The current positive global economic environment provides strong support for advancing on a broad range of issues in support of development. After dismal growth performance during the past quarter century in most developing regions, particularly in the LDCs, an improved scenario appears to be emerging. Indeed, current trends indicate that 2004-2006 will show fairly widespread growth in developing countries, a pattern not seen since the late 1960s and early 1970s. During these three years, developing countries will grow, on average, at a rate of 6 percent. LDCs will perform close to the average. And Sub-Saharan Africa will score an unprecedented rate of 5.4 percent. As we indicated in our 2006 report on the World Economic Situation and Prospects, some key factors behind this have been the mix of high commodity prices, low interest rates and increasing ODA to the poorest countries. The continuation of this mix will be critical to the sustainability of this positive growth conjuncture.
The stability of the underlying global economy must be assured if our efforts to achieve the internationally agreed development goals are to have a lasting impact on the opportunities for sustained improvement in the welfare of citizens in the developing world.
Our assessment of the global economy indicates that it will grow in 2006 at a moderate pace slightly above 3 per cent estimated at market exchange rates. While the large, yet ever-widening, global imbalances remain the primary uncertainty for the stability of the world economy, other factors include the persistence of high and recently rising oil prices, the cooling off in the housing sector in a number of economies, the risk of the avian influenza turning into a pandemic, and rising interest rates worldwide.
Despite an exceptionally strong pace in the United States in the first quarter of the year, growth in the world’s major economy is expected to moderate during the rest of 2006 as a consequence of rising interest rates, rising production costs due to the persistently high oil price, and a weakening of the housing market. Growth prospects for the European and Japanese economies are improving, but only very modestly; their growth is not expected to exceed 2 per cent.
The dynamic growth of China, India and a few other large developing economies is becoming increasingly important to world economic growth. China and India are expected to maintain a strong pace in 2006, but the sustainability of their strong growth performance is increasingly at risk because of tightening conditions in the global supply of energy and raw materials, and because of the growing pressures to push for further domestic reforms.
Economic growth across developing countries in general is expected to remain strong. East and South Asia will continue to lead during 2006. Growth in Africa is expected to remain robust at over 5 per cent. Latin American growth should be above 4 per cent. Growth in West Asia should maintain its strong pace at around 5 per cent, and a similar performance is expected for most economies in transition.
Growth in the least developed countries (LDCs) continues to be particularly strong. On average, the LDCs are expected to reach a high of 6.6 per cent in 2006. Growth in the LDCs has been remarkably robust and well over 5 per cent per annum since 2001. The high prices of oil and other commodities have favoured this remarkably good economic performance for many of the LDCs. In some LDCs improved political stability and economic governance are also contributing factors
While the large, yet ever-widening, global imbalances remain the primary uncertainty for the world economy, other factors include the persistence of high and recently rising oil prices, the cooling off in the housing sector in a number of economies, the risk of the avian influenza turning into a pandemic, and the rising interest rates worldwide.
The possibility of a disorderly adjustment of the US deficit remains the most serious threat to the growth and stability of the world economy. The current account deficit of the United States surpassed $800 billion by the end of 2005 and is expected to widen further to over $900 billion in 2006. At the same time, savings surpluses are increasing in Europe, East Asia and oil-exporting countries.
Interest rates are rising worldwide. In particular, the notable increase in the real yields of the long-term US treasuries in recent weeks should raise serious concern about the sustainability of the global imbalances. The accumulated increase in the net foreign liability position of the United States, and its rising cost, could eventually erode foreign investors’ confidence in dollar-denominated assets. This could lead to a precipitous fall in the value of the US dollar, an abrupt and disorderly adjustment of the global imbalances, and thus a disruption in global trade, finance and growth.
The second risk is associated with persistently high oil prices. World oil prices reached $70 per barrel in April. Higher oil prices have no doubt benefited oil-exporting economies, including a number of developing countries. However, a growing number of oil-importing countries have started to feel the adverse impact of higher oil prices. Many countries initially adopted measures to protect domestic consumers by introducing or strengthening energy price controls and subsidies. These measures are becoming more and more difficult to finance as high oil prices persist, and more of the oil price increases is being passed on to consumers.
Strong global oil demand has been the key factor behind the recent rise in oil prices. Geopolitical uncertainties and other supply-side factors, however, have aggravated the situation, including increased speculative activity in the global oil market. Oil prices are expected to stay, therefore, above $60 per barrel in 2006. There is a risk, however, that supply shocks will cause further oil price increases, hitting world economic growth more severely than the high prices have thus far.
The third risk lies in a reversal of the booming housing sector. A cooling of house prices could lead to the moderation of household consumption and thus of economic growth. This seems already to be the case in Australia, New Zealand, the United Kingdom and a few other European countries. Also, in the United States, there are nascent signs of a slowing housing market. With its low level of household savings and wide external deficits, a sharp fall in house prices in the world’s major economy could have far reaching consequences for global financial markets and precipitate an abrupt and destabilizing adjustment of global imbalances.
Last, but not least, a pandemic outbreak of avian influenza is a clear and present danger. The avian flu continues to spread into more countries, with increasing economic losses and human casualties. The world is not yet adequately prepared for an outbreak of pandemic proportions, which could have, in addition to its human toll, enormous macroeconomic costs.
The external financing conditions for developing countries and economies in transition have improved notably during 2005. For emerging economies, the costs of external financing have reached historical lows. But this news should be taken with some caution. One of the lessons from recent financial crises is that low risk premiums for external borrowing may encompass some degree of exuberance, lead to excessive capital inflows and create the risk of a sharp reversal in the future. The most recent increases in the benchmark real interest rates of the United States treasury bills will increase perceived investment risk and could precipitate a sudden change in financial market sentiments and a major re-appraisal of risk premiums. Although the real interest rates are still low by historical standards, governments in emerging economies as well as the international financial institutions should be vigilant about the current trends in international financial conditions.
Official development assistance (ODA) has recently increased in nominal terms. But—excluding resource flows for emergency assistance, debt relief and reconstruction—the amount of aid received by the LDCs in recent years was only marginally higher last year than a decade ago. Major donors have committed to delivering increased and more effective aid. Nonetheless, even if these commitments were fully met, the share of ODA in the gross national income of DAC countries would reach only 0.36 per cent, still far short of the 0.7 per cent target reaffirmed in the 2005 World Summit Outcome.
Despite these positive trends, however, the accumulation of record foreign exchange reserves by developing countries has increased again the negative net transfer of resources from developing to developed countries, which has reached nearly one half of a trillion dollars. This is clearly a reversal of the traditional development paradigm in which resources were to flow from the developed to the developing countries in order to offset deficient domestic savings and finance the acquisition of exports from developed countries needed for development. Developed countries’ net foreign lending was to finance the net export sales of their domestic industries. In the current situation, developed countries’ net imports finance the net sale of their domestic financial assets to developing countries. This reversal is largely due to the adoption by developing countries of fiscal solvency and macro stability that has increased domestic savings and made many developing countries net creditors, rather than net debtors. This is a positive situation if developed countries are in a better position to support high debt burdens without creating the risk of financial or exchange rate crisis.
As long as the returns on developed country financial assets are higher than returns that could be earned in developing countries, the new paradigm supports the increase in income of developing countries. In practice, however, this is generally not the case, although for many countries in Asia the difference in returns is not large—in the range of 100 basis points. To the extent that this is the cost of financing the large reserves that they feel they need to ensure against a reversal of capital flows and crisis, it is cheaper than the cost of a standby loan from the IMF or a private bank. And rising US interest rates should eventually reduce this cost or reverse it. But for most Latin American countries, the costs of negative net resource flows are much higher, indicating an inefficient use of resources. It is also unlikely that US rates will rise sufficiently to reverse the costs, while they are likely to bring about a reduction in capital flows to the region.
One of the reasons for creating an international fund to pool reserves was to reduce the national costs of holding foreign exchange reserves. That many countries do not use the Fund for this purpose suggests that some change is necessary in the costing and available amounts of its international liquidity provision. Many analysts argue that an increase in Fund quotas is not necessary because its overall liquidity position is more than adequate. But the actual behaviour of many countries suggests that they consider their ability to use the Fund’s resources, given their quotas, to be insufficient. In other words, the Fund’s overall position can be sufficient even as each country considers its own quota to be insufficient. This merits careful consideration during the current review of quotas.
It will also be important within this review to find an adequate response to the legitimate request of developing countries for increased responsibility within the international system through increased voice and representation. Since the call for this in the Monterrey Consensus, a great deal of discussion has occurred, but yielding little in terms of concrete, actionable proposals. We hope that the IMFC will reach a breakthrough in the area of voice and representation of developing countries during this session, which could be ratified next September in Singapore.
One way of looking at the positive performance of many developing countries is that it is simply the reflection of the large global imbalances in trade and finance. To the extent that the continued expansion of trade balances and the associated increasingly large financial flows represents a risk to global stability, the positive performance of developing countries may be ephemeral and illusory. While most Asian countries have followed policies to insulate their exchange rates from international capital flows in order to preserve international competitiveness, many Latin American countries are again experiencing substantial nominal and real appreciation of their exchange rates, along with increasing nominal debt stocks reminiscent of the period of financial crisis in the 1990s. Also, much of the improvement in external accounts is due to improved terms of trade and higher demand from Asia for agricultural and primary commodities. History suggests that such movements in commodity prices are cyclical, which implies in turn that the elimination of the external constraint may also be only cyclical.
Preserving global growth will thus require more and better global coordination of economic policies and in particular economic adjustment to reverse the imbalances before the market does so through financial crisis. Given its broad representation of the relevant parties, the IMF is clearly the most appropriate forum for this coordination. Surveillance has always represented one of the most important contributions to global stability, and all countries need to recognize the importance of strengthening this aspect of the Fund’s operations. In this respect, we welcome the proposals to extend IMF surveillance to include the implications of national policies for stability of the global economy. Further, support should be given to the possibility of multilateral assessments in which inter-related groups of countries could explore policy alternatives that would provide a better overall outcome. In a fully interdependent world, it is no longer the case that the best policy is for each country to pursue stability independently. A multilateral approach will require a major commitment on the part of countries, in particular, developed countries, and a loss of national autonomy in policy making. Yet better coordination and cooperation is the best alternative to either more complex institutions of global governance or the risk of persistent imbalances that are resolved by global crises.
In these coordination efforts, the adjustment to the global imbalances must preserve global growth. Traditional adjustment policies have tended to be asymmetric, providing restraint in the high growth economies without any automatic increase in the slower growing economies. One of the intentions of the founders of the Bretton Woods institutions was to provide a more symmetric global adjustment mechanism; this objective should be at the centre of efforts to coordinate global adjustment. It is imperative that developing country growth be preserved. In addition to the use of counter cyclical policies suggested above, an improved provision of liquidity for developing countries is required. This must go beyond the recently announced Exogenous Shocks Facility to provide a more rapid and automatic provision of liquidity to support growth. The recently proposed new financing vehicle for high access contingent financing is a step in the right direction, although the limit of 300 per cent of quota is not generous and the automaticity of the drawing needs to be assured.