Less dynamic trade and financial outlook in 1998

Geneva, 20 July -- The world trade and financial outlook for 1998 is on the whole less dynamic, though still buoyant, and the prospects are of trade adjustments reducing incomes and jobs in several countries instead of raising them, according to the UN's World Economic and Social Survey.

The overview and two chapters of the survey -- on the state of the world economy and the international economy -- published Friday in New York said that 1998 will also be another disappointing year for many commodity-dependent countries.

In 1996, the developing world had a net deficit of $8 billion in their balance of trade in goods and services and thus were net recipients of financial transfers of $9 billion to finance the deficit.

But in 1997, and for the first time since 1990, developing countries made a net transfer of financial resources abroad of almost $27 billion, a situation that is not expected to improve in 1998 either, says the UN survey.

Data on net transfers, the UN says, need to be interpreted carefully, since a negative net transfer could be a sign of economic strength or weakness - depending on whether it is brought about by an expansion of export earnings or contraction of imports, and whether the net transfers represent surplus domestic savings or sacrificed domestic investment.

In 1997, the net transfers resulted from positive developments in some countries and negative ones in others. But more of the negative than the positive are expected in 1998, particularly in the crisis-stricken countries of East Asia.

And while finance will still be plentiful for those with access to markets, it will be at a somewhat higher risk premiums for emerging market borrowers. No generalized break is also foreseen in the disappointing trend in ODA flows.

The policy changes under way, such as the EU decision to establish the monetary union at start of 1999 (with 11 members having a single currency, euro) will change the shape of international economic relations in the 21st century. And the shock of the Asian currency crisis is resulting in an intense process of reflection about the short-comings of the present policy 'architecture' of international finance, the UN adds.

The world economy is now expected to grow by 2-1/2 percent in 1998, compared to 3.3 last year, according to the United Nations.

In purchasing power parity (PPP) terms, a measure used by the IMF, the world GDP growth would be 3-1/4 percent compared to last year's 4.1.

Like other official and commercial forecasters, the UN too has been constantly revising downwards the growth expectations, as a result of the financial crisis that broke out an year ago in Thailand, but whose regional and global effects are still not over.

In its latest estimates in the annual World Economic and Social Survey published Friday, the UN estimates that the industrialized economies would grow by 2-1/4 percent, compared to 2.7% last year; developing economies by 3-1/4 percent compared to 5.8% last year; and the transition economies by 3-1/2 percent compared to 2.7 last year.

The deceleration in the growth in the developing world as a whole is due primarily to the direct and indirect effects of the Asian financial crisis.

But the survey says that the uncertainty is overwhelmingly on the downside, and the slowdown could be even more severe than now estimated, and whatever the final outcome, 1998 will prove to be a year of "major disruptions" in the world economy, with the international economic environment becoming less propitious for most developing countries.

Within the developing world, Africa is expected to grow by 3-3/4 percent, slightly better than the 3% of last year.

Growth in East Asia, but excluding China, will be one percent compared to the 5.5 last year, while in South Asia the growth will be 5.25% compared to 5.1 last year.

Even the one percent in East Asia is an "optimistic" outlook and is on the assumption of continued financial stabilization in the region, progress in adjustment and debt rescheduling, particularly in Indonesia, and an unchanged exchange rate in China, and on the further assumption that the Japanese economy does not fall deeper into recession this year.

In South Asia, the survey thinks stronger growth is attainable, but the analysis and projections do not appear to be taking into account the effects of US-engineered sanctions against India and Pakistan over their nuclear tests.

Western Asia will slow down to 3.25% compared to last year's 5.9. And so would Latin America and the Caribbean - from a 5.4 last year to 3-1/4 this year.

The deceleration in Latin American growth is due to weaker external conditions associated with the Asian crisis and the policy measures put in place by countries in response.

The austere fiscal and monetary measures taken by Brazil will slow down the region's largest economy to about one percent. High, though gradually declining, interest rates will dampen investment and consumption while a high price is being paid for the defence of the exchange rate, paid in terms of growing unemployment (which at 7.4 percent in February 1998, reached a 14-year high), says the Survey.

Venezuela's growth prospects have also been seriously weakened by the sharp drop in price of oil and the economy is unlikely to expand over one percent.

Among the other regional economies, four of the fastest growing -- Argentina, Mexico, Peru and Chile -- will also experience a significant deceleration.

Argentine growth, which was expanding briskly in the first quarter, will experience a knock-on effect by the slowdown in Brazil.

Central America's performance will also be affected because of weather factors, among others.

On the fiscal side, in Brazil the benefits of the $17 billion emergency package will be partly offset by the higher interest payments and fiscal pressures of an electoral year. In Argentina, lower revenues as a result of economic slowdown might lead to a postponement of planned infrastructure projects and early implementation of tax-raising measures.

"Latin America's external account are once again one of its most vulnerable areas. Large or rising external imbalances in several countries including Argentina, Chile, Colombia, Ecuador and Peru, represent a major constraint on sustained growth."
The Survey also points to the "social deficit" in the region -- unemployment, poverty and inequality which appeared to improve slightly in 1997, but may well worsen again in 1998.

Tightening fiscal and monetary policies and the expected economic slowdown could lead to higher unemployment in the region - a trend already evident in Brazil.
"In turn a deteriorating social situation might weigh on the future of current tight policies, especially in countries undergoing major elections in the months ahead," says the Survey.

"Moreover," the Survey adds, "the earnings gap between skilled and unskilled workers in the region remain the largest in the world and is greatest in Peru at 30 percent, in Mexico 25 percent, in Colombia 20 percent. Indeed, in this decade, the earnings of the region's skilled workers have been increasing annually at a rate of atleast three percentage points higher than those of the unskilled."

On the financial resources issue, the UN survey notes that the two most striking developments in the international flow of resources in 1997 were the net transfer to the USA of $131 billion, the highest level in a decade, and the developing countries as a group seeing an "extraordinary swing" from a small positive transfer to them in 1996 to a negative transfer in 1997.

In the case of the USA, an aspect of the $131 billion net transfers, was the extraordinary $307 billion of portfolio investment -- the 'flight to quality' as a result of the Asian crisis and the disruption of financial investors' confidence around the world. The net foreign portfolio purchases by US residents also dropped by nearly $30 billion in 1997; but there were still $80 billion of US foreign purchases.

As for the developing world, the net transfers to the least developed was not much changed nor that to Africa. But they did not see any significant improvements either.
But there was a sharp increase in net outward transfers from some Asian economies, only partly offset by the substantial increase in net transfers to Latin America and the Caribbean.

In some cases as that of China (made possible by a large increase in exports) and some of the small Asian 'tigers', says the UN it was a sign of economic strength, but for others it was the beginning of a difficult adjustment process.

The Asian 'tigers' transferred almost $21 billion to other countries.But for one, their trade surpluses shrank.

Virtually all other South and East Asian economies remained net recipients of the transfers, although with smaller total inflows, while in cases of some like India, the net transfers increased.

The change was particularly sharp in Thailand and Indonesia where, according to preliminary incomplete data, there was a surplus of $3.5 billion in Indonesia (mainly export increases) and $6.5 billion in Thailand mainly import reductions.

Reflecting the 'contagion' effects of the Asian crisis, Latin America and the Caribbean experienced a roller-coster year. In the first half of the year, the region received substantial private credit inflows on a net basis. But as the Asian crisis sent ripples in other emerging markets, growth of credit flows suddenly stopped. The net transfer on foreign credit for the year as a whole was $11 billion - almost half the amount received in 1996. But short-term borrowing and other unidentified flows continued to come in - unlike in Eastern and Southern Asia.

But Africa largely escaped the financial consequences.

Net inflows of FDI to developing countries reached a record level of almost $90 billion in 1997, but not a large increase over 1996 when it was $86 billion.

And while the impact of the regional financial crisis has not yet been felt in Eastern and Southern Asia -- with gross direct investment flows including that to China estimated at $80 billion -- FDI to the region is expected to be lower, primarily due to declined in China.

Gross FDI flows to Latin America and Caribbean also reached a record level of about $50 billion, while that to Africa increased to about $4.5 billion.

The UN survey takes a positive view of the entry into force of the EMU and euro from 1999.

And while the euro will completely eliminate exchange rate instability among the 11 EU members who are in the EMU (EUR11), its implications for the stability of the exchange rates between the euro and the currencies of the rest of the world are less clear, says the UN.

The instability of the euro visavis other currencies may increase if the sharp fall in the share of "external trade" in the GDP of the monetary union influenced policy makers.
The share of extra-EU imports in the GDP of the EU will be of the same order of magnitude as the corresponding share for the USA, about 10 percent. And because of this small trade share, policy-makers in the US have on occasion taken a 'benign neglect' approach to exchange rates, which the EUR11 authorities might also take from time to time.

In the case of the US, benign neglect has meant that monetary policy targeted domestic monetary conditions and the exchange rate adjusted to resolve inconsistencies between monetary and fiscal policy. (SUNS- Chakravarthi Raghavan)