TWN Info Service on Finance and Development (June10/01)
4 June 2010
Third World Network

Global economy to grow by 3% this year, but recovery subdued
Published in SUNS #6933 dated 31 May 2010

Geneva, 28 May (Kanaga Raja) -- Following a contraction of 2.0% in 2009, world gross product (WGP) is expected to grow by 3.0% in 2010 and 3.1% in 2011, but the pace of the recovery remains subdued and is far from sufficient to recuperate the job losses and close the output gap created by the deep recession.

This projection has been outlined by the United Nations in its latest update to the "World Economic Situation and Prospects 2010" report that was released back in January. The current outlook is an update of the global economic situation as of mid-2010.

(In its January outlook, the UN had forecast world gross product to fall by 2.2% in 2009, and see a mild growth of 2.4% in 2010. See SUNS #6847 dated 22 January 2010).

According to the latest outlook, the baseline forecast assumes that the multi-year policy stimulus measures put in place in the major economies will be implemented as envisaged, implying that in most countries, government stimulus will continue at least during 2010, and that private sector confidence will pick up gradually.

Buttressed by unprecedented government support worldwide, global financial markets have progressively stabilized. By mid-2010, systemic risks in the world financial system have abated notably, while risk premia in most credit market segments have dropped to pre-crisis levels.

Also, says the outlook, major equity markets have recovered on average about half of the losses incurred during the crisis, while banks and other financial institutions have managed to rebuild their capital. Capital inflows are gradually returning to many developing economies, and prices of primary commodities have rebounded after steep declines from the start of the crisis to the second quarter of 2009.

The recovery in the real economy has also gained more traction. Propelled by fiscal stimulus packages and expansionary monetary policies, most economies registered positive growth in late 2009 and early 2010.

Yet, important weaknesses remain in the world economy, the report cautions, saying that despite the huge amount of liquidity that was injected into the financial system, credit flows to non-financial sectors in many economies, particularly the major developed economies, remain subdued. While the rebound in equity prices has mitigated the losses of many financial institutions, the process of establishing sounder balance sheets through write-downs of troubled assets and de-leveraging is still on-going.

At the same time, it adds, public finances of many developed countries have deteriorated rapidly due to the impact of the crisis and the policy responses. "In some, such as in Greece, Portugal, Spain and Ireland, they have already become a new source of financial instability."

The report notes that the recovery of economic activity at the global level is weaker and slower than observed after previous recessions of recent date. Economic recovery is also uneven across countries. In most developed countries, private sector activity is not yet on a solid footing. Facing elevated unemployment rates, soaring public debt, and limited credit flows, growth prospects for most developed economies remain lacklustre, unable to provide sufficient impetus to the global economy.

While developing Asia, particularly China and India, is leading the way among developing countries, the recovery is much more subdued in many economies in Africa and Latin America.

Many developing countries are still suffering from the fallout of the global financial crisis. Though only a reduced number of developing countries are expected to register another year of decline of per capita income during 2010, the impact on labour markets and social conditions is still being felt more broadly. The reduction in employment and income opportunities has led to a considerable slowdown in progress towards poverty reduction and the fight against hunger.

By the end of 2010, says the report, the crisis will have left an estimated 64 million more persons in extreme poverty relative to the pre-crisis trend. The steep rise in food prices during 2007-2008 is estimated to have increased the number of malnourished people by 63 million, while the global economic crisis may have led to another 41 million undernourished than would have been the case without the crisis.

The number of unemployed worldwide rose by more than 34 million people in 2009, as the estimated global rate of unemployment increased from 5.7% at the end of 2007 to 6.6% by the end of 2009. At the present rate of recovery, it is expected to take at least 4 to 5 years to bring unemployment rates down to pre-crisis levels in most developed countries.

Weak labour markets, lower global demand and excess capacity contributed to general downward pressures on prices in 2009, with global inflation declining from 4.7% in 2008 to 1.4% in 2009. Inflationary pressures are expected to remain muted in developed and in many developing economies.

The risk of a protracted period of mediocre growth for the world economy remains high in the aftermath of the global financial crisis. This poses new policy challenges. In the near term, policy support remains essential for solidifying and broadening the global recovery. One key area is to strengthen support for boosting employment.

During the financial crisis, international policy cooperation among major economies, particularly in the Group of 20, played an important role in restoring confidence and averting a much deeper crisis.

According to the report, given their diverse pace of recovery and their idiosyncratic challenges, individual countries have different policy priorities: some will be able to unwind stimulus policies earlier, while others may have to consolidate their public debt more urgently. These country-specific policy adjustments, however, require more international coordination to strengthen policy synergies at the global level and to mitigate negative policy spill-overs to the world economy.

As to the regional outlook for the developed economies, the report forecasts the US economy to grow by 2.9% in 2010 and slowing to 2.5% in 2011. Private consumption growth is expected to remain subdued at 2.5% in both 2010 and 2011. Payroll employment has decreased by more than eight million from 2007 to 2009 and unemployment will remain over 9% in 2010 and 2011.

Noting that the government deficit has soared to $1.4 trillion, or about 10% of GDP, the report says that while the cyclical factors driving up the fiscal deficit will weaken as the recovery progresses, maintaining fiscal sustainability over the medium-term poses a key challenge to the government. Given that a large proportion of public debt is held abroad, pressures may emerge to raise interest rates if the dollar weakens with a re-surging external deficit which in turn would make reducing the budget deficit more challenging.

Japan's economy contracted by more than 5% in 2009; its worst performance since the oil shock in the early 1970s. Growth is expected to remain lackluster throughout 2010-2011, averaging 1.3% over the two-year period.

Most of Western Europe exited recession by the third quarter of 2009. Nonetheless, in the Euro area, the collapse in activity earlier in the year resulted in a decline in GDP by 4.0% for 2009 as a whole. So far, the rebound has been driven by net exports, the end of inventory de-stocking and substantial fiscal support, through both automatic stabilizers and fiscal stimulus. Going forward, activity is expected to be driven by net exports with domestic demand, particularly investment, starting to contribute more in 2011.

Nonetheless, the report warns, domestic demand growth will remain subdued, being held back by continuing balance sheet adjustments and tight financing conditions. Investment may pick up with increasing foreign orders but no sooner than after capacity utilization has sufficiently rebounded from its record lows of mid-2009. Consumption expenditure is constrained by high rates of unemployment and meagre wage growth.

"As a result, overall output growth in the Euro area is forecast to remain subdued at 0.9% in 2010 and 1.5% in 2011. With such a meagre rebound in activity, unemployment is expected to remain elevated through 2011, though without significantly increasing from current levels."

The report finds that fiscal positions have moved sharply into deficit since the onset of the recession.

Macro-economic policy in most European countries is expected to shift from stimulus to consolidation in 2011, but the fiscal crisis in Greece is forcing immediate fiscal consolidation in those countries with perceived unsustainable budget positions.

In Greece, with an estimated deficit of 13.6% of GDP in 2009 and a public debt of 115% of GDP, the government became caught in a solvency crisis requiring external assistance from the IMF in concert with the European Union, but not before causing contagion effects in other countries.

"Heightened scrutiny by financial markets and downgrades by ratings agencies have led to a sharp rise in sovereign bond spreads for Portugal, Ireland, and Spain, which have already strongly tightened fiscal policy."

As for the developing economies, the report says that a rebound of exports and commodities prices contributed to a higher-than-expected GDP growth in Africa of 2.4% in 2009, as did the fiscal and monetary stimuli, the continued rapid expansion of the telecommunication sector and the ongoing revival of manufacturing and increased investments.

Overall, growth is expected to accelerate to 4.7% in 2010 and 5.3% in 2011. In most countries, the recovery will be insufficient to achieve meaningful improvements in social conditions.

Following the severe downturn in late 2008 and early 2009, East Asia's economies have rebounded strongly over the past year and the outlook for 2010 and 2011 is favourable, as industrial production and exports continue to expand while improved labour market conditions will support household demand.

Led by strong growth in China, regional GDP is expected to increase by 7.3% in 2010, up from 4.7% in 2009. In 2011, growth is forecast to slow to 6.9%, as a further recovery in external demand is expected to only partly offset the gradual withdrawal of monetary and fiscal stimulus measures.

China  will again be the region's fastest-growing economy in 2010 and 2011 with GDP estimated to rise by 9.2% and 8.8%, respectively. Against the backdrop of mild inflation and ongoing risks in the global economy, monetary conditions will continue to support growth, though central banks will gradually become more restrictive in the course of 2010 and 2011.

Economic activity in South Asia has also gained strength since mid-2009, driven by fiscal stimulus measures and a gradual recovery in private sector demand. Growth has picked up in India and Sri Lanka, but economic conditions have remained relatively weak in the Islamic Republic of Iran and Pakistan.

Average growth is expected to accelerate to 6.5% in 2010 and 6.9% in 2011, as exports continue to recover and domestic conditions improve in most countries.

The recovery is led by India, where growth accelerated to 7% in the second half of 2009 due to a rapid expansion in manufacturing and in services. A recovery of exports and a further strengthening of investment and consumption demand is expected to lift growth in India to 7.9% in 2010 and 8.1% in 2011.

According to the outlook, economic activity in Latin America and the Caribbean has also recovered more strongly than previously expected. GDP growth in the region will reach 4.0% in 2010 and 3.9% in 2011, compared to a contraction of 2.1% in 2009.

"The international economic environment for developing countries generally has started to improve. Capital inflows are returning, external financing costs are declining, commodity prices are rebounding, and trade flows are recovering."

The report forecasts the price of Brent crude oil to average $72 per barrel in 2010; 16% higher than the average for 2009. Demand for oil is expected to grow by 1.5% in 2010, mainly due to the measured increase in demand from major developing countries, including China and India. Food prices, in contrast, are forecast to decline by 3.4%, on average, in 2010.

World trade continues to pick up gradually owing to the rebound of export production in East Asia and other developing regions. However, the recovery remains constrained by weak aggregate demand and somewhat elevated trade finance costs. In the first two months of 2010, the world trade volume was 13% higher than a year ago, but still 9% below the corresponding level in 2008.

World trade is expected to grow by 7.6% in 2010, having declined by 13.1% in 2009. This gradual upward trend is forecast to continue in 2011, with trade volumes expanding by 5.9%.

After a precipitous decline in late 2008 and early 2009, net private capital inflows to emerging market economies have rebounded. The net private inflows to these economies in 2009, totalling some $500 billion, remain well below pre-crisis levels of 2007, however, when they peaked at $1.2 trillion.

While foreign direct investment inflows declined by about 30% in 2009, portfolio investment rebounded markedly, turning from net outflows in 2008 to inflows of some $100 billion. Foreign commercial banks also registered net outflows in 2009.

In the outlook for 2010, total net capital inflows to emerging market economies are expected to recover by about 30%, to above $700 billion, but their growth will moderate considerably in 2010.

"A quick return to pre-crisis levels of capital flows is not likely, however. On the supply side, the still ongoing de-leveraging of many financial institutions in advanced market economies is likely to limit capital flows to developing economies. Demand for foreign capital inflows may also not be very strong given abundant availability of domestic liquidity in many emerging market economies."

On official development assistance (ODA) flows, the report finds that current projections of OECD/DAC (Development Assistance Committee) suggest that aid flows may increase to about $130 billion in 2010, which would be about $20 billion short of the commitments made in 2005 at the G8 Summit held at Gleneagles. The gap in delivering on the commitments to raise ODA for Africa would be about $14 billion.

According to the report, the global financial crisis and attendant recession has seen large swings in the major exchange rates as the competing forces of risk and expected relative returns ebbed and flowed. The value of the US dollar against the euro has fluctuated within a narrower band since 2008, but volatility remains high.

Most recently, the dollar strengthened again due to a weaker euro caused by the Greek and other looming debt crises. "The situation has also exposed institutional weaknesses of the European monetary union, for lacking a lender-of-last-resort mechanism. The existence of such a mechanism would have allowed a swifter response to the Greek debt crisis."

Although the global economy is slowly recovering from the deep recession, a number of uncertainties and risks cloud the outlook, in particular, those associated with rising public sector indebtedness in major economies and re-surging global imbalances under the present path of global recovery.

The discretionary fiscal measures have contributed to widening budget deficits, though the direct impact of the recession (via lower tax revenues and/or higher unemployment benefit payments) has been larger. According to IMF estimates, the stimulus packages account for approximately 40% of the increase in structural primary balances in the developed countries that are part of the G20 and 30% in the case of the developing countries that are G20 members.

Levels of public indebtedness have also increased significantly, especially among developed countries.

"The perception of increased risk of sovereign debt default is exemplified by recent woes of several smaller European countries, including Greece and Portugal, but concerns are wider and extend to larger economies like Spain. As these countries are part of the euro-zone, their problems transmitted to turmoil in global currency and financial markets."

The report observes that the countries involved have already scheduled severe fiscal cuts to redress the situation. With the withdrawal of fiscal support, the recession in these economies will prolong during 2010 and possibly beyond, making a return to fiscal sustainability an even bigger challenge.

The report reiterates that "a premature move to fiscal consolidation at this stage of the recovery would risk lower growth and tax revenue, thereby possibly exacerbating fiscal difficulties and causing the public debt ratio to rise even further, For most countries, it remains important to maintain fiscal stimulus measures until a marked recovery is taking place."

Since the onset of the crisis, government support has contributed to a progressive stabilization of global financial markets. Significant fiscal stimulus packages were enacted, central bank policy rates were cut decisively and a wide range of unconventional monetary measures were introduced.

According to the outlook, the authorities of most major developed economies are expected to maintain their current policy stance throughout 2010, and begin a process of tightening of policy thereafter. Central banks are not expected to reduce their holdings of long-term securities, purchased during the crisis, in 2010, thus keeping long-term interest rates at relatively low levels.

Meanwhile, the stimulatory fiscal stances will remain intact for 2010. It is expected though that many countries will begin taking steps towards fiscal consolidation in 2011.

The subdued and uneven recovery of the global economy poses additional policy challenges, the report cautions.

First, dealing with the jobs crisis is of immediate urgency as persistent high unemployment and under-employment rates are slowing the global recovery itself as well as progress towards poverty reduction in developing countries.

Second, there is a need for more resources and greater efforts to make up for the significant setbacks in progress towards the Millennium Development Goals (MDGs).

Low-income countries with limited fiscal space are in need of additional ODA to finance the expansion of social services and programmes needed to meet the MDGs and engage in counter-cyclical policies.

More broadly, the global crisis has highlighted the need for very large liquidity buffers to deal with sudden and large capital market shocks. In response to the financial crises of the 1990s, many developing countries have responded by accumulating vast amounts of reserves as a form of self-insurance. But doing so comes at high opportunity costs and, moreover, it has been conducive to the problem of the global imbalances.

"By better pooling reserves regionally and internationally, such costs to individual countries could be reduced and it could also form the basis for more reliable emergency financing and the establishment of an international lender of last resort mechanism. Broadening existing SDR (special drawing rights) arrangements could be part of such new arrangements and ... form part of a much needed broader reform of the global reserve system."

Third, says the report, those efforts will need to be underpinned by strengthened international policy coordination to avoid weakening of the recovery which may result from premature and uncoordinated exit strategies from the macroeconomic stimulus measures and failure to address the spill-over effects from emerging public debt crises in developed countries. Further progress on systemic reforms will also be needed.

"The lack of a concerted approach and greater policy coordination among members of the European Union to tackle concerns of fiscal sustainability particularly in Greece, and the fallout of the initial indecisiveness on financial markets, highlights the importance, particularly in times of greater uncertainty, of a broad and effective policy coordination among the major economies to prevent the return of global imbalances and to ensure that the recovery is sustainable," the report concludes. +