EconSouth (Fourth Quarter 2003)

INTERNATIONAL FOCUS



The Global Economy Heats Up

After several years of disappointing economic growth, the global economy is poised to enjoy stronger output in 2004. Strength in the U.S. and Asian economies led the turnaround that began in the second half of 2003. The European and Japanese economies have improved as well, and Latin American economies should see an upturn in 2004. Low inflation and supportive economic policies remain key to the favorable outlook.

The global economy was heating up as 2003 waned, and it should maintain this momentum into 2004. Coming on the heels of a disappointing 2003 and slow growth in 2001 and 2002, this upturn is welcome.

The United States is poised to lead the global recovery, with Europe and Japan contributing more positive outlooks than in the past several years. The United States’ NAFTA partners, Canada and Mexico, should benefit from their wealthy neighbor’s improved prospects. Asia’s developing economies are expected to maintain strong growth in 2004 while Latin America should improve overall. Low inflation and supportive fiscal and monetary policies in most economies should aid this positive global outlook.

2003 — two halves, two stories
Slow growth in the first half of 2003 was brought on, at least in part, by general economic uncertainty surrounding the geopolitical developments in the Middle East and the resulting rise in global energy prices. The outbreak of SARS in several Asian countries and Canada also negatively affected output. Consumer confidence declined sharply in response to these negative developments and fed expectations of weakening demand throughout most of the world. Businesses faced with the prospect of weak consumer demand scaled back production of goods and delivery of services.

When it became clear that the initial conflict in Iraq would be short and would not result in regionwide hostilities, oil prices retreated, and consumer and business confidence bounced back. Meanwhile, policymakers around the world acted to support economic growth by keeping interest rates low and providing fiscal stimulus in their respective countries. By the summer, a global rebound was clearly under way. But improvements in economic activity, led by the United States and developing Asian economies, were uneven. By the end of the third quarter, however, rebounds in Europe and Japan were also gaining traction.

CHART 1
World Economic Growth
Note: Data for third quarter 2003 are estimated; data for fourth quarter 2003 and for 2004 are an average of available forecasts.
Source: International Monetary Fund; Federal Reserve Bank of Atlanta; average of available forecasts
 
CHART 2
Fiscal and Monetary Easing in the
Major Economies, 2000–03
Note: LIBOR is the London Interbank Offer Rate, the interest rate banks charge each other for loans (usually in euros) in the international interbank market. Structural fiscal balance is the fiscal balance adjusted for the business cycle.
Source: International Monetary Fund

Analysts estimate that global economic growth in the third quarter was over 4 percent, well above the 2 percent rate in the first half of the year (see chart 1). Fortunately, most of the factors that led to the rebound in the second half of 2003 — namely, supportive fiscal and monetary policies — remain in place as 2004 begins.

Policymakers look toward 2004
In several developed countries, supportive fiscal policies in 2003 were a continuation of policies established when the global economy deteriorated in 2001. But some economies, particularly the United States, eased fiscal policy further in 2003. In addition, many central banks likewise eased or maintained supportive monetary policies developed during the economic downturn in 2001 (see chart 2).

The backdrop to lower interest rates continues to be low inflation. Global consumer prices should rise less than 2 percent for the third consecutive year in 2004, according to the International Monetary Fund’s (IMF) World Economic Outlook.

In fact, the current projection of a 1.3 percent inflation rate for developed economies in 2004 would represent a 30-year low. Inflation in developing economies should fall to 5 percent, its lowest level in more than 30 years. Such modest inflation expectations support many forecasters’ view that central banks will maintain low interest rates in 2004.

Even though analysts expect all major economies to perform well in 2004, there are important regional differences regarding the pace of growth.

North America: The global economic engine revs up
The United States should continue to lead the global economy in 2004, led by strong domestic demand that will help countries that depend on exports to the United States, such as Canada and Mexico. Exports to the United States account for more than one-quarter of economic activity in Canada and Mexico. In 2003 Canada’s economy grew an estimated 2 percent, down from 3.3 percent in 2002. In 2004 Canada’s economic growth rate is forecast to return to approximately 3 percent. The appreciation of the Canadian dollar, which rose more than 17 percent against its U.S. counterpart during the past year, makes Canadian goods more expensive and thus may limit Canadian firms’ ability to fully capitalize on stronger growth in the United States.

Mexico, on the other hand, does not face an unfavorable exchange rate. Its currency depreciated about 8 percent against the U.S. dollar during the past year. The expected improvement in U.S. manufacturing will help Mexican exports in 2004 because many of Mexico’s exports to the United States supply the factory sector. Solid domestic demand should also help Mexico’s outlook. Growth in Mexicans’ personal consumption was a paltry 1.2 percent in 2002 but jumped to nearly 5 percent by the second quarter of 2003 in part because of lower interest rates. Most analysts expect Mexico’s economy to grow between 3 and 4 percent in 2004, well up from the 2003 estimate of only 1.5 percent and 2002’s dismal 0.7 percent.

South America: Positive but uneven outlook
The economies of South America should show varying degrees of improvement in 2004. The region’s largest economy, Brazil, is on target to rebound from a disappointing performance in 2003 that saw real GDP growth remain near 1 percent for the second consecutive year. Brazil’s international trade sector continues to perform well, but domestic economic activity remains subdued. Disinflation in 2003 led the Brazilian central bank to cut interest rates, and these cuts should help domestic demand. The IMF expects real economic growth in Brazil to be 3 percent in 2004.

Rethinking Structural Reform in Latin America

On Oct. 23–24, 2003, the Federal Reserve Bank of Atlanta and the Inter-American Development Bank (IDB) cosponsored the conference “Rethinking Structural Reform in Latin America.”

Conference papers investigated the effectiveness of reforms in a range of areas: trade and finance, where a great deal of progress has taken place; privatization and tax reform, which have experienced mixed results; and labor reform, where progress has been very modest. Four panels focused on governance and institutional reform, second-generation reforms such as tax and labor reforms, financial sector reform, and the relationship between reform and macroeconomic stability.

The conference also featured a policymaker roundtable discussion among three eminent economists: Guillermo Calvo, chief economist at the IDB; Carmen Reinhart of the University of Maryland; and Arnold C. Harberger of UCLA. Calvo noted that adjustments to recent downturns have been made and that future reforms should aim to lessen Latin America’s vulnerability to external shocks that negatively affect the region. Reinhart cautioned policymakers not to oversell how quickly economic reforms can deliver promised benefits and urged them to follow through on the reforms themselves. Harberger noted that further reforms should include provisions to ameliorate the negative effect from sharp fluctuations in capital flows.

Harberger, who also delivered one of the keynote addresses, noted that, at its core, economic reform in Latin America should be based on sound economic principles and that policymakers must apply and pursue these principles consistently.

In another keynote address, former Costa Rican president Miguel Ángel Rodríguez Echeverría provided a personal account of how the reform process advanced and then stalled during his term as president, which ended in 2002. President Rodríguez said he is optimistic about the future of reform, noting that broad support for economic stability pervades Latin America. However, he made it clear that broad policy prescriptions must be applied with particular care to the individual characteristics of each country.

Conference papers are available.

Argentina’s economy has stabilized from its crisis-induced recession. After plummeting over 10 percent in 2002, the economic growth rate bounced back to near 7 percent in 2003. Strong exports led the way in the recovery, and the stabilization of the domestic economy helped as well. Ongoing negotiations with its external creditors regarding debt restructuring will likely prevent large-scale investment in the Argentine economy in 2004. Nonetheless, forecasters expect real GDP growth of 4 to 5 percent in 2004.

Political turmoil in Venezuela continued to have a significant negative effect on economic activity. The strike in the oil sector early in 2003 severely curtailed production of the country’s main export, and uncertainty about a referendum that could remove President Hugo Chavez from office has foreign investors on the sidelines. Economic activity contracted between 10 and 15 percent in 2003 after declining nearly 9 percent in 2002. Forecasters see a return to economic growth in 2004, but political uncertainty makes it difficult to make projections with reasonable accuracy.

The economies of Colombia, Peru and Ecuador should grow between 3 and 5 percent in 2004, a slight improvement over 2003’s performance. Chile’s economy is expected to enjoy solid growth of 4.5 percent in 2004, up from an estimated 3.3 percent in 2003.

Analysts don’t expect inflation to pose a significant impediment to economic growth in Latin America in 2004. The IMF projects consumer prices to rise about 7 percent in 2004, down from 2003’s inflation rate of nearly 11 percent.

A significant factor in the region’s longer-term forecast is the future path of policies to deepen economic reforms instituted during the past decade. The Atlanta Fed and the Inter-American Development Bank held a conference on this issue in October 2003 (see the sidebar). Most participants agreed that reforms are likely to continue but at a slower pace than in the past. Most also agreed that continued reform is key to the region’s long-term economic development.

Hemispheric trade would boost Latin economies
Another important issue expected to positively affect the long-term outlook for the entire Western Hemisphere is the ongoing negotiations on the Free Trade Area of the Americas (FTAA). The eighth ministerial meeting on the FTAA was held in Miami in November 2003, and a follow-up meeting is scheduled for 2004 in Brazil. Negotiations are to be concluded no later than January 2005. Implementation will be sought as soon as possible thereafter, but no later than December 2005.

Meanwhile, in mid-December, the United States and four Central American nations — El Salvador, Guatemala, Honduras and Nicaragua — concluded a free trade agreement, known as CAFTA, that will eliminate trade barriers and promote investment between the United States and participating Central American economies. The agreement must be ratified by the U.S. Congress before it takes effect.

Europe: Slow but stronger growth
After several years of disappointing economic growth, the Euro Area appears to be entering a more prosperous period, but growth is expected to remain modest at best. In 2003 the Euro Area economy grew only about 0.5 percent after logging a paltry 0.9 percent growth the previous year. Investment spending has been a key weakness during recent years. Low business confidence has also permeated the Euro Area’s economy, and, despite recent improvements in the outlook, confidence indicators generally remain at low levels. In addition, unemployment remains high, and industrial production has not improved.

International Trade Reflects Global Economic Performance

The U.S. trade performance in 2003 reflects the fact that the U.S. economy outperformed the economies of its major trading partners. Import growth outpaced export growth, and, as a result, the nation’s trade deficit rose for the second straight year. The outlook for international trade in 2004 is positive: Robust growth in both imports and exports is anticipated as the U.S. economy continues to improve along with the economies of its trading partners. The decline in the dollar’s value may boost exports and limit import growth in 2004, but these trends are far from assured.

The outlook for the Southeast’s international trade is also promising. Through September 2003 the region’s trade improved from a year earlier, led by strong imports and a modest export rebound.

Imports are increasing in all the region’s ports; imports rose 12 percent in 2003 over 2002 levels, in contrast to exports, which remained flat. This uneven growth of regional trade through the third quarter of 2003 nearly doubled the region’s trade deficit over 2002 levels. The United States posted a record trade deficit with China, and the Southeast’s trade gap with China reflects the national trend.

The Southeast’s export performance was mixed in 2003. Shipments to Europe and Japan were generally weak because of lagging economic performances in those areas but began to post some gains in recent months as the two economies rebounded. Exports to Canada and Mexico also recovered. Factory shipments to Mexico and Canada rose in 2003 because NAFTA tariff schedules for almost all manufacturing commodities approached zero. Exports to Latin America remained weak, however, because economic growth there was disappointing in 2003.

The Southeast’s growing auto assembly industry continued to push export growth; shipments of transportation equipment, including autos, continued to rise in 2003.

The European Central Bank lowered its target interest rate 75 basis points to 2 percent in 2003, a move that should ease credit conditions in 2004. But the outlook will not receive much more help on the fiscal side because many Euro Area governments are currently running budget deficits at or near the limit of 3 percent of GDP established as a part of European Monetary Union.

The German economy — which accounts for roughly one-third of the Euro Area’s output — grew less than 1 percent for the third year in a row in 2003, dragging down the region’s performance and possibly hindering the Euro Area’s recovery prospects. The 15 percent depreciation of the dollar against the euro over the past 12 months may slow export growth, further clouding the outlook. In 2004 the IMF estimates that Euro Area real GDP will grow about 2 percent.

In contrast to the Euro Area, the United Kingdom’s economy has performed well. U.K. economic growth slowed somewhat in the first half of 2003 because of weaker investment and consumption as well as a slowdown in export growth. Indicators from the second half of the year point to an improving outlook. Forecasters predict that the economic growth rate will rise to nearly 3 percent in 2004 from a nearly 2 percent rate in 2003.

Meanwhile, those East European economies set to join the European Union fared better than their western counterparts in 2003. Analysts expect them to maintain their growth advantage in the coming year.

Asia continues to boom
Apart from occasional spurts of activity — many times driven by increased public spending — Japan’s economic growth has been subpar since the early 1990s. In 2003, however, growth accelerated to 2.5 percent from 2002’s barely positive rate. Increases in business investment, improving domestic consumption and strong exports drove the economic pickup in 2003, and much of that positive momentum should be maintained in the new year.

Forecasters are hesitant to predict 3 percent growth for Japan in 2004 until a more sustainable trend is clear, but the latest available data for 2003 were positive. This more promising forecast, however, does not diminish the importance of progress on structural adjustments — especially in the areas of financial sector reform, public debt and social security — necessary to improve Japan’s economy over the longer term.

Real GDP Growth in Selected World Areas and Countries
  2001 2002 2003 2004
World 2.4 3.0 3.2 4.1
Advanced economies 1.0 1.8 1.8 2.9
Major advanced economies (G7) 0.8 1.6 1.8 2.8
United States 0.3 2.4 2.6 3.9
Euro Area 1.5 0.9 0.5 1.9
United Kingdom 2.1 1.9 1.7 2.4
Australia 2.7 3.6 3.0 3.5
Canada 1.9 3.3 1.9 3.0
Mexico –0.2 0.7 1.5 3.5
Japan 0.4 0.2 2.0 1.4
Developing Countries 4.1 4.6 5.0 5.6
Central and Eastern Europe 3.1 3.0 3.4 4.1
Commonwealth of Independent States 6.4 4.9 5.8 5.0
Developing Asia 5.8 6.4 6.4 6.5
China 7.5 8.0 7.5 7.5
Middle East and Turkey 2.0 4.8 5.1 4.6
Western Hemisphere 0.7 –0.1 1.1 3.6
Africa 3.7 3.1 3.7 4.8
Sub-Saharan Africa 3.5 3.0 3.1 5.0
         
Source: International Monetary Fund, World Economic Outlook Database, September 2003

The SARS outbreak dealt a blow to the developing economies in Asia in the first half of 2003. Many countries saw their real economic growth decline in the second quarter for the first time since 1998, but all bounced back quickly and strongly in the second half of the year. Driven by strong exports and rising domestic demand, Asia’s emerging economies posted growth rates between 6 and 7 percent in 2003 — a rate similar to 2002’s. Forecasters expect similar results in 2004.

China should continue to grow rapidly in 2004. In fact, the IMF projects a real GDP expansion of 7.5 percent in China in the coming year, similar to its rate of growth in 2003.

Encouraging signs for 2004
The global economic outlook for 2004 is very positive (see the table). After several years of slow growth and recession in several major economies, output is clearly improving and promises to be even healthier in the coming year. Supportive fiscal and monetary policies are likely to remain in place, and inflation should not dampen the positive growth outlook in 2004.

This article was researched and written by Michael Chriszt, Stephen Kay and Gustavo Uceda of the Atlanta Fed’s regional research group. The estimates and forecasts in the article represent a consensus of private sector or multilateral outlooks and are not those of the Federal Reserve Bank of Atlanta or the Federal Reserve System.

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