities in income levels among the
transition economies are becoming rather disturbing. Within
central and eastern Europe the new divide is between the group of
so-called leading reformers B those where institutional and market reforms are
well advanced, economic growth is relatively high and sustained,
and most of which are in the first wave of applicants for EU
membership B and a group, mainly in south-east
Europe, where a coherent programme of reforms has proved much
more difficult to design and implement, which in turn has made it
more difficult to achieve an improved macroeconomic performance.
Similar problems have marred the course of economic
transformation in most CIS countries. In these problematic groups
of transition economies, the external demand shock has been
amplified by the deepening of internal problems which, in turn,
have reinforced the negative trends of 1998.
The Russian crisis was
undoubtedly the event that attracted the most attention
in 1998 due its severity and wide-ranging repercussions
throughout the whole region. The August collapse of the rouble
and the effective default on Russia=s domestic debt was an effective admission that a
three-year strategy of juggling an unsustainable macroeconomic
policy mix in the absence of adequate institutional support and
microeconomic reforms had come to an unproductive end. Shock
waves from the Russian crisis hit all the ECE transition
economies but their repercussions were especially damaging to the
neighbouring CIS countries. Apart from the negative impact on
trade and output performance, these economies were also greatly
affected by the devaluation of the Russian rouble which triggered
a series of currency crises among CIS countries.
The unexpected weakening of
output growth has had a bad effect on the labour markets in the
ECE transition economies. This was especially pronounced in the
second half of the year when unemployment started to increase
rapidly throughout the whole region: between June and December
the average rates of unemployment in eastern Europe increased
from 11.6 to 12.6 per cent; in the Baltic states from 5.9 to 7.3
per cent; and in the CIS from an average 7.7 to 8.5 per cent.
In general, disinflation
continued in 1998 in eastern Europe, in the Baltic region and in
some of the CIS states; in many countries the inflation rate was
significantly lower than expected. This outcome was largely due
to lower import prices, a result of the large fall in the prices
of commodities and other tradables. At the same time, contagion
from the global financial turmoil in 1998, and especially from
the Russia crisis, resulted in increased financial and
macroeconomic turbulence in a number of transition economies; the
most visible consequence was the series of currency crises
leading to sizeable depreciation of the exchange rates. As a
consequence, strong inflationary pressures re-emerged in a number
of transition economies, mainly in the CIS, in the second half of
the year.
The value of the foreign trade
of the east European countries increased by some 8-9 per cent in
1998, more than in 1998 (6 per cent). However, most of the
increase occurred during the first months of the year; trade
performance weakened considerably in the second half. Despite the
apparently strong export performance for the region as a whole,
individual exporters in many countries suffered substantial
declines both in value and volume, mainly because of the
weakening of import demand in the CIS countries, and especially
in Russia.
The aggregate value of the
foreign trade of the CIS declined in 1998: during the first three
quarters of the year, the dollar value of total exports declined
by some 14 per cent, while the value of imports fell by 5 per
cent. All CIS countries are relatively specialized in the export
of primary commodities and these falls in value reflect to a
large extent the collapse of world commodity prices.
In most countries current
account imbalances worsened throughout 1998, accelerating in the
last quarter as the full impact of falling external demand and in
some cases appreciating exchange rates began to be felt. In
general, the deficits reported in the last months of 1998 were
larger than had been expected even under the more pessimistic
projections made earlier in the year. As a result the aggregate
current account deficit of eastern Europe continued to rise, to
an estimated $17 billion (4.5 per cent of GDP), while in the
Baltic states the average deficit rose to over 11 per cent of GDP
in January-September. The imbalances would have been even greater
but for the considerable drop in import prices of commodities and
intermediate goods. In several countries current account deficits
were constrained by the tight international financing conditions
affecting all emerging market economies.
Outlook for the transition
economies: possible recession
During the first few months of
1999 the downside risks surrounding the outlook for 1999 have
increased considerably, and economic performance in 1999, on
average, is likely to be considerably worse than in 1998.
Preliminary data for the first quarter confirm the continuing
weakness of economic activity in many transition economies. It is
virtually certain that in some of the major CIS economies, such
as Russia, Ukraine and possibly Kazakhstan, GDP will continue to
fall in 1999 and this is likely to lead to a further decline in
the aggregate output of the CIS. The weakness in the CIS region
will continue to have a negative impact on the rest of the
transition economies. Moreover, if the deterioration in western
Europe=s economic performance continues in 1999,
as well it might, then a number of east European transition
economies, including some of those that have been growing rapidly
in recent years, could move into recession.
Kosovo crisis adds to the
already unfavourable environment for many transition economies
The outbreak of war between the
NATO Alliance and Yugoslavia has added a new dimension to the
already unfavourable external environment for many transition
economies, worsening further their short-term economic outlook.
The war-related economic damage already incurred is quite
substantial. Neighbouring countries (Albania, Bosnia and
Herzegovina, Bulgaria, Croatia, Hungary, Romania, The former
Yugoslav Republic of Macedonia) have lost important markets as
well as traditional suppliers in Yugoslavia. Transport links to
and from the south-eastern part of Europe have been severely
damaged: navigation along the Danube has been paralyzed by the
destruction of bridges in Novi Sad and all traffic through
Yugoslavia (ground, rail and air) has been brought to a halt. The
negative consequences are especially severe for the trade flows
between western Europe (the main trading partner) and the
countries locked in the Balkan region (in particular Bulgaria,
Romania and The former Yugoslav Republic of Macedonia): as the
available transport alternative routes are of limited capacity,
the result is simply destruction of important trade flows. In
addition, the blocking of the Danube will have a pan-European
impact as it is causing costly interruptions in shipments for all
the countries through which it flows.
The war has undoubtedly
increased investors= perception of risk throughout the whole area
surrounding the zone of conflict and this will both restrain
access to international financial markets and raise the cost of
borrowing for the affected countries which, in general, are those
which are most badly in need of fresh finance. There have already
been some repercussions of this sort in the financial sphere.
(Even Hungary, one of the best credit risks in the region, chose
to delay a large, $750 million bond issue in March; when it
finally went ahead in April, its size was substantially reduced
(to $500 million) and the costs had increased). The inflow of FDI
to this region B an important driving force of economic
restructuring as well as a balance of payments support B is also likely to weaken. The 1999 financial
plans of many south east European countries were relying heavily
on privatization revenues and other sources of FDI to finance
budget and current account deficits. The fact is that the
negative economic impact of the war will be greatest for the
countries of south-east Europe, most of which were already in a
precarious economic state before it started.
The problems facing the
south-east European transition economies are complex and
long-standing. The regional economy had already been destabilized
by the break-up of the former SFR of Yugoslavia, and by the wars
in Croatia and Bosnia and Herzegovina before the Kosovo war.
Regional trading links have been broken or weakened and there are
now many barriers to their restoration, a factor which
discourages significant amounts of FDI. All of these economies
have long been in need of large amounts of investment in order to
restructure their economies and lay the basis for sustained
growth, and it is clear that a great part of this will have to
come from abroad. But it has also been clear for some time that
the latter is unlikely to be forthcoming without significant
progress in institution building (for market-based activity) and
improved security in the region. Without substantial support from
outside, the national authorities will find it very difficult to
create the "breathing space" and the political support required to implement
such a programme; but without a carefully designed programme and
a broad measure of popular domestic support, private foreign
investment is unlikely to be forthcoming. Coming on top of these
chronic problems, the consequences of the war in Yugoslavia could
lead to serious economic and political instability in these
countries. To prevent an already serious situation getting worse
there is an urgent need for western Europe and other members of
the NATO alliance to provide south-east European transition
economies with emergency support, especially for sustaining their
balance of payments.
For further information
please contact:
Economic Analysis
Division
United Nations Economic
Commission for Europe (UN/ECE)
Palais des Nations
CH B 1211 Geneva 10, Switzerland
Tel: (+41 22) 917 27 18
Fax: (+41 22) 917 03 09
E-mail: [email protected]
Website: http://www.unece.org/ead/