This note updates a previous analysis of the economic situation in the UNECE
region published in the Economic Survey of Europe in May 2002.
1. The global context
A slowing recovery and more uncertain short-term prospects.
Economic activity in the world economy picked up in the first quarter of
2002, largely stimulated by a marked swing in inventory adjustment in the
United States. This provided a stimulus to economic activity, via the foreign
trade channel, notably in Japan and Asian emerging markets but also in western
Europe. But this impulse from inventory investment weakened in the second
quarter and had little, if any, positive spill-over effects on final demand,
either in the United States or in the other major regions of the world economy.
The failure of the United States' economy, the locomotive of global growth
from 1995 to 2000, to gain cyclical momentum in the second quarter, weakened
confidence in a sustained recovery and brought back into focus the huge external
and domestic imbalances in the US economy and the associated downside risks
for the short-term economic outlook.1
In the United States, the strong cyclical momentum witnessed in the first
quarter of 2002 was not maintained in the second quarter. Available indicators
suggest that economic activity continued to expand at a more moderate rate.2
This largely reflects a smaller contribution to growth from inventory investment
and a further slowdown in the rate of expansion of personal consumption. Consumer
confidence has been volatile since March 2002; it fell in June against the
background of continuing weak demand for labour, waning confidence in corporate
sector accounting practices and declining shares prices. Business fixed investment
continues to be restrained by ample margins of spare capacity and weak sales
and earnings prospects. In addition, firms are facing a high level of indebtedness.
However, sluggish retail sales, weak labour market conditions and the steady,
albeit moderate expansion of manufacturing output stand in sharp contrast
to robust residential real estate markets. Composite leading indicators for
the economy have been fluctuating from month to month, but the overall tendency
is for a moderate rise. Headline inflation has declined to low levels. Unit
labour costs were held in check by gains in productivity, largely due to cuts
in hours worked.
As for the external balance, the current account deficit rose to a level
corresponding to 4.3 per cent of GDP in the first quarter of 2002, largely
reflecting development on the merchandise trade balance with imports outstripping
exports inter alia because of the asymmetric strength of domestic demand in
the United States and in its main trading partners. The monthly trade deficit
reached a record $36 billion in April 2002. Gross capital inflows declined
significantly in the first quarter of 2002, compared with the preceding quarter,
largely on account of lower portfolio and bank credit inflows. Smaller gross
inflows were partly offset by reduced gross capital outflows, and in sum there
was a decline in net recorded inflows by one third. Net private portfolio
inflows into the United States fell to $67 billion during the first quarter
of 2002, from $100 billion during the previous quarter.
In the United States, disappointing corporate sales and earnings led to
strong selling in equity markets, notably for high-technology stocks. These
pressures were accentuated by a series of corporate financial scandals, which
eroded investors' trust in profit statements and company valuations. At the
end of June 2002 the Dow Jones industrial index had fallen by about 10 per
cent compared with the beginning of the year and the Nasdaq index for high-technology
stocks by some 30 per cent. Major European stock markets also weakened on
account of a more cautious assessment of short-term economic prospects and
related concerns about corporate profits. At the end of June 2002, the Euro
Stoxx 50 index had declined by some 25 per cent from the beginning of January.
The fall in equity markets has adverse effects on private households' direct
net financial wealth and on the stream of revenues from pension funds and
both will impact on spending behaviour. Lower equity prices also raise financing
costs of businesses.
The combination of a slowing recovery and corporate financial scandals have
eroded investors' confidence in the ability of the United States' corporate
sector to continue to deliver an attractive rate of return relative to other
countries. This is reflected in a progressive depreciation of the dollar since
March 2002. At the end of June, the dollar was traded at close to parity against
the euro, a 30-month low, and equivalent to a depreciation of some 15 per
cent from its recent peak of late February 2002. Over the same period, the
dollar depreciated by some 10 per cent against the yen, despite the Bank of
Japan's repeated intervention in the foreign exchange market to stem the appreciation
of the yen due to its concern about the price competitiveness of exports,
the mainstay of Japanese economic activity in early 2002. The dollar also
depreciated against other major currencies such as the pound sterling and
the Swiss franc. But the real effective exchange rate of the dollar is still
very high compared with the level attained in 1995.
Against this background of mounting uncertainty about the strength of the
recovery, United States monetary policy has been on hold since December 2001,
when the target for the federal funds rate was lowered to a forty-year low
of 1¾ per cent. At its meeting on 26 June 2002, the Federal Open Market
Committee confirmed its earlier assessment that the risks are balanced with
respect to the prospects for price stability and sustainable economic growth.
Nominal long-term interest rates (yields on 10-year treasuries) tended to
fall slightly in the second quarter of 2002, probably influenced by revised
expectations about growth prospects and the future stance of monetary policy.
In Canada, there was also a strong rebound in economic growth in the first
quarter of 2002, reflecting increased exports to the United States and robust
domestic demand. Concerns about the rekindling of inflationary pressures led
the Bank of Canada to raise its overnight lending rate by 25 basis points
to 2.25 per cent in mid-April.
In Japan, the economy appeared to have emerged from the deep recession of
2001, led by strengthening exports. Real GDP is estimated to have increased
by an unexpected 1.4 per cent in the first quarter of 2002 (over the preceding
quarter) after three consecutive quarters of decline (table 1). Nevertheless,
output still remains some 1.5 per cent below its level in the first quarter
of 2001. The recovery of exports was largely stimulated by the increased demand
in other Asian markets and the United States and by the sizeable real effective
depreciation of the yen since the autumn of 2001. In contrast, business capital
expenditure fell sharply, especially in the electronics and IT related sectors.
The latest Tankan survey points to improved economic sentiment among large
manufacturing companies in the second quarter of 2002, but the recent appreciation
of the yen could erode price competitiveness and add to the persistent deflationary
pressures.
A more difficult environment for emerging markets.
Financial flows to emerging markets during the first half of 2002 slowed
down markedly due to worries concerning the economic and political situation
of Latin America and Turkey, which were aggravated by international investors'
heightened risk aversion caused by the fall in equity markets of industrialised
countries and their succession of high-profile corporate failures. 3
In South America several countries have suffered from a mutually reinforcing
combination of financial market turbulence and political uncertainty. Falling
prices of equities, international bonds (thereby raising international financing
cost) and domestic currency, were accompanied by rising domestic interest
rates. In many countries, this situation has posed heightened difficulties
to the management of public finances. The economic situation of Argentina
has deteriorated steadily since the country defaulted on its foreign debt
and it abandoned its currency board. Output during the first quarter was 16
per cent below its corresponding level in the preceding year, leading to rising
unemployment and poverty. The financial turbulence in Brazil (since May 2002)
has been due to a concern about the economic policies of the prospective government
and how they would affect the sustainability of its public debt. Developments
in Argentina and Brazil have had a direct negative impact on the economies
of Uruguay and Paraguay, of which they are the largest trade partners. Elsewhere
in the region, political uncertainty and violence have jeopardised the economic
situation, particularly in Venezuela, Colombia and Peru. Although Mexico had
been immune to the worsening economic climate in Latin America, it suffered
from mild contagion in June 2002.
In Turkey, the economy has started to recover from the deep recession of
2001. This occurred against the background of significant progress in implementing
the adjustment programme agreed with the IMF. But the economic outlook has
deteriorated since May, due to currency depreciation, falling equity prices
and a rise in domestic interest rates and international financing costs. Moreover,
the management of public finance has become more difficult. A crisis in the
governing coalition and the uncertainty about the outcome of possible early
elections has raised concerns about the continuation of structural reforms
and of the adjustment programme; the latter is essential for continued support
of the IMF. The steep depreciation of the lira is likely to impact on the
country's trade, particularly that with partners in southern Europe and several
CIS countries.
After a sharp fall in the final quarter of 2001 and a surge in January-April
2002, the spot price for a barrel of Brent crude settled in a range of $23
to $26. On average, crude oil prices in the second quarter of 2002 were 8
per cent below their level in the corresponding period of 2001. Price movements
during the first half of 2002 reflected both the interaction of market fundamentals
and changing market sentiment regarding the overall political situation in
the Middle East. During the first quarter prices were supported by OPEC supply
cuts introduced in January, and which more than compensated for the fall in
demand brought about by the global economic slowdown and a mild winter in
the Northern hemisphere.4
The pick-up in global industrial production in early 2002 and expectations
that it would strengthen further pushed up the prices of most cyclically sensitive
commodities. By April the prices of non-ferrous metals and agricultural raw
materials had risen by 12 per cent above their low points in the last quarter
of 2001. Further increases of a similar magnitude are not expected during
the remainder of the year, however, as these higher price levels already appear
to incorporate current expectations of the likely strength of economic activity
in the rest of 2002.
2. Western Europe
Weak domestic demand holds back economic growth and export prospects
have deteriorated.
In western Europe, economic activity improved in the first quarter of 2002,
following a small decline in real GDP in the final quarter of 2001. Domestic
demand remained sluggish and an increase in real net exports provided the
sole support to overall economic activity. In contrast to the United States,
inventory investment continued to fall and subtract from economic growth.
Economic activity continued to expand in the second quarter of 2002, but at
a moderate rate. The global slowdown in 2001 has significantly reduced the
differences in rates of economic growth among the various west European countries.
In the euro area, revised quarterly national accounts data show a somewhat
more pronounced cyclical slowdown in 2001 than previously estimated. Real
GDP virtually stagnated in the second and third quarters of 2001 and fell
by 0.3 per cent in the final quarter (table 1). During the first quarter of
2002 real GDP recovered somewhat, but preliminary estimates point to only
a modest increase of 0.2 per cent over the final quarter of 2001. Both private
consumption and fixed investment declined slightly in the first quarter of
2002, and further cuts in business inventories also dampened economic growth.
Short-term economic indicators point to only moderate growth in the euro
area in the second quarter of 2002. The upward tendency of industrial output
in early 2002 was reversed in April, when there was a decline of 0.5 per cent
compared with March. Industrial confidence fell in June against the background
of falling orders and higher stocks of finished products. Industrial investment
surveys show firms cutting their planned expenditures for 2002 compared with
their intentions in the autumn of 2001.5 Capacity utilisation rates in the
manufacturing sector fell in April 2002. Retail sales (volumes) have been
sluggish during the first four months of 2002: in April they fell by 0.6 per
cent and were only 0.1 per cent higher than their level in the same month
of 2001. Consumer confidence also weakened in June 2002 although it was still
somewhat stronger than it was at the beginning of the year. Preliminary estimates
show that headline inflation fell from 2 per cent in May to 1.7 per cent in
June. Against the background of weak economic activity, the unemployment rate
was 8.3 per cent in April and May, only slightly higher than at the beginning
of the year. Concerns about the lack of cyclical momentum in the euro area,
where accentuated by recent short-term indicators for Germany, showing a fall
in the ifo business climate index and an unexpected increase in unemployment
in June as well as a decline in industrial output in May.
Against the backdrop of prospects for only relatively moderate economic
expansion, inflation falling below the 2 per cent ceiling of the ECB's inflation
target and the sizeable appreciation of the euro against the dollar, the ECB
decided to leave its key interest rates unchanged in early July 2002. The
main refinancing rate has been at 3¼ per cent since November 2001,
when it was lowered by half a percentage point. Monetary conditions tightened
somewhat as a result of the effective appreciation of the euro against other
major currencies in the second quarter of 2002. The rate of growth of money
supply (M3) remained significantly above its reference value of 4.5 per cent
in the first half of 2002; this continues to reflect portfolio shifts towards
M3-assets in the face of overall uncertainty about the short-term economic
outlook. As in the United States, long-term interest rates tended to fall
slightly in June, and there was only a slight yield gap in favour of euro-denominated
assets.
Outside the euro area, real GDP in the United Kingdom stagnated in the first
quarter of 2002, as it had done in the previous quarter. Real GDP was only
1 per cent higher than a year earlier. The recent marked depreciation of the
pound sterling against the euro should help to ease the trade deficit by stimulating
exports to the euro area, which accounts for around half of the United Kingdom's
external trade. A prime policy concern is the rise in the ratio of consumer
debt to income to very high levels, which is fuelling domestic demand. This
development is closely related to the accelerating rate of house price inflation
in the United Kingdom. To arrest this unsustainable tendency and to avoid
rekindling inflationary pressures, the Monetary Policy Committee of the Bank
of England is widely expected to raise interest rates during the course of
2002 in order to bring about the necessary moderation in consumer demand.
3. The transition economiesWidespread deceleration
of growth due to weak foreign demand
Most transition economies continued to expand in the first half of 2002 but
the rate of growth has decelerated sharply throughout the region. The signs
of weakening were most visible in eastern Europe where rates of GDP growth
in a number of economies were considerably below those of 2001. Thus, aggregate
GDP in eastern Europe in the first quarter of 2002 rose by just 2.0 per cent
year-on-year (table 3); growth also decelerated in the Baltic states and in
the Commonwealth of Independent States although the average rates in these
two regions remained relatively high at 4.1 per cent.
The changes in aggregate output in the transition economies were dominated
by the unfavourable external environment and, specifically, by the weakening
of import demand in Western Europe. The average performance was also influenced
by low or waning growth in the two largest economies in the region, Poland
and Russia. Consequently, the downward trend in aggregate economic activity,
that was already under way in many transition economies during 2001, persisted
in the first quarter of 2002. Due to the deterioration in international trade,
the weakening of industrial output was even more pronounced than that of GDP
(table 3).
As was the case in 2001, the negative impact of weaker external demand was
partly offset by domestic demand (especially private consumption). The generally
strong recovery of personal consumption was partly due to a lagged real income
effect of the previous phase of strong export-led growth throughout the region.
At the same time, the changes in investment were more heterogeneous in this
period: there was no uniform pattern in eastern Europe and the Baltic states,
while investment decelerated throughout the CIS. In Russia, real fixed investment
outlays in January-May 2002 increased by just 1.7 per cent, year-on-year,
while the corresponding figure for the same period of 2001 was 7.4 per cent.
In some countries fiscal policy has been used to offset waning external demand,
especially when elections were in prospect. 6Too heavy a reliance on fiscal
stimuli, however, might endanger the internal and external balance of these
very open economies before an export-led recovery is able to set in again.
Due to weaker foreign demand, especially in western Europe, the year-on-year
rates of growth of industrial output during the first quarter of 2002 were
substantially lower than they were in 2001 in virtually all the east European
and Baltic economies (table 3). The most affected were the economies of south-east
Europe and the heavily trade-dependent Baltic economies, after their very
strong performance in 2001: during the first three months of 2002 industrial
output even declined in Estonia, Latvia, Bulgaria, The former Yugoslav Republic
of Macedonia, and Yugoslavia, but also in Poland.
Growth in the CIS economies in the first quarter of 2002 was significantly
weaker than in 2001 as a whole and in comparison with the final quarter. At
the same time the differences between countries increased: most first quarter
GDP growth rates were between 3 and 5 per cent (table 3) but the range was
from more than 10 per cent (for the oil and gas producing Kazakhstan and Turkmenistan)
to -2.3 per cent for Kyrgyzstan, which suffered from a significant decline
in gold extraction.7 Total industrial output in the CIS grew by about 3 per
cent in the first three months of 2002, less than half its annual rate in
2001. Russian industry slowed to a year-on-year growth rate of 2.6 per cent
in the first quarter of 2002, one of the lowest in the CIS. Although the ongoing
reforms are expected to bear fruit in the medium and long term,8 if output
continues to weaken in the short run, Russia's capacity to serve as the region's
growth engine will be reduced.
Inflation continues to moderate
The downward trend in consumer price inflation, which generally resumed in
the transition economies in early 2001, continued in the first half of 2002.
Food and domestic fuel prices were the main factors behind this favourable
performance, particularly in the second quarter when disinflation gained momentum.
The real appreciation (in some cases significant) of exchange rates which
alleviated external supply-side cost pressures also contributed to the generally
lower rates of inflation. Due to transmission lags, the effect of the rising
world commodity prices (which have been recovering from the lows of the last
quarter of 2001) has not yet fed through into domestic prices.
In many of the east European economies for which such data are available,
the rates of core inflation (CPI excluding food and energy prices), however,
remained rather stable in this period; the rate fell only in Poland, largely
due to the lagged effects of a long period of tight monetary policy and a
strong zloty. Inflation rates changed little in Bulgaria, Slovenia, Belarus
and Russia.
On the domestic side, wage inflation remained strong and rose much faster
than measured labour productivity in industry, particularly in those countries
where the slowdown in industrial output was accentuated by declining foreign
demand. Consequently, with few exceptions, unit labour costs continued to
rise in the first half of 2002. The significant fall in industrial producer
price inflation in most of the transition economies suggests that a considerable
part of the rising labour cost pressure has been absorbed by unit operating
profits.
A tense situation in the labour markets
The available data on registered unemployment suggest that the weakening
of economic activity was accompanied by a further deterioration of the labour
markets in a number of east European economies in the first months of 2002.
Many of these countries continue to face high and persistent levels of unemployment,
which constitutes a serious challenge for economic policy. In some economies,
the social consequences of weak labour markets are further exacerbated by
the continuing rise in the number of long-term jobless people who are no longer
eligible for unemployment benefits. The situation, however, differs considerably
among countries and sub-regions.
In central Europe, Hungary is the only country where the unemployment rate
declined in the 12 months to April 2002. In Slovakia and Slovenia, it remained
at the same level as a year ago, and increased in the Czech Republic and Poland.
In Poland, sluggish economic growth combined with the restructuring of unprofitable
industries and the arrival of newcomers to the labour market, led to a sharp
rise in joblessness. The unemployment rate hit a post-communist record high
of just over 18 per cent of the labour force in March, two percentage points
higher than a year earlier and the largest increase among all the transition
economies. There was also a further deterioration in the labour markets of
the south-east European transition economies. The average unemployment rate
in this region was 18.3 per cent in April, nearly one percentage point more
than a year earlier. In the 12 months to April, unemployment increased in
all countries of the region except Albania and Bulgaria.
Developments were more encouraging in the Baltic states and in the CIS region.
During the first months of 2002, the unemployment rate was broadly unchanged
(measured on a year-on-year basis) in Latvia, and it declined in Estonia and
Lithuania. In both countries the decline was the first since 1998 when unemployment
surged as a result of the Russian financial crisis and then increased further
due to enterprise restructuring. Estimates of unemployment based on data from
labour force surveys indicate further improvements in the three largest economies
in the CIS. In the first quarter of 2002, the unemployment rates in Russia,
Kazakhstan and Ukraine were lower than those in the final quarter of the previous
year and some 1-2 percentage points lower than a year earlier.
Weaker trade performance
The foreign trade of the transition economies continued to weaken in the
first quarter of 2002 (table 4), the decline in current dollar terms reflecting
the global economic slowdown and falls in the dollar prices of traded goods.
In the east European and Baltic countries, the stagnation of trade volumes
- there was no increase in the volume of aggregate exports and aggregate imports
increased by just 2 per cent - reflects the delayed impact of the economic
slowdown in western Europe.9 In recent years improving competitiveness
has buoyed the exports of many of these countries, although in many cases
domestic currencies have appreciated steadily (in both nominal and real effective
terms) and several countries have experienced a recent rise in unit labour
costs. The terms of trade of many countries improved in January-March as import
unit values (in dollars) declined more than export unit values, due mainly
to the year-on-year fall in international market prices for energy and other
raw materials. This helped to reduce the merchandise trade deficit of the
region as a whole by nearly $500 million from the level in January-March 2001.
However, the changes in the aggregate trade and current account balances mask
considerable differences among countries which also reflect variations in
the strength of local demand and in the stance of macroeconomic policies.
In January-March 2002, the dollar value of east European and Baltic exports
and imports to and from the EU both declined by some 3 per cent. Exports to
the EU fell in eleven of the 15 countries, the most affected being Estonia
because of its dependence on ICT sales. The export downturn in Hungary, Poland,
Slovakia and Slovenia was also quite pronounced in the first two months of
the year. Later (in March and April), however, this downward trend subsided
noticeably. Aggregate exports to Russia and other CIS countries rose some
11 per cent in dollar value, while those within eastern Europe and the Baltic
region shrank by 4-5 per cent.
Except for a few countries, imports into eastern Europe and the Baltic states
have also fallen since the beginning of the year reflecting lower (year-on-year)
world commodity prices and faltering input demand by manufacturing industry.
Imports of new machinery were sluggish as investment was somewhat subdued
in most of the region, but in some countries buoyant private consumption boosted
the imports of motor vehicles for private use and of manufactured consumer
goods.
The dollar value of the CIS countries' aggregate exports fell by 10 per
cent in the first quarter of 2002, largely because of the lower export prices
for primary commodities (except gold which rose by 7 per cent). Crude oil
prices in this period were by 20 per cent lower than a year earlier, gasoline
prices fell by almost a third while the average price of Russia's natural
gas decreased by an estimated 20 per cent. The price of cotton - a major export
commodity in Central Asia - was down almost 40 per cent year-on-year while
prices for base metals such as aluminium, copper and nickel were lower by
some 5 to 13 per cent.
The value of Russian exports declined by 14 per cent year-on-year in the
first quarter of 2002, despite increased shipments of crude oil and oil products
(by 16 and 10 per cent, respectively). However, the volume of natural gas
exports fell by 2 per cent. Similarly, the value of exports from many other
CIS countries also declined, the falls ranging between 1 per cent in gold-producing
Kyrgyzstan to 14 per cent in Azerbaijan whose exports are dominated by crude
oil. Strong output growth in the CIS region led to an increase in the value
of aggregate CIS imports by 4 per cent in the first three months of 2002.
This growth largely reflected greater demand in Russia where the value of
imports was up by 7 per cent on the strength of a 20 per cent increase in
imports of machinery and equipment. Only in Turkmenistan and Uzbekistan was
there a significant fall in total imports.
Selective widening of current account deficits
At the beginning of 2002, it was expected that there would be at least a
temporary deterioration in the current account balances of eastern Europe
and the Baltic states, due to the lagged effect on exports of the global and
west European slowdown. As noted above, the growth of merchandise exports
indeed weakened, and this was also true of services (which had provided a
significant boost to export revenues in 2001). Data for the first quarter
of 2002 indicate that on average the current account deficits of this group
of countries remained little changed from a year earlier (table 5). In 2001
more than half of these countries had posted large external deficits, and
in several cases these worsened in the first quarter of 2002. However, Bulgaria,
Lithuania and Romania have managed to arrest or reverse such negative tendencies,
in part through a tightening of fiscal policy. In some countries, widening
current account deficits have been attributed to buoyant domestic and foreign
investment, and thus have not been considered a cause for concern, although
a rapid growth of investment-related imports does not necessarily translate
into more dynamic exports.
In Russia, the rise in international oil prices in April and May 2002 gave
a strong boost to its trade surplus and presumably halted the decline in the
current account surplus. In the most other CIS countries, merchandise trade
data suggest that current account balances have generally deteriorated.
Capital flows to eastern Europe remain buoyant
Current account deficits in eastern Europe and the Baltic states were, in
general, easily financed in the first quarter of 2002. Various types of loans
tended to boost net capital inflows, which in many cases led to overall balance
of payments surpluses, thus increasing official reserves. FDI inflows tended
to slow down in the first quarter of 2002 although in a few countries there
were large increases. Although many east European states had no need to borrow
in the international markets, those that did continued to benefit from favourable
conditions. Confidence in their economies has increased due to improved macroeconomic
stability and approaching EU membership, and this in turn has attracted investors
shunning the emerging markets. In the first six months of 2002, eight east
European entities, mostly sovereign borrowers, issued bonds worth some $5.1
billion; these include a $1.3 billion swap of Brady bonds into eurobonds by
Bulgaria and two sovereign bond issues worth a total of $1.7 billion by Poland.
There have been further important improvements in the financial situation
of Russia. The recent increase in the trade surplus and the reduced net outflow
of capital led to a surge in official reserves (to $38.8 billion in mid-June).
Falling spreads on the country's foreign debt have enabled several oil and
telecommunications companies to access the eurobond market (issuing bonds
worth $1.6 billion in January-June) for the first time since the rouble crisis
in 1998. Indications of improving standards of corporate governance and increased
transparency in some Russian companies have contributed to the resurgence
of the stock market and have helped two Russian companies, Yukos and Wimm-Bill-Dann,
to raise funds in the primary equity markets. This vastly improved financial
situation and the current prospects for (relatively high) oil prices have
further increased confidence that Russia will be able to fully meet its debt
servicing obligations in the foreseeable future.
4. The short-term outlook
Western Europe and North America
Increased uncertainty and downwside risks for the second half of 2002
The first quarter of 2002 witnessed a steady upgrading of consensus forecasts
for GDP growth in the United States in 2002 from 0.9 per cent in January to
2.1 in March. This more optimistic assessment of economic prospects for the
United States continued in the second quarter, but revisions were more modest:
in early June, the consensus forecasts had edged up to 2.7 per cent from 2.6
per cent in May. By contrast, forecasts for economic growth in the euro area
in 2002 have remained stable at 1.3 per cent (table 2). A major factor behind
this weak outlook is the persistent sluggishness of economic activity in Germany,
where real GDP is forecast to increase by only 1 per cent. However, economic
growth is expected to be only slightly higher in Italy (1.2 per cent) and
France (1.4 per cent). For western Europe as a whole, real GDP is currently
expected to reach 1.4 per cent in 2002, slightly up from the 1.3 per cent
forecast in January 2002. Within this aggregate, an annual growth rate of
1.8 per cent is forecast for the United Kingdom. In Japan, real GDP is expected
to decrease by 0.5 per cent.
These forecasts of early June, however, do not take into account the further
substantial dollar depreciation in the course of that month and other adverse
factors such as the slide in share prices and the fall in consumer confidence
in the euro area and the United States. In general, these forecasts envisage
a gradual strengthening of economic growth in the second half of the year,
but the case for this has weakened. In fact, the downside risks to this already
moderate outlook for growth have increased in recent weeks. It has become
clear that it will take longer than expected earlier for corporate profits
and investment in the United States to turn around in the face of large margins
of spare capacity, a tendency for the growth of domestic private consumption
to weaken, and a not very supportive external environment [and a general deterioration
in confidence]. And in western Europe, the sizeable depreciation of the dollar
will, with a lag, restrain growth of exports to the rest of the world. In
this general context, a tightening of monetary policy in the euro area would
not be adequate.
Expectations of a rapid rebound of corporate sector spending on IT products
after the bursting of the high-tech bubble have not materialized; rather,
there are indications of an increase in the PC upgrading cycle. Business surveys
show that IT budgets have not been growing either in the United States or
in western Europe in 2002. The rate of expansion of private household consumption
in the United States, moreover, will eventually have to slow down in the face
of a low savings rate and high levels of debt, which will have to be corrected
sooner or later. Growth in the rest of the world is sluggish, largely dependent
as it is on a recovery in the United States. US export growth, moreover, continues
to be restrained by the still high level of the dollar exchange rate.
There are, moreover, growing concerns about the financing of the large current
account deficit in view of the weakening confidence of foreign investors that
the United States corporate sector will continue to be able to generate the
relatively high rates of return of recent years, given the slowing recovery
in the second quarter and the more uncertain short-term prospects for growth.
The decline in net private portfolio flows in the first quarter of 2002 could
be a first indication of this. The series of corporate financial scandals,
which started with the Enron case, have only helped to reinforce this tendency.
There is a need for an expenditure switch in the United States
A significant but gradual dollar depreciation would enable United States'
domestic demand to switch from spending on foreign goods to domestic goods
and to bolster export growth via improved price competitiveness. Abstracting
from the short-term J-curve effect, this would help to reduce the trade and
current account deficits. This change in the pattern of competitiveness and
the related changes in the composition of domestic absorption, however, would
dampen demand for imports from the rest of the world, including western Europe.
A more expansionary monetary policy in western Europe, especially in the euro
area, would therefore be required to stimulate domestic demand in order to
offset the effects of weaker net exports. Such a change in circumstances would
likely once again test the flexibility of the fiscal rules stipulated in the
Stability and Growth Pact. There have been concerns recently about expansionary
fiscal measures (tax cuts) announced by some countries because they would
run into conflict with the budget deficit targets stipulated in the stability
programmes. The intended revision of the Growth and Stability Pact in the
euro area should provide a more conducive framework for the operation of automatic
stabilizers in case of a cyclical downturn by putting the focus of fiscal
discipline on structural budget deficits and levels of government debt.10
The main downside risk to such a scenario would be an acceleration of the
recent rate of dollar depreciation, triggered by a more abrupt withdrawal
of international capital from the United States. This would be likely to be
accompanied by a sharper decline in the equity markets and the consequent
fall in net financial wealth would lead to a marked curb in private consumption.
At the same time, a rapid and sizeable appreciation of the euro would threaten
to choke off the anaemic recovery in western Europe. The open question then
would be how the ECB and the Federal Reserve would react to such a sudden
shift in the pattern of international capital flows. Given the risks of overshooting
in the foreign exchange markets this might require a co-ordinated intervention
by the major central banks. Other downside risks are associated with the likely
development of the oil price in view of the uncertain political situation
in the Middle East. But developments in Latin America are also a matter of
concern. The deep economic and financial crisis in Argentina and the uncertainty
over the outcome of the next elections in Brazil, and the related possible
changes in macroeconomic policies, are reflected in an increasing aversion
to risk on the part of international investors. This could have broader contagion
effects in other emerging markets and limit their ability to raise external
funds, although for the time being the transition economies appear to be largely
unaffected by these developments.
Eastern Europe and the CIS
The transition economies as a whole remain highly susceptible to external
disturbances. The impact of the deterioration in the external environment
(weaker import demand from western Europe and lower commodity prices) became
evident in the deceleration of growth in first quarter of the year. It is
not yet quite clear whether this weakening is just a temporary or a more lasting
phenomenon; much will depend on the strength of recovery in the global and
west European economies and whether or not it falters in the wake of events
in the United States. In any case, the slowdown that has already occurred
in the first quarter is likely to have a negative impact on the average growth
figures for the year as a whole. If the external conditions deteriorate further,
a number of countries may face difficulties in meeting their growth targets.
The weaker than expected output in the first quarter has already prompted
a lowering of forecasts in a number of transition economies. In eastern Europe,
official forecasts of GDP growth in 2002 have been lowered in Albania, the
Czech Republic, Hungary and Romania. Within the CIS region some forecasts
for 2002 have also been lowered. In June, Russia's Ministry of Economic Development
revised its forecast for GDP growth to 3.6 per cent; however, the macroeconomic
framework for this year's budget, which assumes 4.3 per cent GDP growth, has
remained unchanged. Similarly in Ukraine, the central bank lowered in June
its forecast for GDP growth to 4.5-5 per cent although the government has
not yet revised its own forecast of 6 per cent. There are also some exceptions
to the general pattern among the CIS countries. Thus, the continuing economic
boom in Kazakhstan has led to the forecast of GDP growth for the year as a
whole being raised by some 3 percentage points to a range of 9-11 per cent.
The official forecast for GDP growth in Kyrgyzstan has also been raised to
5-7 per cent although the mediocre performance of the economy in the first
quarter hardly substantiates such a change.
Slower than expected west European growth could result in a further deterioration
in eastern Europe's current account balances. In some cases corrective action
might be required, but a tightening of macroeconomic policies would have adverse
implications for growth in the transition economies. Moreover, the current
account balances of the net fuel importers have come under renewed pressure
from the recent increases in oil and (with a lag) gas prices. On the other
hand, the energy exporting CIS countries will benefit from such a development,
although part of their terms-of-trade gain will be offset by the fall in the
value of the dollar. Despite the apparent slowing of inflows in the first
quarter, FDI from planned privatisations is likely to continue to provide
the bulk of current account financing in 2002.
********
Notes
* The data covers the period up to 8 July 2002.
1. Economic Commission for Europe, Economic Survey of Europe 2002 No.1, New
York and Geneva, 2002, chapter 1.
2. The Federal Reserve Board, The Beige Book, June 12, 2002 [www.federalreserve.gov/fomc]
3. These trends have affected not only portfolio flows - which are usually
very volatile - but also FDI inflows. These had remained stable in the face
of past international financial turbulence, but at present they are themselves
undergoing a cyclical worldwide downturn.
4. Between January and March 2002 OECD petroleum demand declined (year-over-year)
at the steepest rate in twelve years. IEA, Monthly oil market report, 13 May
2002.
5. European Commission, Business and Consumer Survey Results, June 2002.
6. In the first half of 2002 elements of such a policy stance could be seen
in the Czech Republic, Hungary and Slovakia.
7. All three economies are highly concentrated on these products.
8. At the end of May 2002, Russia was declared a market economy by the European
Commission; the US Government followed suit in early June.
9. Preliminary data for April 2002, indicate some recovery in the dollar values
of exports and imports in most east European and Baltic countries, but it
is still too early to judge its significance.
10. Economic Commission for Europe, op. cit., pp. 7-10
TABLE 1
Quarterly changes in real GDP in the major seven economies,
2000QIV-2002QI
(Percentage change over preceding
quarter)
TABLE 2
Real GDP in the ECE market economies, 2000-2002
(Percentage change over previous
year)
TABLE 4
International trade of the ECE transition economies, 2000-2002
(Percentage change over the same period
of the previous year and per cent)
*******
For further information please contact:
UNECE Economic Analysis Division
Palais des Nations
CH - 1211 Geneva 10, Switzerland
Tel: +41(0)22 917 24 92
Fax: +41(0)22 917 03 09
E-mail: [email protected]
Web site: http://www.unece.org/ead/ead_h.htm
Ref: ECE/GEN/02/20