World economic developments in 1998

An overview

Global economic developments in 1998 were heavily influenced by the economic crisis in Asia, the impact of which was severely felt in trade, and in financial and foreign exchange markets, as well as in the output growth of all regions. World growth slowed to 2% and inflation rose to 6.5%. In the major industrial nations, average growth slackened to 2%, and in countries in transition, aggregate output contracted by 0.2%. Economic expansion weakened most, however, in the developing countries, where output growth dropped sharply to 2.3%. The volume of world trade shrank to 3.7%, less than half the rate recorded in 1997.

Economic growth moderated slightly in major industrial countries to an average of 2% in 1998, primarily as a result of weakened demand for exports and stock market volatility. The average inflation rate dropped to 1.4%. Limited progress, however, was made in addressing structural unemployment, with average unemployment decreasing only slightly to 6.4%.

Output growth in the United States remained robust at 3.5%, underpinned by fiscal consolidation and the buoyant expansion of domestic demand and investment. Inflation fell to 1.6%, and unemployment to 4.6%, its lowest level in decades. Japan, by contrast, fell further into recession, with output growth contracting by 2.6%, a downturn triggered by stagnation in domestic demand, weakening of the financial sector and deceleration of exports to Asia. Unemployment rose to 4.1%, and inflation dropped to 0.5%. Economic recovery continued in Germany and France, both of which registered 3% growth, largely as a result of upturns in investment and consumer spending. Inflation fell to less than 1% in both cases, and unemployment eased slightly, to 11.2% and 11.8%, respectively. In the United Kingdom, output growth slowed to 2%, with a marked weakening in export growth prompted by the situation in Asia and low competitiveness due to the relative strength of the pound sterling. Inflation stood at 3% and unemployment dropped to 5%. The economy of Italy continued its upward trend, with output growth increasing to 2%, driven partly by an acceleration of investment supported by low interest rates. Inflation was kept at an estimated 2%, although unemployment remained high at 12%. In Canada, strong domestic demand coupled with exchange rate depreciation against the U.S dollar and major European currencies cushioned the effects of the downturn in exports to Asia and lower commodity prices. Growth moderated to 3%, as inflation remained subdued at 1% and unemployment dropped further to 8%.

Performance among other industrial countries was also varied. A strengthening of growth with low inflation was observed in Austria, Switzerland, Sweden, The Netherlands, Portugal, and Spain. Expansion decelerated, however, in Greece, Denmark, Finland, Luxembourg, Belgium, and Ireland. In Australia and New Zealand, the Asian crisis had a significant impact due to their large trade exposure in the region.

Countries in transition

The overall economic recovery of countries in transition during 1997 proved to be short-lived. Aggregate output in 1998 shrank by 1%, compared to a 2% growth rate the previous year, while average inflation remained high at 30%. There were, however, significant differences in performance across countries.

The downturn was led by the recession in Russia, where GDP fell by 6% and inflation rose by an estimated 50%, a trend indicative of the contagious effects of the Asian crisis. Country-specific problems also played a role, as devaluation of the rouble triggered the collapse of the financial system and prompted a sharp contraction of domestic demand. This turmoil spread to other economies in the region, with impact most profoundly felt in the Commonwealth of Independent States (CIS), where aggregate output fell by 3.6%. CIS countries worst affected were the Ukraine, Belarus and Kazakhstan, all of which have strong trade and financial links with Russia. Aggregate output slowed less dramatically in central and eastern Europe nations and in the Baltic states, where trade with Russia is less important. Solid economic performances were turned in by Albania, Bulgaria, Poland and Hungary, all of which registered increases in growth ranging from 4% to 9%. In contrast, economic activity contracted in the Czech Republic, Croatia, Romania and the Slovak Republic.

Developing countries

Aggregate output growth in the developing countries dropped sharply to 2.3% in 1998, with the average inflation rate increasing to 10.5%.

Africa

Africa was the fastest growing region in the world in 1998, with most countries escaping the turbulence in emerging markets due to their limited access to international financial markets. The impact of the Asian crisis was felt mainly through its effect on commodity prices, diminished demand for African exports, and intensified competition from Asian exporters. Aggregate output growth in the region increased to 3.7% in 1998 and average inflation dropped to 7.7%.

In North Africa, a number of countries benefited from the strengthening of growth in Europe, as well as from improved agricultural production and cheaper commodity imports. Growth rebounded to 6.8% in Morocco, increased by 4.7% in Tunisia, and was sustained at 5% in Egypt. Economic performance in sub-Saharan Africa varied. In Tanzania, output growth decelerated to 3.3%, due to both the decline in commodity prices and reduced agricultural production. In contrast, solid output growth was recorded in Cameroon (5%), Côte d'Ivoire (6%), Ghana (5.6%), Kenya (2.7%), Sudan (6%), and Uganda (5.5%), chiefly due to continuing macro-economic reforms and progress in reducing political and social conflicts. South Africa, where output growth slowed to 0.8%, was the only country in the region where substantial spill-overs from Asia were felt.

Asia

Economic conditions in Asia worsened considerably during 1998 due to the financial crisis and the region's vulnerability to the economic recession in Japan. Aggregate output dropped to 2%, while the average inflation rate climbed to 8%. Declines were particularly steep in those economies most seriously affected by the financial crisis: In Indonesia, Thailand, Malaysia, and the Philippines, average output growth contracted by 10%, and slowdowns were also experienced in Hong Kong, Singapore, South Korea, Taiwan and Vietnam.

Output growth in China dropped markedly to 5.5%, with a further reduction in inflation. The stability of the renminbi was nevertheless maintained, supported by a sizable foreign exchange reserve and controls over the capital account. In India, where the Asian crisis was reflected in weak exchange rates and equity markets, output growth eased to 5% and inflation increased to 7%. Growth in Pakistan also reached 5%, supported by improvements in the agriculture, industry, and service sectors; while inflation dropped to 8%.

Middle East

Average growth in the Middle East weakened significantly to 2.5% as governments in oil exporting countries were forced to curb public expenditures following steep oil price declines. The deceleration of growth in oil exporting states also affected economic activity in other countries of the region. Inflation remained high at an average rate of 23%.

In Turkey, output growth slowed to 4%, and inflation remained high at 78%. For Jordan, an oil-importing country, the fall in oil prices had beneficial effects on the current account position. Economic growth increased to 2.5%, with inflation rising to 4%.

Latin America

Economic activity in Latin America decelerated noticeably to 2.8%, with average inflation dropping to 11%, a decline caused primarily by the financial crises in Asia and Russia. In Brazil, concerns about a widening fiscal deficit and a large current account deficit resulted in a reversal of capital inflows, putting increased pressure on the Brazilian real. Austere fiscal and monetary measures caused growth to slow to 1.5%, while inflation eased to 5%. Financial pressures also intensified in Argentina, as growth decelerated to 5%, and inflation rose to 1.3%. In regional economies heavily dependent on the export of oil and non-fuel primary commodities, financial market pressures were exacerbated by a decline in the average prices of such goods. Countries in this category include Chile, Colombia, Ecuador, Mexico and Peru, all of which posted reduced growth rates.

OPEC member states

Average output growth in OPEC countries declined by an estimated 3.7%, against a 4% increase in 1997, while the average inflation rate increased slightly to over 28%. The slowdown was a consequence primarily of changes in oil prices, production, and export volumes. Efforts to contain the deterioration of fiscal and current account balances restrained growth of both public consumption and public investment expenditure, with knock-on effects in the private sector.

Combined oil output in OPEC member countries reached 27.81 million barrels a day (bbls/d) in 1998, up on the 25.38 million of the preceding year. World oil demand was sustained at an estimated 73.63 million bbls/d, as vigorous demand growth in the United States countered the decreases in demand in Asia. The average spot price of the OPEC reference basket fell dramatically to $12.25 per barrel, from $18.78 in 1997, causing oil revenues to decrease by a significant 35% in 1998, the lowest level recorded since 1989, despite a slight increase in exports.

Growth in Algeria was kept at 4.9% in 1998, despite strong expansion of agricultural output following the severe drought of 1997. Inflation stood close to 5% and substantial reserves helped cushion the impact of the decline in oil revenues. Sustained progress was made towards a market-oriented and diversified economy, the creation of an enabling environment for foreign investment, financial reform, and the development of capital markets. The current account shifted from a surplus of 6.4% of GDP in 1997 to a deficit equivalent to 1.2% of GDP, and the unemployment rate remained very high at 30%; the debt service ratio stood in 1998 at 45% of exports of goods and services.

The recession in Indonesia deepened and broadened. Output declined by 13.1%, against a growth rate of 4.6% in 1997, stemming in part from severe currency pressures, credit supply constraints, and a sharp contraction of domestic demand growth. Inflation climbed to 77.6%, from 11.1% in 1997, chiefly as a result of the increased cost of imports following the depreciation of the rupiah. The current account showed a surplus equivalent to 4.5% of GDP, compared to a deficit of 2.3% in 1997, owing mainly to the steep currency depreciation. The fiscal deficit for FY 1998/99 is estimated at 8.5% of GDP, reflecting the depth of the economic crisis and the associated substantial increase in social safety net spending.

GDP growth in the Islamic Republic of Iran is estimated to have dropped to 1.7%, from a growth rate of 2.9% in 1997, while inflation and unemployment are estimated to have increased to 22% and 12% respectively. The weakening of economic performance since mid 1997 is a result of external shocks emanating from the Asian crisis and the ensuing decline in international oil prices, as well as reductions in construction activities and government development expenditures. These external and internal shocks, combined with inflationary expectations and reduced availability of foreign financing, resulted in intensified pressure on the country's balance of payments. The government accelerated efforts to promote foreign direct investment and boost non-oil exports by easing foreign exchange restrictions so as to improve the availability of imported inputs for non-oil industries.

Output growth in Iraq increased by 15%, up from 10% in 1997, driven mainly by a rise in oil output. The inflation rate eased to an estimated 140%, reflecting a slight improvement in the availability of basic goods. The current account deficit widened to $574 million from $336 million in 1997.

In Kuwait, a series of preventive government measures, in anticipation of the fall in oil earnings, caused output growth to slow slightly to 2.2%, compared with 2.5% in 1997, with inflation dropping further to 0.5%, from 0.8% in the preceding year. The drop in oil revenues led to a sharp reduction in the current account surplus; and the Kuwaiti stock market fell by 27%, reflecting the oil price slump and the weakness in equity markets worldwide. Further progress was made towards strengthening conditions for private sector growth with cabinet approval of a new foreign investment code in June.

GDP growth in the S.P. Libyan A.J. contracted by 0.5%, against a 2.6% growth rate in 1997, mainly as a result of lower oil revenues. Inflation continued to be high, reflecting strong domestic demand for imported goods; and the current account deficit widened to an estimated $2.2 billion, from $235 million in 1997.

Oil price developments were also a major factor in the deceleration of growth in Nigeria, where output dropped to 1.7% from 3.9% in 1997, and inflation increased slightly to 9%. The current account position deteriorated significantly, with a sharp swing into deficit of 6.8% of GDP, from a surplus of 4.7% of GDP in 1997. Nevertheless, further headway was made with economic liberalization, privatization, private sector development, public sector reform, and foreign investment promotion.

The shortfall in oil revenues had a direct bearing on economic performance in Qatar. Growth slowed to 2%, down from 15.5% in the previous year, while inflation eased slightly to 2.4%. The budget deficit for FY 1998-99 widened to $908 million, despite a reduction in public expenditures. The sharp decline in oil revenues offset the impact of the expansion of non-oil exports, which contributed to a narrowing of the current account deficit to 21% of GDP.

Output growth in Saudi Arabia slowed to 1.6%, from 1.9% in 1997, with inflation dropping to 0.2%, from 0.5% in the previous year. The decline stemmed in part from a sharp deterioration in oil prices, which directly affected economic activity, forcing the government to take measures to contain the deterioration in the fiscal position. However, the private sector expanded by an estimated 2.1%, reflecting its increased efficiency, reduced dependency on government spending, and continuous efforts towards privatization and the improvement of the investment climate. The current account shifted from a position of virtual balance in 1997 into a deficit of nearly $13 billion.

Low oil prices and reductions in government expenditure caused growth in the United Arab Emirates to slow to 2.1%, with inflation dropping to 2%. Growth in the non-oil sector decelerated to 5.4%, against an average of 9.5% during the period 1993-1996, as a result of a slowing of demand in major markets and reduced stimulus from government expenditure. A milestone was reached with the establishment in November 1998 of an official stock exchange. The financial crises in Asia and Russia sharply reduced the demand for re-export trade in Dubai, an important regional center for trade, retail and tourism.

Economic activity in Venezuela contracted by 2.5%, compared to a 5.1% growth rate in 1997, while inflation stood at 37%. The decline in output was primarily due to the weakening of oil and copper prices, exacerbated by renewed financial market pressures following the Russian crisis, and an associated tightening of monetary and fiscal policies. The current account position shifted from a $6 billion surplus in 1997 into a deficit of nearly $800 million, and the unemployment rate rose to 11%.

World trade

The greatest impact of the Asian crisis was felt through its effect on the growth of world trade, which decelerated significantly to 3.7%. This decline was a result of both a weakening of export expansion, and a pronounced contraction of import demand growth in Asia, which was only partially offset by stronger than expected domestic demand growth in the United States and Western Europe.

In the major industrial countries, both import and export growth declined. Most notable was the weakening of exports in the United States to 1% as a result of the appreciation of the dollar and slackened import demand in Asia. Domestic import growth, however, remained strong at 11.5%. In the European Union (EU), export expansion weakened to 6%, while imports decelerated to 8%.

In the developing countries, too, both export and import demand contracted, the former to 4% and the latter to 1%, with terms of trade suffering further deterioration. The decline in imports was particularly severe in Asia, causing spill-over effects on the exports of neighboring states. Other developing countries and regions suffered a loss in export revenues mainly as a result of the compression of import demand for their products in Asia, and a marked decline in the prices of oil and non-fuel primary commodities.

As for the composition of world trade, the sharp decline in oil prices lowered the share of fossil fuels, which, at 8% of total trade in 1997, was already at only one third of its 1981 historical peak.

Financial and foreign exchange markets

In major industrial countries, short-term interest rates dropped as a result of efforts to counter the effects of deteriorating international and economic conditions on domestic activity. Long-term rates also declined.

In the United States, as the full extent of the crisis in Asia became evident, a policy shift towards short-term interest rates reductions was introduced. Long-term rates also fell back, reflecting progress in reducing fiscal imbalances. In the European Union, the European Central Bank decided to cut short-term interest rates in response to concerns that economic growth would slacken in 1999 in Europe and much of the rest of the world. Long-term interest rates also declined, indicating safe haven demand by investors and downward revisions in inflation expectations.

In Japan, exceptionally low short-term interest rates prevailed. As economic and financial sector conditions continued to deteriorate and inflation dropped to near zero, long-term interest rates moved to unprecedented lows, dropping to only slightly above 1% before a temporary rebound in June and July.

In the developing countries and countries in transition, there was a decline in short-term interest rates in countries whose currencies had previously come under attack, including South Korea, Thailand and the Philippines. The decrease can be ascribed to a general easing of monetary policy as capital inflows resumed, and currency pressures eased. Long-term interest rates increased, reflecting the rise in risk premia for holding long-term emerging market debt.

Stock market prices in many industrial countries suffered sizable downward corrections after mid-July, prompted by the prospect of a slowdown in the world economy.

Developments in foreign exchange markets in 1998 were characterized by extreme turbulence. Initially, the U.S. dollar strengthened against major currencies, but fell sharply later in the year as the financial market crisis spread. The yen, too, experienced instability, dropping to an 8-year low against the U.S. dollar mid-year, but strongly regaining value during the last quarter.

The Deutsche mark, French franc and other EU currencies recorded gains against both the U.S. dollar and the yen as a result of strengthened confidence in the European Monetary Union (EMU). Among countries participating in the EMU, convergence policy as agreed in the Maastricht Treaty stabilized currencies for most of the year. In the United Kingdom, the pound sterling weakened somewhat against the U.S. dollar and major European currencies in the last quarter of 1998 following short-term interest rates cuts.

External payments and debt

Current account imbalances in the industrial countries widened significantly. The United States absorbed most of the contraction, with the U.S. current account deficit increasing to 2.8% of GDP, mainly as a result of the reduced demand for US exports, the continued buoyancy of domestic demand, and the strength of the dollar. Japan's surplus broadened to 3.6% of GDP, and the deficit of the United Kingdom widened to 1.4% of GDP, reflecting the appreciation of the pound sterling, and the strength of domestic demand. Elsewhere in Europe, Germany's current account position improved somewhat, registering a surplus of 0.3% of GDP. And in France, the current account balance again showed a surplus, equivalent to 2.2% of GDP.

The aggregate current account deficit in the countries in transition broadened, from $25 billion in 1997 to $30.8 billion, partly due to Russia's lower oil export receipts.

The combined deficit in the developing countries also expanded, from $62 billion in 1997 to $78 billion. Asia's surplus increased to $37 billion and Africa's deficit rose to $14.7 billion, from $5.3 billion in 1997, due in part to the weakness of commodity prices triggered by the Asian crisis. The aggregate current account position of the Middle East and Europe worsened significantly, shifting from a surplus of $4 billion in 1997 into a deficit of $20 billion, largely as a result of the deterioration in the current account balances of oil-exporting countries. In Latin America, the slump in oil prices contributed to a widening of the deficit from $65 billion in 1997 to $80 billion.

Net private capital flows to the developing countries dropped to $66 billion, from $139 billion in 1997. This reversal was partially offset by increased inflows from official sources, most of which went to Asia. The Asia region accounted for most of the decline in net private capital flows, with net outflows reaching $44 billion. Latin America came second, with net inflows falling to $75 billion. Net flows to Africa also declined to $6.4 billion. In the Middle East and Europe net capital inflows rose to $28.4 billion. And in countries in transition, net inflows decreased slightly to $20 billion.

The external debt burden of the developing countries increased to $1,812 billion in 1998. The ratio of debt to GDP rose to 33% at the end of 1998, while the ratio of debt to export earnings increased to 148%. The ratio of debt service payments to exports of goods and services increased to 22%. The external debt burden of countries in transition also worsened, reaching $322 billion, with the ratio of debt to exports increasing to 105% at the end of 1998. The ratio of debt service payments to exports increased to 15%.

Global economic prospects

The prospects for 1999 are extremely uncertain. In the cautiously optimistic scenario, world output is projected to rebound moderately to 2.5% in 1999: global inflation is expected to remain low, assisted by recent and anticipated commodity price developments. The volume of world trade is forecast to grow by 4.6%.

Average growth in major industrial countries is projected at 1.9%, with inflation remaining subdued. Output growth in the United States is expected to slow down with inflation rising to 1.8%, reflecting a sharp deceleration of business investment and less buoyant consumer spending. The Japanese economy is forecast to recover modestly to 0.2% in response to fiscal stimulus and banking sector restructuring. Average output growth in the EU seems likely to be reasonably well sustained at 2.8%. The introduction of the euro in January 1999 will completely eliminate exchange-rate instability among the 11 countries participating in the EMU, although implications for the stability of exchange rates between the euro and other major currencies are less clear.

Aggregate output in countries in transition is forecast to contract slightly, with average inflation rising further to 35%. Their external debt burden is projected to increase further, to $340 billion. Projections are for Russia to lead the decline, and for the gap between central and eastern economies and the CIS to widen.

Aggregate output growth in the developing countries is projected to strengthen to 3.5% with average inflation dropping to 8.5%. Export expansion is forecast to rebound to 5.5%, while import growth should recover to 4.6%, and the external debt service burden should become lighter. Predictions speak of economic performance being strongest in the Africa region, with a 4.7% growth rate, followed by the Asia region (3.9%), and the Middle East and Latin America (2.7% each).

In OPEC member states, average output growth is expected to rise moderately, with the average inflation rate dropping to 18%, assuming a partial recovery of oil prices and a gradual exhaustion of oil stockpiles in industrialized countries. An important economic policy consideration in a number of OPEC member countries will likely be the need for expenditure-reducing and revenue-raising measures to ensure fiscal sustainability. The oil price slump has given added impetus in many member countries to ongoing initiatives to diversify the economy, reducing dependency on oil and widening the revenue base by enhancing the role of the private sector, encouraging foreign investment, and expanding capital markets. These efforts are expected to continue in 1999.