Mr. President, Distinguished Delegates,
I am pleased to present to you the World Economic Situation and Prospects (WESP) 2007. The WESP is a joint product of the Department of Economic and Social Affairs (DESA), the United Nations Conference on Trade and Development (UNCTAD), and the five UN regional commissions.
The report provides the UN’s short-term economic outlook for the world economy. It also summarizes the views of the UN Secretariat on key issues in international macroeconomic policy making, trends in world trade and multilateral trade policies, and trends in international finance and development assistance. As such, the WESP aims to serve as a point of reference for deliberations on economic and social issues taking place in the UN throughout the year, particularly in ECOSOC.
1. World economic outlook
After a solid and broad-based growth for three consecutive years, the world economy is expected to decelerate in 2007, with the growth of world gross product (WGP) moderating to a pace of 3.2 per cent, down from 3.8 per cent in 2006. (endnote 1) All country groups are expected to witness a certain degree of slowdown, but the growth rates in most developing countries and economies in transition should remain at relatively high levels.
The economic growth performance of the Least Developed Countries (LDCs) was remarkably strong over the past few years, averaging nearly 7 percent per year, and their growth is expected to remain strong in 2007. This is good news for the potential to achieve the MDGs. It should be said, however, that the performance of this group of countries has been diverse, with some countries lagging significantly behind.
In the outlook, the economy of the United States of America will be the major drag, as its growth is forecast to soften on the back of a weakening housing market, to a rate of 2.2 per cent in 2007.
The most recent available data (after the release of the WESP) show that GDP growth in the United States rebounded in the 4th quarter of 2006 (with annual growth for 2006 of 3.4 %, compared with the estimate of 3.2% in the WESP), and some data about the housing sector also seem to indicate that it has stabilized. Although these are somewhat more positive signs, they are not strong enough to preclude the risks for a further downturn. However, together with other indicators (such as healthy corporate finances), they do suggest that the current slowdown need not degenerate into a recession.
No other developed economy is expected to emerge as an alternative engine of global growth. Indeed, although economic growth in Japan remains robust, having sustained an expansion since 2003 at an average rate of 2.5 per cent, it is expected to slow down to 1.7 per cent in 2007.
Similarly, growth in Western Europe greatly exceeded expectations in 2006, as GDP in the euro area grew by 2.5 per cent, the fastest since 2000, and rates outside the euro area were also strong. This good performance has been anchored by domestic demand, particularly investment expenditure. But a slowdown is equally expected for 2007.
Among the economies in transition, the Commonwealth of Independent States (CIS) has maintained a strong pace in 2006, largely owing to high international prices of oil, gas and metals. Rising export revenues have also spilled over into strong domestic demand. Private capital inflows have further contributed to the strong economic performance in the Russian Federation and Kazakhstan, while official financing and remittances remain an important source of funding of domestic spending for the smaller economies of the CIS. Robust regional growth is expected to continue in 2007, but at a more moderate pace as compared to 2006.
Growth in South-Eastern Europe has regained dynamism during 2006 as growth accelerated to 5.9 per cent. Robust domestic demand has generated large external imbalances in the region. Supported by strong inflows of foreign direct investment (FDI), modernization of production bases has continued in the region. Growth is expected to maintain momentum in 2007.
Among developing countries, sustained high growth in China and India has engendered more endogenous growth through increasing South-South trade and financial linkages. This is reflected in, among other things, in continued strong demand for and higher prices of energy and primary commodities. Commodity-exporting countries benefit from this and this explains for a good part the continued strong performance of economic growth in most African and Latin American countries.
Notwithstanding the improvement in their domestic economic conditions and stronger interregional linkages, most developing countries remain vulnerable to a slowdown in the major developed economies and to volatility of international commodity and financial markets. The increased volatility, as well as the decline in the prices of oil and some metal commodities as observed in the past few months, should be a vivid warning for countries with a heavy dependence on primary commodity exports.
2. International trade and financial conditions
Generally, the trade environment has been favourable for developing countries, with a strong expansion of trade volumes and high commodity prices. The slowdown of the world economy will imply, however, that trade will decelerate in 2007, and non-oil commodity prices would stabilize or decline from their 2006 levels.
The oil price trend in 2006 was marked by both strong increases and considerable volatility. Tight worldwide oil production and refinery capacity, coupled with a solid global oil demand, has been the fundamental factor behind the upward trend in oil prices, while geopolitical tensions are among the major factors driving volatility. The combination of these two factors will likely keep prices capricious. Oil prices are therefore expected to remain high at about $55-$60 per barrel on average in 2007.
High oil prices have thus far not affected global economic growth, and have obviously benefited oil-exporting countries. Other developing countries have seen strong non-oil commodity prices compensate for higher oil bills. Yet several countries have been negatively affected by persistently high oil prices.
The growth of the volume of world merchandise was robust during 2006, increasing at a pace of approximately 10 per cent. The strength of global trade was broad-based. Asian economies continued to lead the dynamism in global trade, with exports of China and India increasing by about 20 percent in real terms. Also, many developing countries in Africa and Latin America managed to expand their exports at double-digit rates. Oil-exporting countries continued to experience large increases in export revenues. Exports of the major developed countries were also robust, driven by global demand for capital goods. In the outlook for 2007, growth of global trade is expected to moderate to about 8 per cent for the year.
Multilateral trade talks in the Doha Round were suspended in July 2006 owing to differences between major trading partners, especially in the area of agriculture and non-agricultural market access (NAMA), as well as to a more general sense that the economic and commercial benefits of any agreement would not outweigh the political costs of making additional concessions on issues often highly sensitive on the domestic political front. This represents a setback with respect to achieving an open and rule-based world trading system. Furthermore, the proliferation of large numbers of bilateral and regional trade agreements has put the integrity of the multilateral trading system at risk. While there is currently no agreement on the next steps in the negotiating process, efforts have intensified in order to reach consensus on the resumption of the Doha Round.
Also external financing conditions for developing countries remained favourable in 2006. The external financing costs for emerging market economies remain low. The spreads in the Emerging Markets Bond Index (EMBI) reached all-time lows in the first quarter of 2006, but then increased during the turmoil in financial markets in May-June. Since then, they have tended to fall again. Also, despite a continuous monetary tightening in the United States, the benchmark interest rates underlying the external financing costs for emerging market economies have remained low. Such favourable external financing conditions may not be sustainable, as the current-account deficit of the United States may eventually induce higher benchmark interest rates.
Private capital flows to developing countries were strong, particularly foreign direct investment (FDI). Developing countries like China and India as well as the major oil-exporters have also become important foreign investors themselves.
Also Official Development Assistance (ODA) from OECD countries to developing countries has increased recently. The current projections are that with current trends total ODA by OECD/DAC members is expected to reach the target of $130 billion set forth for 2010. It is important to note, however, that the recent increases in ODA have to a considerable extent been due to one-time effects. In addition, aid from non-DAC sources has increased notably. Countries like China and India are among these “emerging donors” which have begun to contribute significant additional development assistance.
The Heavily Indebted Poor Countries (HIPC) Initiative remains the primary international instrument for the provision of debt relief to low-income countries. The volume of debt relief has increased owing to both progress made by eligible countries and the introduction of the Multilateral Debt Relief Initiative. However, a series of challenges remain, including increasing the resources effectively available for the implementation of poverty reduction programmes by HIPCs as well as the adoption of measures to avoid the re-emergence of unsustainable debt burdens.
On balance, however, poor countries continue to transfer more resources to rich countries than they receive. Net outward transfers by developing countries reached $658 billion in 2006 and those by economies in transition $125 billion. This trend of poor countries financing rich countries has continued for a decade, raising questions about its sustainability. The building-up of official reserves has been a key mechanism through which these financial net transfers have occurred. Developing countries now own well over $3 trillion in foreign-exchange reserves, with China alone holding more than $1 trillion. The strengthened reserve positions have provided greater protection in dealing with external shocks.
The mirror image of the accumulation of reserves in developing countries is, however, the widening external deficit of the world’s major reserve currency country, the United States. Thus, while their current reserve position may have made developing countries less vulnerable to idiosyncratic shocks, it does not insulate them from more systemic shocks, such as an abrupt adjustment of the external deficit in the United States and a large devaluation of the dollar.
3. Downside risks
There are a number of uncertainties and downside risks that may turn the outlook for the global economy more gloomy. Let me elaborate here only on two of them: the housing sector and global imbalances.
The possibility of a more severe downturn in housing markets represents a significant downside risk to the economic outlook. A number of economies have witnessed substantial appreciation of house prices over the past decade, and the associated wealth effects have contributed to solid economic growth rates. A reversal of the process will negatively affect the world economy. Various indicators measuring the performance of the housing market in the United States show a significant recession in activity in 2006: new home sales in 2006 dropped by 17.3% from 2005, the biggest decline since 1990. The sales rebounded in recent two months, but the risks for further decline in housing prices remain. A sizable drop in housing prices will have a more significant impact on consumption than the decline in housing volume activity.
While the baseline forecast assumes a mild adjustment in the housing market, and hence a moderate slowdown in the US economy, an alternative, more pessimistic scenario, shows that a more severe decline in housing prices in the United States would not only reduce its own growth to a pace below 1 per cent in 2007, but also reduce economic growth in the rest of the world by more than one percentage point. In addition, a collapse of house prices in major economies could provoke a crisis in mortgage markets and might set in motion a deflationary adjustment of global imbalances.
Current-account imbalances across countries have widened further during 2006. The deficit of the United States rose to about $870 billion, an increase of $80 billion from the previous year. In the aggregate, the current account of the developed economies shows a deficit of more than $600 billion. While Germany has maintained a sizeable surplus of about $120 billion, the euro area as a whole is showing a small deficit. Japan’s surplus of $170 billion remains the largest in absolute terms among developed countries.
Most developing regions are running surpluses, with the surplus in the group of oil-exporting countries increasing the most in 2006, to about $500 billion. The surplus in developing Asia remains above $200 billion, concentrated almost exclusively in China, Hong Kong SAR and Taiwan Province of China. Latin America has managed to run a surplus for an unprecedented four consecutive years, though this has also been concentrated in a few countries, while Africa is also in a small surplus. The surplus in the CIS group has surpassed $100 billion, mainly on account of the Russian Federation.
In the baseline outlook for 2007, the global imbalances are expected to decline, albeit only slightly. With the economic growth in the United States expected to moderate more than that of other major economies, its current-account deficit is expected to narrow slightly from an estimated $870 billion in 2006 to $840 billion in 2007. As a result of its widening current-account deficit, the indebtedness of the United States has deepened. This is undermining the sustainability of the current constellation of global imbalances.
The dollar depreciated against the euro and the Japanese yen. In the outlook, the dollar is expected to continue the trend of depreciation against most other currencies. The risk for a sharp depreciation of the dollar in association with an adjustment of the large US current-account deficit has increased: since 2002, the trend of the depreciation of the dollar has been interspersed by periodic rebounds as the differentials in the interest rates and gross domestic product (GDP) growth rates among the major economies have been in favour of the dollar, but in 2007 these favourable differentials for the dollar are expected to narrow substantially.
Therefore, notwithstanding the expected reduction in the global imbalances for 2007, the risk of a disorderly adjustment has not dissipated. Since the differentials in growth rates and interest rates across major economies regions are expected to bring an unfavourable change the United States dollar vis-à-vis other major currencies, a self-fulfilling sell-off of the dollar in foreign exchange market could trigger a steep fall of this currency, which could upset financial markets and cause an abrupt adjustment of global imbalances.
4. Policy implications
Existing macroeconomic policy stances of the major economies are not designed to achieve a benign adjustment in the global imbalances. The current tendency towards more restrictive monetary and fiscal policies will have a dampening effect on demand in some of the surplus countries, especially in Germany and Japan, making it more difficult for the US to lower its external deficit through export growth. At the same time, more expansionary fiscal policies in some of the Asian surplus countries seem insufficient to compensate for such deflationary effects and to yield the necessary export growth for the US economy in the absence of major exchange-rate adjustments.
A coordinated strategy, in contrast, could help avoid the negative growth effects and create confidence in the stability of financial and foreign exchange markets. Cooperation would make use of the spillover effects of the policies of one country as an offsetting factor for the negative demand effects of the adjustment in another country. Growth stimulus in Europe, Asia, and the major oil-exporting countries could then offset the initially contractionary effect of adjustment policies conducted by the United States.
In the WESP, we propose a number of concrete steps that may lead to an effective international consultation mechanism, a step towards international policy coordination. This mechanism would include the IMF as an outside mediator to generate a consensus on such policies. Such consultations should further involve all major players, including a fair representation of developing countries. Therefore, existing platforms, such as the Group of 8 (G-8), are unsuitable in this regard.
Apart from working towards coordinated policies, the new consultation mechanism should also work towards more fundamental reforms of the international monetary system which would replace the current constellation under which the dollar acts by and large as the dominant reserve currency for the world. I would like to urge the Economic and Social Council to seek ways to facilitate the creation of such a consultation mechanism and address this in its forthcoming meeting in April with the Bretton Woods Institutions. The need for international policy coordination is more pressing than ever and reaching consensus about the necessary adjustments will likely be easier while the world economy is still growing at a relatively strong pace, as these adjustments will be less painful than when such efforts come too late.
Endnote 1 - The United Nations estimates growth of world gross product (WGP) using country weights for gross domestic product (GDP) measured in dollars at market prices. Other agencies, such as the IMF, use purchasing power parity (PPP) based weights. So for comparison, WGP growth at PPP weights would be 5.1 per cent for 2006 and 4.5 per cent for the forecast for 2007.