[Index]
Russian
Geneva, 28 February 2003
EMBARGO
Not to be released before
4 March 2003, 00:01 GMT
The
economic outlook for the UNECE region
in 2003: clouded by downside risks
UNECE releases its Economic Survey
of Europe, 2003 No.1
Global economic developments were disappointing
in 2002. Hopes for the beginning of
a sustained recovery from the recession
of 2001 were frustrated. The consensus
of forecasters is now for a recovery
to start in the second half of 2003
and to gain further momentum in 2004.
The short-run outlook for the world
economy, however, remains dominated
by significant downside risks stemming
in particular from a possible war in
Iraq and from global financial imbalances
(see below).
World output growth in 2002 continued
to be strongly dependent on economic
developments in the United States. Economic
activity in Japan and western Europe,
both potential engines of growth for
the world economy, remained disappointingly
sluggish, partly because of self-imposed
constraints on more growth-supporting
macro-economic policies. In contrast,
growth in eastern Europe and the CIS
remained quite resilient to the weak
international economic environment.
(For details on the economic performance
in eastern Europe and the CIS see Press
Release ECE/GEN/03/P04).
Western Europe and North America
Uncertainty surrounding the
short-term economic outlook is amplified
by the increasing possibility of a war
with Iraq. This has already contributed
to the weakening of consumer and business
confidence and has fostered a wait-and-see
attitude with regard to big spending
items. Even the available baseline forecasts,
which assume that there will be no military
conflict, however, suggest only a moderate
strengthening of growth in the global
economy in the course of 2003.
The United States is again
seen as leading the global recovery.
Expectations are for a limited cyclical
upturn in the first half of 2003, which
should gather momentum in the second
half of the year. The associated strengthening
of domestic demand would then stimulate
economic activity in the rest of the
world, including western and eastern
Europe and the CIS.
Real GDP in the United States
in 2003 is expected to increase by about
2.5 per cent (table
1.1.2). This outcome is based on
the assumption of a faster rate of economic
expansion in the second half of the
year, driven by strengthening private
consumption and a recovery of business
fixed investment. The growth of consumer
demand, however, will be restrained
by the need of households to increase
savings in the face of their high debt
servicing burdens, the considerable
loss of financial wealth stemming from
the plunge in share prices, and concerns
about the problems facing pension funds.
The scope for higher business capital
spending will similarly be circumscribed
by the need to reduce corporate debt.
Exports should be supported by the gains
in price competitiveness stemming from
the depreciation of the dollar in 2002
and the expected upturn of economic
activity in other regions of the world.
Changes in real net exports are expected
to be less of a drag on economic growth
in 2003 than in 2002. The current account
deficit is forecast to reach some 5¼
per cent of GDP, reflecting inter
alia the differential strength
of domestic demand in the United States
and the rest of the world.
In western Europe, forecasts
of economic growth in 2003 have been
generally lowered since the autumn of
2002. Real GDP in the euro area
is now forecast to increase by 1.4 per
cent in 2003, up from 0.8 per cent in
2002 (table
1.1.2). The modest expected growth
rate for 2003 is pulled down by the
continued sluggishness of the German
economy, where real GDP is forecast
to increase by less than 1 per cent
for the third consecutive year. But
growth will also be weak in France and
Italy and many of the smaller economies.
Exports will be the most dynamic component
of final demand, reflecting a stronger
cyclical momentum in the global economy
in the second half of the year. But
the overall stimulus to economic activity
will still be relatively modest, as
is reflected in the expected modest
acceleration in the growth of total
domestic demand. This increase of domestic
demand, moreover, will be accompanied
by rising imports, while export growth
is likely to be restrained by the appreciation
of the euro. Changes in real net exports
are therefore likely to be broadly neutral
in their impact on overall economic
activity in 2003. Output growth in the
euro area will remain below trend, leading
to a further increase in the output
gap. Against this background, inflation
is expected to fall below the 2 per
cent ceiling of the ECB's target range
in 2003 and unemployment can be expected
to increase.
Monetary policy in the euro area shifted
to a more accommodative stance in early
December 2002, but the real appreciation
of the euro has effectively led to a
tightening of monetary conditions, offsetting
the impulse from lower real interest
rates. The appreciation of the euro,
moreover, will tend to reduce imported
inflationary pressures and this, in
combination with the expected sluggishness
of economic activity in early 2003,
should enable the ECB to reduce interest
rates again. Fiscal policy is faced
with deteriorating total and structural
government financial balances and the
constraints on active policies imposed
by the Stability and Growth Pact (SGP)
(See: Press Release ECE/GEN/03/P06).
On average, fiscal policy will not be
supporting economic activity in the
euro area in 2003, given inter alia
the significant budgetary consolidation
required in Germany and other large
economies to meet their SGP commitments.
Outside the euro area, real GDP in
the United Kingdom is forecast
to grow by some 2.4 per cent in 2003,
up from 1.6 per cent in 2002. There
are major uncertainties, however, related
to the future developments of house
prices and the related strength of private
consumption expenditures. Low interest
rates will continue to support domestic
demand.
In aggregate, real GDP in western
Europe is expected to increase
by some 1¾ per cent in 2003,
up from 1 per cent in 2002. This is
not an inspiring prospect and one, which
will contribute very little to correcting
the major imbalances in the global economy.
Downside risks
Leaving aside the lingering banking
crisis in Japan, the major downside
risks are the high levels of indebtedness
of the private sector (both business
and household) in major industrialized
countries, and the large current account
deficit in the United States and, partly
related to that, low household savings
and the high value of the dollar. But
in addition there is now the acute risk
of a military conflict in Iraq.
Military and non-military
costs highly uncertain
The economic consequences of a war
in Iraq are difficult to estimate and
depend on the duration of the conflict
(ranging from a short intervention to
a more protracted conflict), the total
damage caused to Iraq, and the possible
extension of the conflict and instability
beyond that country.
The budgetary costs for the United
States (and possibly other countries)
are highly uncertain, as is the broader
economic impact on the global economy.
The latter will depend not only on what
happens to the price of oil but also
on the impact of (higher) defense spending
and how the outbreak of war will affect
consumer and business confidence.
Consumer confidence in western Europe
fell in January 2003 to its lowest level
since the end of 1996, while in the
United States, it reached its lowest
level since the end of 1993. In the
international equity markets, prices
fell to six-year lows in late January
2003. These developments, however, reflect
not only the threat of war in Iraq but
also the bleak outlook for jobs and
profits. The open question is to what
extent confidence and the equity markets
will continue to decline in the event
of the actual outbreak of military conflict.
In any case, the already low levels
of confidence and share prices do not
bode well for private sector spending
in 2003.
Higher oil prices might
cause a recession
Oil prices rose above $31 per barrel
in January 2003. If maintained at that
level throughout 2003, this would be
tantamount to a considerable "oil tax"
which would increase inflation and dampen
the growth of real incomes and the global
demand for goods and services. According
to some estimates, a temporary
(one-year) increase in oil prices by
$10 per barrel would, on average, reduce
total economy output by a quarter of
a percentage point in the industrialized
countries and raise inflation by half
a percentage point. Given the weakness
of the present conjuncture, however,
the effect of such an increase on output
might be much larger.
A sustained rise in oil prices to much
higher levels could even push the western
economies into recession. This might
happen in the event of a conflict that
is more protracted than expected, especially
if combined with disruption (or threats
of disruption) to oil supplies and further
adverse shocks to consumer and business
confidence.
The conflict could however be short
and be followed by a sharp fall in oil
prices, thereby boosting business and
consumer confidence as well as real
disposable incomes. However, the adjustment
problems associated with the considerable
global financial imbalances would still
be present. It is therefore not certain
that even a swift resolution of the
Iraq crisis would actually lead to a
sustained recovery of economic activity
in the United States and the global
economy at large.
Global financial imbalances
A major challenge remains the gradual
reduction of the United States' huge
current account deficit and, associated
with that, a gradual depreciation of
the dollar. Although the dollar was
weakening significantly and in an orderly
fashion in 2002 and early 2003, there
is still a risk of a more abrupt adjustment
in international capital flows and exchange
rates. This might reflect increased
concerns on the part of international
investors about the persistence of large
external imbalances and the associated
accumulation of foreign debt in combination
with the re-emergence of large government
budget deficits (the so-called "twin
deficit" problem).
Any accelerated depreciation of the
dollar would raise imported inflation
and would eventually force a tightening
of monetary policy in the United States.
It would, moreover, act as brake on
economic growth in the euro area, Japan
and other Asian economies. Such an outcome
would be likely to trigger a coordinated
intervention by the major central banks.
Another downside risk is that the pace
of balance sheet adjustments by private
households and the corporate sector
in the United States could be more rapid
than assumed, which would depress domestic
demand growth. This might also be caused
by a further sharp fall in equity prices
or a reversal in the boom of residential
real estate. The latter is also a matter
of concern in the United Kingdom.
Deflationary risks need
attention
In a context of low inflation and sluggish
economic activity, a collapse of equity
prices, large margins of excess capacity
and interest rates already at low levels,
many commentators have expressed worries
about the risk of sliding into a deflationary
spiral. The reason is that since official
nominal interest rates cannot be reduced
below zero, the room for manoeuvre of
monetary policy in a severe cyclical
downturn may be quickly exhausted. In
Germany, where inflation was about 1
per cent in 2002 and economic activity
was stagnating at a low level, there
appears to be the potential for a deflationary
development.
The sustained deflationary slump in
Japan illustrates the point that once
an economy has entered a deflationary
process, it may be very costly and difficult
to reverse. Compared with that situation,
the costs of a temporary, excessive
monetary loosening would have been more
limited and more easily corrected. In
Japan, the degree of monetary loosening
proved inadequate and, with hindsight,
a precautionary further loosening of
monetary policy in the first half of
the 1990s would have been justified.
In a similar vein, a timely and moderate
additional fiscal loosening might have
been sufficient to maintain economic
activity.
The general lesson is that when inflation
and interest rates have fallen close
to zero, active policies should not
be held back by fears of an excessive
stimulus, which can be reversed later
through the tightening of policies.
Although the possibility of deflation
still appears to be remote in most industrialized
countries, the risk has increased and
should not be ignored. Any prospect
of deflationary tendencies can certainly
be countered by the timely creation
of a conducive environment for a sustained
economic recovery.
For further information please contact:
Ref: ECE/GEN/03/P05