International Monetary Fund. Research Dept.
Published Date:
October 2001
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The tragic events of September 11 came at a time when, with all major regions already slowing, the global economy was particularly vulnerable to adverse shocks. Indeed, recent data suggest that the world economy was weaker than earlier thought even before the terrorist attacks. Furthermore, these attacks—while affecting the United States most directly—can clearly be seen as a shock with global reach, given the worldwide impact on confidence, financial markets, and growth prospects.

The Global Outlook

Reflecting these developments, the IMF's projections for almost all regions of the world have been marked down compared with those in the October 2001 World Economic Outlook (whose projections were finalized before the terrorist attacks). These reductions are most apparent in the outlook for 2002, where the strengthening of activity that had previously been expected in late 2001—particularly among advanced economies—is now generally not expected until around the middle of 2002. Growth in the advanced economies is now expected to be only 0.8 percent in 2002, down from a weak 1.1 percent in 2001 (Table 3.1). The outlook for 2002 is 1¼ percentage points lower than projected in the October World Economic Outlook, including reductions of about 1½ percentage points in the United States, Japan, and Canada, 1 percentage point in the euro area, and over 2 percentage points in the newly industrialized Asian economies (see Table 1.1 in Chapter I). For developing countries as a whole, the growth projection for 2002 has been lowered by nearly 1 percentage point, with the largest reductions among countries of the Western Hemisphere—especially Argentina and Mexico—and also among the members of the Association of South East Asian Nations (ASEAN). Nevertheless, growth of close to 4½ percent is expected for the developing country group in 2002 compared with 4 percent in 2001, supported by relatively strong activity in China and India, a significant turnaround in Turkey's economic prospects, and reasonably firm growth in the transition economies and Africa.

Table 3.1.Advanced Economies: Real GDP, Consumer Prices, and Unemployment(Annual percent change and percent of labor force)
Real GDPConsumer PricesUnemployment
Advanced economies3.
Major advanced economies3.
United States4.
United Kingdom12.
Other advanced economies4.
Taiwan Province of China5.46.0−−
Hong Kong SAR3.010.5−0.31.0−4.0−3.7−
New Zealand23.
European Union2.
Euro area2.

Consumer prices are based on the retail price index excluding mortgage interest.

Consumer prices excluding interest rate components; for Australia, also excluding other volatile items.

Consumer prices are based on the retail price index excluding mortgage interest.

Consumer prices excluding interest rate components; for Australia, also excluding other volatile items.

The limited amount of data since the terrorist attacks against which to gauge economic prospects and the virtually unprecedented nature of these recent events inevitably imply a high level of uncertainty in the latest projections. Particular concerns are the prospective depth and duration of the general downturn in confidence and activity, the risk that existing weaknesses in some sectors (such as information technology) will be exacerbated, the addition of new sectoral pressures (e.g., in travel and tourism), and the vulnerabilities apparent in some systemically important countries. At a more general level, forecasters have not been particularly successful in capturing turning points in the cycle and the ensuing pace of activity, and this needs to be taken into account when policy responses are being considered. Over the past decade, however, the IMF's global growth forecasts have been generally unbiased—although with substantial variation in region-by-region performance—and the mean and standard deviation of the forecast errors for the Group of Seven countries are similar to those of private forecasters (Box 3.1).

United States and Canada

Almost all economic indicators in the United States have weakened in recent months. While part of this downturn reflects greater-than-expected weakness in the economy before September 11, the attacks and their aftermath led to further declines—including among indicators such as consumer spending and nondefense durable goods orders that had signaled a possible bottoming out of activity prior to the attacks. The initial sharp fall-off in some indicators has at least partially reversed since September—helped in the case of retail sales, for example, by significant sales incentives for automobiles—but most indicators of household and business activity continue to suggest that growth remains subdued in the latter part of 2001 (Figure 3.1). In the labor market, for example, job losses and new claims for unemployment benefits in October reached their highest levels since the early 1990s and, although slowing since then, point to further increases in the unemployment rate in the months ahead. The housing market appeared surprisingly robust through August, but recently released indicators suggest that a substantial slowing is in prospect. Moreover, some sectors, particularly travel and entertainment, have faced particularly severe financial difficulties since September 11 (see Chapter II).

Figure 3.1.Macroeconomic Indicators—Advanced Economies

Sources: Thomson Financial for industrial production, inflation, unemployment, and consumer and business confidence for the United States and Japan; European Central Bank for euro area industrial production, inflation, and unemployment; European Commission for euro area consumer and business confidence.

Nevertheless, various forces should contribute to a strengthening recovery in 2002, although the speed and strength of their impact is difficult to anticipate. These forces include the recent reduction in energy prices, the ending of the inventory cycle downturn, the recovery in equity prices, and somewhat stronger levels of consumer and business sentiment about the future compared to the present. Most important, there is now significant macroeconomic stimulus in the pipeline. On the monetary side, official interest rates have been reduced by 4¾percentage points since the beginning of 2001, including l¾ percentage points since September 11, and there is scope for additional easing if economic conditions weaken further. The easing to date has spurred a record surge in the refinancing of home mortgages, which should help sustain spending in the household sector, and further support to demand can be expected given the lags between interest rate cuts and their impact on activity. Fiscal policy has also been eased substantially during 2001, including in response to the events of September 11; rapid implementation of additional stimulus as currently under discussion—if carefully designed to strengthen consumer confidence and boost activity in the short run—would provide further helpful support for recovery (see Box 3.2). As the economy recovers, however, tax or spending measures may be needed to ensure that medium-term Social Security obligations can be met.

In the baseline projections for the United States, the decline in economic activity is expected to stabilize in early 2002, with a firmer pickup emerging in the second half of the year. Overall, the growth projection for 2002 has been marked down to 0.7 percent, 1½ percentage points lower than in the previous World Economic Outlook (whose projections were finalized before the attacks). Given the expected strengthening of activity during the year, however, growth would reach over 2½ percent in the fourth quarter of 2002 compared with the same quarter of 2001. Substantial uncertainty still surrounds this short-term outlook. A stronger and more rapid recovery could emerge if confidence rebounds rapidly, oil prices fall more than anticipated, or the inventory cycle downturn ends quickly. On the other side, concerns about personal security and rising unemployment, together with the sharp downturn in corporate profitability and the difficulties faced by some specific sectors, could delay the recovery of household and business confidence and push deferred spending—especially on business investment and household durables—further into 2002 than currently envisaged. Such tendencies could be aggravated by the legacy of high levels of business investment in the late 1990s and high levels of household debt.

Box 3.1.The Accuracy of World Economic Outlook Growth Forecasts: 1991–2000

Each issue of the World Economic Outlook includes forecasts of economic growth for the world and for various country groupings. By their nature, forecasts are subject to uncertainty, which—as extensively discussed elsewhere in this issue—needs to be explicitly taken into account by policymakers when considering the implications for policy. This Box reports some indicators of the accuracy of the World Economic Outlook growth forecasts over the period 1991 through 2000.1 It is important to stress, however, that the historical record with respect to the forecast accuracy of the World Economic not necessarily a good guide to the future. For example, IMF forecasts—like those of outside analysts—tend to underestimate growth during booms and overestimate growth during recessions. Thus, as discussed further below, forecast accuracy depends importantly on the time period in question, and the specific events that occurred during it.

World Economic Outlook: Estimates of GDP Growth Forecast Errors1
Spring of Previous YearFall of Previous YearSpring of Current YearFall of Current Year
Average errorStandard deviationAverage errorStandard deviationAverage errorStandard deviationAverage errorStandard deviation
Advanced economies0.−
Major advanced economies0.
United States−0.51.7−0.51.5−
United Kingdom0.−0.20.8−0.20.4
Other advanced economies0.−0.21.0−0.20.5
Developing countries0.21.41.1−0.30.7−0.20.4
Developing Asia−0.62.2−0.72.0−0.71.3−0.30.7
Middle East, Malta, and Cyprus0.−0.21.3
Western Hemisphere1.−0.41.1−0.30.9
Countries in transition6.−0.61.2

Forecast errors are defined as forecast minus outturn. Sample period covers 1990 to 2000.

Excludes countries in transition.

Includes Indonesia, Malaysia, the Philippines, and Thailand.

Includes countries in transition.

Forecast errors are defined as forecast minus outturn. Sample period covers 1990 to 2000.

Excludes countries in transition.

Includes Indonesia, Malaysia, the Philippines, and Thailand.

Includes countries in transition.

The first table presents the mean and standard deviation of the forecast error, defined as the difference between the growth forecast and the actual outturn, for various country groupings over the period 1991–2000.2 The average error provides an indication of whether the forecast was subject to bias over the period—a positive value, for example, shows that growth was on average overestimated; the standard deviation of the error provides a measure of the degree of uncertainty in the forecast. The forecast errors are shown at four different points in time: (1) the May issue one year prior to the year in question; (2) the October issue one year prior to the year in question; (3) the May issue of the year in question; and (4) the October issue of the year in question. This methodology provides information on the accuracy of the World Economic Outlook growth forecasts at four different points in time leading up to the point when the growth outturn was realized. The sample of countries includes all member countries of the IMF, except the countries in transition (where forecast errors in the early part of the transition—a unique event—were very large, and would significantly bias the results).

Consensus Forecast: Estimates of GDP Growth Forecast Errors1
Spring of Previous YearFall of Previous YearSpring of Current YearFall of Current Year
Average errorStandard deviationAverage errorStandard deviationAverage errorStandard deviationAverage errorStandard deviation
Major advanced economies0.
United States−0.51.7−0.41.6−0.20.8−0.10.7
United Kingdom0.−0.10.9−0.20.4

Forecast errors are defined as forecast minus outturn, Sample period covers 1990–2000.

Forecast errors are defined as forecast minus outturn, Sample period covers 1990–2000.

The following points are worth noting:

  • The average error for global growth is modestly positive for the one-year ahead forecasts, turning slightly negative in the current year forecast. The standard deviation of the global growth forecasts averages 0.9 percentage points in the one-year ahead forecast, falling to 0.3 to 0.5 percentage points in the current year.3 Unsurprisingly, across almost all regions, the average forecast error (in absolute value) and the standard deviation declined the shorter the forecast period.
  • The moderate overestimation of growth in world output in the one-year ahead forecast stems largely from the forecast errors in the advanced economies, most of which are associated with turning points. This was due to an underestimation of the extent of the recessions in the United States, Canada, and the United Kingdom in 1991; the euro area in 1993; and Japan during 1992–95 and 1997–99. Offsetting this positive error to some degree was an underestimation of growth in the United States in the second half of the 1990s, a period of surprisingly rapid productivity growth.
  • As can be seen from the second table, the mean and standard deviation of the errors in the World Economic Outlook forecast for Group of Seven (G-7) countries are similar to those of private forecasters. While the average error of the consensus forecasts for most G-7 countries was slightly smaller for the one-year ahead fore-casts compared to the World Economic Outlook forecasts, the standard deviation of the consensus forecast error was slightly higher. A more detailed comparison of consensus forecasts, World Economic Outlook forecasts, and OECD forecasts finds a high degree of similarity among all three, and concludes that it is difficult to say unambiguously which one is better (Loungani, 2000).
  • For developing countries in the first table, the overall bias to the projections is generally small, but the forecasting experience differs significantly across regions, largely reflecting the differing shocks that each faced.

In Africa, the average forecasting error was significantly positive for the period (and in every individual year); in part this arises from the obvious difficulties in predicting conflicts and natural disasters that have seriously affected growth during the decade, as well as a possible tendency to overestimate growth in the context of IMF programs.4 Also, for many African countries, data are available with a longer lag and are subject to larger revisions than those for other countries.

In developing Asia, growth was on average underestimated, entirely reflecting an under-estimation of growth in China (which has a large weight in the aggregate) during the overheating period in the first half of the 1990s. This was offset in part by an overestimation of growth in the ASEAN-4, primarily during the Asian Crisis in 1997 and 1998 (which also accounts for the very large standard deviation in the forecast for this group).

In the Middle East, the one-year ahead fore-casts overestimated growth in the 1990s, mainly reflecting an overestimation of the speed of recovery from the Gulf War.

In the Western Hemisphere, the average for the one-year ahead growth forecast growth was positive, mainly reflecting an overestimation of growth during the Mexican crisis in 1995 and the Brazil crisis in 1998–99. In the current year, however, forecast errors have been slightly negative, mainly reflecting an underestimation of pickups in Argentina and Brazil.

In conclusion, the above analysis suggests that, excluding the transition economies, the IMF's global growth forecasts have been relatively unbiased over the past decade. However, the experience varies substantially across regions, generally reflecting the particular shocks they have experienced. In particular, like out-side forecasters, IMF forecasters have not been particularly successful in capturing major turning points and the ensuing impact on activity. This is, of course, particularly relevant at the present juncture, and while this tendency was recognized while making the forecast, it remains a source of potential downside risk. It is also likely, in the present situation, that the uncertainty around the forecast is larger than historical values of the standard deviation would tend to suggest. In some cases, notably Africa, there is evidence of more persistent overestimation of growth, in part for the structural reasons described above, a tendency that needs to be kept in mind in interpreting the forecasts and drawing the appropriate policy conclusions.

1 The forecasts for the Group of Seven countries are evaluated over the period from 1985 through 2000.2 The outturn is taken from the October issue of the World Economic Outlook one year after the year question.3 Implying that the forecast was within these intervals over two-thirds of the time.4 IMF forecasts assume that programs are implemented.

In Canada, the slowdown has been sharper than earlier envisaged, mainly reflecting events in the United States. Real GDP growth has slowed substantially since late 2000, with growth of 1.4 percent now expected in 2001 and 0.8 percent in 2002. Economic activity is expected to turn around starting in the first half of 2002 and gradually gather pace during the year—supported by a similar strengthening of activity in the United States, easier monetary conditions (the Bank of Canada having lowered official interest rates by 3½ percentage points in 2001), fiscal stimulus stemming from the tax cuts legislated last year, and the workings of the automatic stabilizers. As elsewhere in the global economy, however, the heightened level of uncertainty makes the timing and pace of a rebound difficult to gauge.


The events of September 11 and their after-math have exacerbated what was already a difficult and troubling economic situation in Japan. Household and business confidence have fallen further in recent months, while business conditions have continued to weaken—especially in the manufacturing sector, where indicators of excess capacity, employment, and inventories have all deteriorated. Weaker economic prospects and persistently low equity prices have added to concerns about financial system stability, particularly in view of writedowns in bank capital under mark-to-market accounting rules and uncertainties about the full extent of non-performing loans.1 The steep downturn in exports since 2000 also looks set to continue, especially given the prospect of delayed recoveries in the United States and Asia and the ongoing weakness in the global electronics market.

Box 3.2.Fiscal Stimulus and the Outlook for the United States

Together with the substantial easing of monetary policy since January, the tax cuts enacted in June and emergency spending measures passed in the immediate aftermath of the September 11 attacks have ensured that a considerable stimulus is in the pipeline in the United States. These initiatives will provide $375 billion in fiscal stimulus over the 2002 to 2004 fiscal years (the 2002 U.S. fiscal year runs from October 2001 to September 2002; see the Table). This equals 1 percent of GDP for 2002 and nearly 1¼ percent of GDP in 2003 and 2004. The tax cuts enacted in June 2001 comprise $243 billion of the stimulus, while emergency spending authorized by Congress immediately following the September 11 terrorist attacks adds another $63 billion. This includes $38 billion for defense, $20 billion for disaster recovery, and $5 billion to aid the airline industry.

In addition, the Bush Administration has proposed a new fiscal stimulus package of $60 to $75 billion over fiscal years 2002 to 2004, while Congress is considering packages amounting to around $100 billion in fiscal year 2002 and around $210 billion total through 2004. The resulting stimulus could be smaller if the spending initiatives of $69 billion requested in the Administration's fiscal year 2002 Budget but not yet enacted were to be used instead to meet new spending requirements. Along with additional spending for national security expected to amount to around $50 billion over 2002 to 2004, a new fiscal package of $75 billion would result in a total fiscal stimulus during fiscal years 2002 to 2004 of around $500 billion, roughly 1½ percent of GDP for the period.

Fiscal Stimulus Measures, Fiscal Years 2002 to 2004(Billions of dollars for each fiscal year)
Total fiscal stimulus measures176184140500
(Percent of GDP)
Stimulus under current
2001 tax cut package3893112243
Additional stimulus77472125
New fiscal stimulus
Source: IMF Staff estimates. Columns may not sum to total due to rounding.
Source: IMF Staff estimates. Columns may not sum to total due to rounding.

With a new fiscal package comprised of temporary measures, the unified budget in the United States is now expected to be slightly in deficit in FY2002 after surpluses from 1998 to 2001. Most of the decline relates to the impact of the fiscal policy initiatives, although the operation of the automatic fiscal stabilizers also has an impact. The cumulative surplus would be reduced from around $2.4 trillion to $2.2 trillion in fiscal years 2002 to 2011—a fairly modest change, as U.S. growth is expected to rebound strongly after 2002. If tax measures in the new stimulus package were permanent rather than temporary, the cumulative budget surplus would fall to $1.3 trillion over the fiscal years 2002 to 2011. If economic growth turned out to be even weaker than forecast, a $75 billion temporary stimulus package would likely result in the cumulative budget surplus over fiscal years 2002 to 2011 falling to less than $1.0 trillion.

Assessment of a New Fiscal Stimulus Package

The economic and budgetary impact of a fiscal stimulus will depend crucially on the particular tax and spending initiatives enacted. The objective should be to structure a package that shores up consumer confidence and boosts activity, without unduly compromising the longer-term fiscal position.

Well-targeted spending increases are typically considered to have a larger multiplier impact on activity than tax reductions, and could thus yield a quick and effective boost to the economy. The Administration and Congress are considering such measures as extending the duration of unemployment insurance and providing grants to assist in financing health care coverage to unemployed workers and their families. While assistance to unemployed workers could help shore up confidence, there would likely be adverse effects on individuals' incentives to find employment, though this could be mitigated by ensuring that the assistance is explicitly temporary. A number of proposals are also being considered in the wake of the terrorist attacks to increase spending on transportation security and infrastructure, as well as other programs less obviously related to the events of September 11. As with any spending initiatives, the benefits of these programs must be weighed against long-term costs, including the possibility that a “piling on” of new programs could undermine fiscal discipline over the longer term, implying a permanently higher path of public spending.

Temporary income tax cuts would be likely to have only a limited near-term impact, unless they are targeted at “liquidity-constrained” individuals, who would have a higher propensity to spend such tax reductions. Corporate tax measures being considered—including the elimination of the corporate alternative minimum tax, and an increase in the carryback period for net operating income losses—would entail significant revenue losses, while potentially providing little short-term stimulus to the economy. Temporary incentives aimed at investment, such as proposed partial expensing of business investment (or accelerated depreciation) could be more useful in bringing forward private investment. Of course, reducing tax burdens can have salutary medium-term effects, and these measures should be considered in due course consistent with achieving medium-term fiscal objectives. Other measures under consideration include a reduction in the capital gains tax for individuals and an increase in the amount of capital losses that can be deducted from income. These proposals face the risk of a perverse effect of encouraging a sell-off in equities; the resulting decline in stock prices and household wealth would further affect consumption.

The “reversibility” of various policies is also an important consideration. Given the lags involved between the easing of fiscal and monetary policy and the impact on activity, it could become necessary to withdraw some of the stimulus as the U.S. economy rebounds. This would tend to favor using monetary policy for any further stimulus, since policy interest rates can be adjusted relatively rapidly. In contrast, in the event of a quick recovery in the middle of 2002, institutional and political considerations might make it more difficult to withdraw fiscal stimulus within the timeframe needed to avoid overheating. Among the risks would be that permanent tax measures that have a significantly adverse impact on the U.S. debt profile could lead to higher long-term interest rates and thus offset the stimulus from a shorter-lived policy. Looking forward, it will be important as well to take off-setting action by either tax or expenditure measures when the economy recovers so that the United States can achieve its medium-term objective of saving the surplus in the Social Security trust fund in order to begin dealing with the challenges associated with the aging of the U.S. population.

Reflecting these developments, the modest recovery that had been projected to emerge early in 2002 is now not expected until at least the second half of the year. In 2002 as a whole, the economy is expected to contract by 1 percent, accompanied by ongoing deflation. A high level of uncertainty and risk—predominantly on the downside—surrounds even this bleak outlook. A key concern is of a vicious cycle involving weakening growth, rising numbers of corporate bankruptcies, and increasing concerns about the health of the banking sector. With a gradual pickup later in 2002 expected to be driven by the external sector, greater-than-expected weakness in the global economy or a depreciation of the dollar against the yen—for example, as a result of heightened economic or security concerns in the United States—would imply additional downside risks for Japan.

The prospect of continuing and possibly intensified weakness in the Japanese economy high-lights even more forcefully than before the need to implement an ambitious and coordinated strategy to tackle deep-seated economic weaknesses. This strategy has two key elements. First, persistent weaknesses in the banking sector need to be addressed, particularly through stronger loan classification and provisioning practices, disposal of nonperforming loans, and, where appropriate, targeted use of public funds through mechanisms that lead to substantive restructuring of the institutions involved.2 In addition, corporate restructuring should be accelerated, with banks continuing to take the lead in restructuring their potentially viable borrowers, but under stronger incentives and clearer timetables for achieving results. Second, macroeconomic policies need to be supportive of this strategy, to help offset potential short-term impacts of structural reforms on real activity and to counteract deflationary pressures. In particular, a more ambitious monetary response is required: the Bank of Japan needs to make a clear commitment to end deflation within a reasonable timeframe and support this by further quantitative easing, even if such a policy were to result in some further depreciation of the yen. On the fiscal side, with near-term economic prospects weakening, the second supplementary budget will go a significant way toward avoiding a withdrawal of stimulus in 2002, and thereby reduce downside risks to activity. The budget will focus on priorities of the government that will aid structural reform, including public works spending on urban regeneration, information technology, and support for the elderly. At the same time, however, the authorities need to push ahead with measures that will support fiscal consolidation over the medium term, including health sector reforms and ending the earmarking of tax revenues.

Euro Area

Economic prospects in the euro area have also deteriorated over recent months, with the events of September 11 hitting economies that were already slowing as a result of regional and global shocks—including higher oil and food prices, the reassessment of the technology and telecommunications sectors, and the associated fall in equity prices. Indicators of industrial production, service sector activity, and business confidence have weakened throughout the area. The widely-followed IFO business confidence indicator in Germany has fallen to its lowest level since 1993, while the declines elsewhere have been less stark. Other leading indicators of business conditions have yet to show a turning point, making the timing of recovery uncertain. The fall in global confidence and activity is also significant, given the importance of trade and other international economic and financial link-ages. For example, the large share of trade between the United States and Europe taking place between subsidiaries of multinational companies (such “related party trade” accounted for around 65 percent of all U.S. imports from Germany in 2000) may tend to strengthen the balance sheet linkages associated with this trade channel. Consumer confidence has also been declining, probably reflecting international link-ages in sentiment together with weak real income growth and rising unemployment, and appears likely to stay under pressure as a result of the increase in domestic and global uncertainty.

As a result, GDP growth for the euro area in 2002 is now projected at 1.2 percent, 1 percentage point lower than projected in October. Part of this downward revision reflects the carryover effect on growth in 2002 from recent data indicating growth was weakening even before September 11. Among the largest economies, the weakness in Germany—where growth is expected to be only 0.7 percent in 2002—is particularly marked and, given the strong economic linkages within Europe, will adversely affect growth in the region.3 Growth in France and Italy is expected to be 1.2 to 1.3 percent in 2002, also well below potential.

A number of influences should tend to support activity in the period ahead. Inflation is expected to continue falling, particularly in response to lower energy and food prices, and this should help to unwind some of the downward pressures on real incomes and spending that were evident earlier in the year. Support for export activity should come from the continued favorable exchange rate for the euro. On the policy side, the European Central Bank has lowered official rates by 1½ percentage points since the beginning of the year, including 1 percentage point since September 11, and with inflationary pressures weakening there will be room for additional easing if necessary. With fiscal policy, the automatic stabilizers should be allowed to operate across the euro area but, beyond this, the scope for additional support varies across countries. Earlier tax reductions in Germany and France should continue to provide support to demand, and modest tax cuts are to occur in Italy in 2002. These countries though have little additional room for maneuver on the fiscal front, given the 3 percent deficit ceiling under the Stability and Growth Pact, and the only limited progress made in improving structural fiscal balances during the recent period of relatively strong growth (Table 3.2). Other countries, including Ireland, Finland, Netherlands, and Spain, appear to have greater scope for a cautious easing of fiscal policy if downward pressures on activity prevail.

Table 3.2.Major Advanced Economies: General Government Fiscal Balances and Debt1(Percent of GDP)
Major advanced economies
Actual balance−3.7−4.1−3.4−2.0−1.4−1.1−0.2−1.3−1.80.2
Output gap2−0.5−2.2−2.0−1.4−1.2−0.8−1.4−3.2−0.2
Structural balance−3.4−3.2−2.6−1.3−0.8−0.7−0.6−0.8−0.60.2
United States
Actual balance−4.7−3.3−2.4−1.3−−0.50.9
Output gap2−1.3−3.2−2.8−1.6−−0.8−3.1
Structural balance−4.2−2.3−1.5−
Net debt51.459.659.257.053.448.943.742.041.330.2
Gross debt65.772.972.870.366.663.457.455.254.240.3
Actual balance0.6−3.5−4.2−3.2−4.5−6.8−7.9−7.2−7.1−1.4
Excluding social securitcolspan−2.5−6.3−6.7−5.8−6.5−8.6−9.2−7.9−7.5−2.4
Output gap21.1−−2.4−3.2−2.5−4.1−6.2−0.9
Structural balance0.3−3.2−4.3−3.4−3.6−5.8−7.0−5.6−4.7−1.2
Excluding social securitcolspan−2.9−6.0−6.9−5.9−6.0−8.0−8.7−7.1−6.2−2.4
Net debt13.512.716.017.529.535.842.950.157.761.7
Gross debt70.687.192.496.9110.2120.3129.7140.8152.5153.5
Euro area
Actual balance−4.7−5.0−4.3−2.6−2.2−1.30.2−1.1−1.40.1
Output gap2−0.3−1.2−1.9−1.8−1.2−1.0−0.1−0.9−2.1−0.2
Structural balance−4.1−3.0−1.4−1.3−0.7−0.7−0.8−0.60.1
Net debt43.860.662.462.861.360.458.257.457.149.8
Gross debt59.473.375.575.373.672.670.268.968.659.5
Actual balance4−1.9−3.3−3.4−2.7−2.2−1.6I.?−2.5−2.5
Output gap2−0.20.4−0.7−1.2−1.1−1.1−1.2−2.4
Structural balance−1.5−3.4−2.8−1.7−1.3−0.8−1.3−1.8−1.2
Net debt24.949.451.
Gross debt43.858.359.860.960.761.160.359.860.854.2
Actual balance4−3.3−5.5−4.1−3.0−2.7−1.6−1.4−0.9−2.1
Output gap2−0.3−2.7−3.3−3.1−1.8−1.2−0.2−0.6−1.7
Structural balance−2.9−3.7−1.9−1.0−1.5−0.9−1.2−1.2−1.4
Net debt28.345.848.149.649.848.947.948.848.243.8
Gross debt36.954.657.159.359.558.557.557.057.953.5
Actual balance4−10.5−7.6−7.1−2.7−2.8−1.8−0.3−1.2−1.0−0.5
Output gap2−0.1−1.1−2.0−2.3−2.4−2.7−1.8−1.9−2.6
Structural balance−10.4−7.0−6.2−1.7−1.8−0.6−0.7−0.5−0.6−0.5
Net debt93.2116.6116.0113.7110.1108.4104.4102.3101.690.0
Gross debt99.5123.2122.6120.1116.2114.5110.2108.0107.395.2
United Kingdom
Actual balance4−3.2−5.4−4.1−−0.1−0.8
Output gap20.4−1.1−1.3−0.50.2−0.50.1−0.9
Structural balance−2.5−4.6−3.3−−0.7
Net debt26.536.846.244.641.939.034.331.330.128.0
Gross debt43.451.751.849.646.543.940.738.337.033.5
Actual balance−6.9−5.3−
Output gap2−1.8−5.5−6.5−5.1−3.9−1.7−0.1−1.4−3.2
Structural balance−5.6−
Net debt66.388.687.884.181.274.966.361.559.544.0
Gross debt98.0120.4120.3117.6115.7112.3102.697.494.972.6

Debt data refer to end of colspanear; for the United Kingdom thecolspan refer to end of March.

Percent of potential.

Data before 1990 refer to west Germancolspan. For net debt, the first column refers to 1988–94. Beginning in 1995, the debt and debt-service obligations of the Treuhandanstalt (and of various other agencies) were taken over bcolspan general government. This debt is equivalent to 8 percent of GDP. and the associated debt service to i4 to 1 percent of GDP.

Includes one-off receipts from the sale of mobile telephone licences equivalent to 2.5 percent of GDP in 2000 for Germancolspan, 0.5 percent of GDP in 2001 for France. 1.2 percent of GDP in 2000 for Italcolspan, and 2.4 percent of GDP in 2000 for the United Kingdom.

Includes asset sales equivalent to 0.2 percent of GDP in 2001, 0.7 percent in 2002, 0.5 percent in 2003, and 0.1 percent in 2004.

Debt data refer to end of colspanear; for the United Kingdom thecolspan refer to end of March.

Percent of potential.

Data before 1990 refer to west Germancolspan. For net debt, the first column refers to 1988–94. Beginning in 1995, the debt and debt-service obligations of the Treuhandanstalt (and of various other agencies) were taken over bcolspan general government. This debt is equivalent to 8 percent of GDP. and the associated debt service to i4 to 1 percent of GDP.

Includes one-off receipts from the sale of mobile telephone licences equivalent to 2.5 percent of GDP in 2000 for Germancolspan, 0.5 percent of GDP in 2001 for France. 1.2 percent of GDP in 2000 for Italcolspan, and 2.4 percent of GDP in 2000 for the United Kingdom.

Includes asset sales equivalent to 0.2 percent of GDP in 2001, 0.7 percent in 2002, 0.5 percent in 2003, and 0.1 percent in 2004.

More generally, while the euro area has less policy stimulus in the pipeline than the United States, it also appears less vulnerable in some respects than the United States to adverse shocks to confidence and activity: external balances are stronger; households are less indebted and less exposed to stock market developments; and concerns about overinvestment and overcapacity among firms appear to be lower. But, to underpin a robust recovery, it is critical—both for Europe and for the rest of the world—that such strengths are complemented by more aggressive structural reforms to labor, product and financial markets, and other areas that have been holding down Europe's potential growth rate and contributing, at least indirectly, to broader imbalances in the global economy. The historic introduction of euro notes and coins, beginning January 1, 2002, will further strengthen European integration and support the structural reform process—for example, by increasing the transparency of price differences within the euro area and reducing the costs of cross-border transactions.

As in other advanced economies, the prospective depth and duration of the downturn in household and business confidence represent a key uncertainty in the current outlook. While recovery could start earlier than envisaged, the key policy concern is clearly that of a more prolonged downturn. In addition to the impact of the global slowdown and of increased international tensions, a particular concern in Europe stems from the weaker labor market outlook—with unemployment again increasing from already high levels in the largest euro area economies. In addition, a further decline in economic prospects could lead to renewed weakness in stock prices, which are already down significantly since the beginning of the year. Although the significance of equity holdings differs among euro area economies, and as noted above is generally lower than in the United States, such a fall would add to downward pressures on household demand and on business investment spending.

Other Advanced Economies

The outlook for other advanced economies has also deteriorated, driven by the weakening prospects for trade and declining business and consumer confidence, but with important country-by-country differences. In the United Kingdom, economic activity has so far been more resilient to the global downturn than activity in other major advanced economies. Industrial output has continued to fall while exports weakened in the second quarter, influenced mainly by the shocks to the information technology (IT) sector and also by the strong exchange rate. Demand has been buoyed by strong private consumption growth and by already budgeted increases in government spending. However, the recent softening of business and consumer confidence as well as house prices and labor market indicators suggest that private consumption growth is likely to slow down. Reflecting this, growth projected for 2002 has been marked down to 1.8 percent (compared with 2.4 percent in the last World Economic Outlook). The Bank of England has lowered interest rates by 1 percentage point since the terrorist attacks and, provided the inflation outlook remains benign, there would be scope for further reductions if economic prospects deteriorate more than currently envisaged.

The 2002 outlook for the smaller European economies outside the euro area has also been marked down by varying degrees—by 0.3 points in Denmark and Norway, and 0.8 to 0.9 points in Sweden and Switzerland. In addition to poorer export market conditions in Europe and falling domestic confidence, these countries also face some more specific pressures. Norway, for example, is exposed to oil market developments; Switzerland has experienced some currency appreciation stemming from safe haven related capital inflows following September 11; and Sweden has faced persistent weakness in the krona, which should provide some support to exports. How these pressures unfold, together with the outlook for inflation and output more broadly, will determine the scope for further easings in monetary policy—each of these countries having already lowered interest rates in the after-math of September 11.

Elsewhere, economic conditions in Australia and to a lesser extent New Zealand appear reasonably robust despite some recent weakening in confidence. Growth in Australia in 2002 is expected to reach 3.3 percent, stronger than in 2001 although ½ of a percentage point lower than projected in the October World Economic Outlook, while growth in New Zealand is projected to weaken somewhat to 1.9 percent. Export performance has been well-sustained in both countries in 2001—helped by weak currencies and, in New Zealand, by more favorable agricultural growing conditions—and this has contributed to sharp reductions in their current account deficits. External performance could still come under pressure, however, if global growth and commodity prices remain weak. Household spending has also held up quite well: house construction is up strongly in Australia, supported by lower interest rates and earlier homeowner incentives; and lower interest rates, rising rural incomes, and continued low unemployment are contributing to the resilience of demand in New Zealand.

Emerging Markets

Developing and transition economies are being hit on several fronts by the events of September 11 and their aftermath, with the result that projections for almost all regions have been marked down from those in the October World Economic Outlook (Table 3.3). This weaker outlook stems from several interrelated influences: the further slowing now expected in the advanced economies and spillover effects on trade and confidence; the particularly strong impact of the slowdown on some sectors—notably information technology and tourism—to which some emerging markets are heavily exposed; financial market linkages with advanced economies, especially in view of increased market uncertainties and deterioration in external financing conditions since September 11; and downward pressures on prices of fuel and nonfuel commodities, many of which were already weak.

Table 3.3.Selected Developing and Transition Economies: Real GDP, Consumer Prices, and Current Account Balance(Annual percent change unless otherwise noted)
Real GDPConsumer Prices1Current Account Balance2
Developing countries3.−−1.2
South Africa1.−0.4−
Developing Asia6.
Middle East33.−0.6
Iran, Islamic Rep. of3.
Saudi Arabia−−1.3−0.6−−6.4
Western Hemisphere0.−3.2−2.5−3.0−2.9
E U. accession candidates4.30.23.425.324.421.518.1−4.1−5.2−3.6−3.9
Czech Republic−−2.9−4.8−5.5−5.2
Slovak Republic1.−5.7−3.7−8.6−7.7
Commonwealth of Independent States4.

In accordance with standard practice in the World Economic Outlook, movements in consumer prices are indicated as annual averages rather than as December/December changes during the year, as is the practice in some countries.

Percent of GDP.

Includes Bahrain, Egypt, islamic Rep. of Iran, Iraq, Jordan, Kuwait. Lebanon, Libya, Oman. Qatar, Saudi Arabia, Syrian Arab Republic, United Arab Emirates, and Republic of Yemen.

In accordance with standard practice in the World Economic Outlook, movements in consumer prices are indicated as annual averages rather than as December/December changes during the year, as is the practice in some countries.

Percent of GDP.

Includes Bahrain, Egypt, islamic Rep. of Iran, Iraq, Jordan, Kuwait. Lebanon, Libya, Oman. Qatar, Saudi Arabia, Syrian Arab Republic, United Arab Emirates, and Republic of Yemen.

The relative significance of these channels varies from region to region, although they all tend to be relevant to some degree. Asia, for example, will probably be strongly affected through the trade channel, with both export prices and volumes shown to be sensitive to the advanced economy cycle.4 Compounding this linkage is the heavy exposure of many Asian economies to the severe downturn in the global electronics cycle, and some will also be hit by the downturn in tourism. Trade ties are also a key determinant of the outlook elsewhere: for example, the steeper slowdown in the United States will weaken further the outlook for Mexico and other countries in Central America; and countries in Central Europe and the Baltics will be hurt by the rapid slowing in Western Europe.

The sharp reactions of advanced economy financial markets to the September 11 attacks were echoed and amplified in emerging markets, with falling stock prices, widening bond spreads, and weakening currencies. While these trends have subsequently reversed in many emerging market economies, countries with substantial external financing requirements remain vulnerable to potential reassessments of global or domestic economic prospects and to further shocks to international financial markets. These concerns are probably the strongest in Latin America—notably in Argentina, which is experiencing renewed financial turbulence, but also in other regional economies with persistently high current account deficits and large external debts. There have also been heightened concerns regarding the outlook for Turkey, where the exchange rate fell substantially in September and early October, although it has subsequently strengthened. The economies of Central and Eastern Europe and the Baltics could potentially be at risk from adverse developments in global financial markets, given the rather high current account deficits in most of these countries; however, indications so far suggest that they are attracting funding without significant difficulty, possibly reflecting increased discrimination among investors toward countries with stronger economic fundamentals.

Recent commodity price developments will have the most direct and sizable impact in the Middle East, among the Commonwealth of Independent States (CIS), and in Africa, where many countries are heavily dependent on a narrow base of fuel or nonfuel commodity exports. As discussed below, growth and current account prospects for 2002 have weakened among most oil exporters, although in some cases—including Russia—significant carryover effects from strong growth in 2001 are still present. Lower oil prices will also have an adverse impact on a number of emerging market debtor countries, including Indonesia and Venezuela. The growth outlook for many African economies is expected to be held back by falling prices of almost all nonfuel commodities, some of which—notably coffee and cotton—were already at very depressed levels, although the impact will be partly offset by the lower price of oil imports.

In the following sections, countries and regions are broadly grouped according to three themes: those most exposed to weaker external demand, those with large external financing requirements, and those highly dependent on commodity exports. It should be stressed, however, that these influences are interrelated to some degree and most regions will be affected by more than one; as a result, regional distinctions are not clearcut. Moreover, the impact of these pressures is not necessarily symmetric across the regions concerned—for example, deteriorating external financing conditions may have much more serious consequences for emerging market borrowers with weak fiscal and structural conditions than for those borrowers whose fundamentals are strong.

The Impact of Weakening External Demand

Weaker global growth is hampering the trade-dependent economies of Asia and Central America, the latter particularly influenced by the U.S. slowdown. In Asia, the marked weakening in the newly industrialized and ASEAN economies was driven initially by external influences—especially by lower growth in the United States and Europe, economic contraction in Japan, and the decline in the global electronics cycle (Figure 3.2). Particularly in a number of the newly industrialized economies, these pressures now appear to have been stronger than earlier thought, and have generally intensified since September 11. Furthermore, the slow-down has spread increasingly into domestic demand and into a broader range of nonelectronics and service sectors, including the tourism sector—of particular importance for Hong Kong SAR, Singapore, Thailand, and for a number of small island nations in the Asia-Pacific region.

Figure 3.2.Technology and Total Exports in Emerging Asia

Source: IMF staff estimates.

1 Three-month moving averages of 12-month percent change.

In response to the slowdown, macroeconomic policies across the region have generally been eased. Most countries have lowered official interest rates since September 11, continuing the trend established before this date, and the weakening of most regional currencies (apart from those with fixed pegs) has also contributed to an easing of monetary conditions. In countries with low inflation and flexible exchange rates—such as Korea, Singapore, and Taiwan Province of China—there is still room for maneuver on the monetary front if necessary. On the fiscal side, the scope for adjustment varies considerably. Following widespread easing of fiscal policy earlier in the year, some countries—including Hong Kong SAR, Malaysia, and Singapore—have eased further in recent months, and there remains room for stimulus in Korea and other countries with low public debt. But high public debt or deficits in some cases—particularly in India, Indonesia, and the Philippines—greatly constrain the scope for further fiscal support.

Reflecting the greater-than-expected slowing in external demand and the weakness evident in sectors of domestic activity, growth projections across Asia have been revised down from those in the October 2001 World Economic Outlook, recovery delayed into 2002. The sharpest reductions are in the outlook for the newly industrialized economies: Hong Kong SAR, Singapore, and Taiwan Province of China are now expected to grow by only around 1 percent in 2002, while firmer growth of 3¼ percent is projected for Korea. Growth in the ASEAN economies is projected to reach just under 3 percent in 2002, with the outlook for Malaysia (which in addition has been hit by lower oil revenues) and Thailand much weaker than anticipated in October. Activity is expected to hold up relatively well in China, where growth of close to 7 percent is projected for 2002, and in south Asia, including India and Pakistan, where growth of 4 l/2 to 5 percent is expected. The more robust activity among these countries reflects the fact that they are less exposed, although not completely immune, to the downturn in global trade and activity compared with most of the smaller Asian economies. The prospective winding down of the conflict in Afghanistan and provision of large-scale international assistance for recovery should contribute significantly to growth in that country and may also boost activity in the surrounding region.

The key uncertainty in the outlook for much of Asia is the strength of export demand—especially the pace of recovery in technology sectors—but there are also concerns about a broader-based deterioration in domestic activity and confidence. Further risks could arise from financial sector weakness in some countries, including Indonesia, Taiwan Province of China, and Thailand. More generally, the deterioration in external financing conditions since September 11 could affect capital flows, including direct investment, to Asia and other emerging markets—highlighting the importance of further structural reforms to strengthen financial and corporate sectors and hence to sustain external confidence. With still large current account surpluses and reserves, however, together with flexible exchange rates in many countries, Asia is relatively well placed to withstand external shocks. Lower world interest rates and lower oil prices should also help—although declining oil revenues will add to fiscal and external financing pressures in oil-exporting Indonesia.

The outlook for Central America and the Caribbean has been revised down sharply, largely reflecting the impact of weaker U.S. growth, falling remittances, and, for the Caribbean in particular, the downturn in tourism (see Box 3.3). The U.S. slowdown has led to a marked downturn of activity in Mexico, with growth of only 1¼ percent projected for 2002 compared with the 4 percent predicted in the October World Economic Outlook. However, the maintenance of firm fiscal and monetary policies has helped support investor confidence, as has the ongoing strengthening of the financial system. This has been reflected in the continued strength of the peso and a narrowing of bond spreads, following some weakening in the immediate aftermath of the September 11 attacks. The early passage of tax reform measures would further strengthen fiscal sustainability and flexibility over the medium term.

The smaller countries in Central America and the Caribbean are particularly vulnerable to recent developments. In Central America, exports to the United States account for almost 20 percent of GDP while, in the Caribbean, tourism accounts for 7 to 50 percent of GDP and by some estimates 25 percent of employment in the region (Box 3.3). Given the size of the external shock these countries are facing, domestic adjustment efforts—already under way in the Caribbean—will need to be complemented by additional external financing.

Countries with Substantial External Financing Requirements

The increased uncertainty in global financial markets since September 11 has added to already significant concerns about economic prospects for economies with sizable external financing requirements. These concerns have been most acute in Latin America—notably Argentina—given the particularly high level of external debt and external financing needs of this region (Table 3.4). Moreover, many of these countries face additional pressures: some will be hard hit by the downturn in commodity prices—especially oil and metals—and in tourism; and, more generally, they face weaker export markets and lower domestic confidence. As a result, growth projections for Latin America in 2002 have been sharply reduced compared with those in the October World Economic Outlook. The out-look for Turkey has similarly been marked down, largely reflecting increased financial market uncertainties, and Pakistan has also seen a large increase in its bond spread and external financing requirement in the aftermath of September 11. But countries in Central and Eastern Europe and the Baltics, which continue to run generally high current account deficits, have appeared better able to weather these uncertainties and meet their financing needs and are expected to show relatively robust growth in 2002.

Table 3.4.Emerging Market Economies: Net Capital Flows1(Billions Of U.S. dollars)
Private capital (lows, net3145.6151.3205.7233.2116.869.659.68.920.159.8
Private direct investment, net54.181.496.5119.6145.2155.4153.4146.2162.4142.6
Private portfolio investment, net87.6113.141.286.948.6−4.231.0−4.3−13.013.7
Other private capital flows, net3.9−−77.0−81.6−124.8−133.0−129.4−96.6
Official flows, net46.33.726.60.162.654.35.1−3.634.221.4
Change in reserves4−63.9−69.9−117.1−109.4−62.5−45.2−87.9−114.2−98.0−34.4
Current account5−116.5−72.6−93.1−95.5−69.6−53.237.8128.951.5−47.5
Private capital flows, net32.513.411.511.18.410.
Private direct investment, net3.
Private portfolio investment, net0.−1.8−6.34.2
Other private capital flows, net−−6.9−0.7−5.81.6−5.8−5.2
Official flows, net4.43.24.1−−2.7−0.20.7
Change in reserves42.8−5.8−2.0−9.5−11.30.7−4.3−14.8−11.2−2.0
Current account5−11.1−11.5−16.6−5.1−7.0−20.0−15.43.8−3.6−14.2
Developing Asia6
Crisis Gauntries7
Private capital flows, net330.835.055.274.1−5.9−31.9−18.3−20.9−24.1−10.5
Private direct investment, net6.76.510.311.710.
Private portfolio investment, net25.013.318.627.68.8−−0.92.6
Other private capital flows, net−0.815.226.334.8−25.0−34.3−40.3−32.9−25.0−18.0
Official flows, net3.21.19.0−4.514.117.3−3.33.0−0.2−1.6
Change in reserves4−20.0−6.5−17.3−5.339.4−46.9−39.3−23.8−5.7−5.9
Current account5−13.5−23.2−40.4−53.0−25.569.762.945.731.923.3
Other Asian emerging markets
Private capital flows, net322.535.137.450.522.9−
Private direct investment, net26.438.239.645.649.648.543.041.741.936.9
Private portfolio investment, net0.−0.1−6.30.7−3.3−3.81.2
Other private capital flows, net−4.7−10.6−4.31.3−26.6−55.1−34.1−33.5−21.0−32.1
Official flows, net8.22.5−3.7−7.9−7.3−0.32.1−9.1−1.93.6
Change in reserves4−16.8−51.6−25.4−41.6−46.8−16.9−38.7−26.2−41.9−23.7
Current account5−
Hong Kong SAR
Private capital flows, net311.7−
Middle East, Malta, and Turkey8
Private capital flows, net330.716.08.58.817.711.8−1.1−22.4−29.2−0.7
Private direct investment, net3.
Private portfolio investment, net6.−0.9−13.2−4.2−15.1−9.6−5.2
Other private capital flows, net20.−2.3−14.6−26.1−3.8
Official flows, net1.−1.0−0.610.60.9
Change in reserves41.6−4.7−11.3−22.0−20.510.6−6.2−25.3−13.48.9
Current account5−30.8−6.3−−24.711.459.439.3−6.7
Western Hemisphere
Private capital flows, net339.347.144.066.470.671.743.637.938.839.5
Private direct investment, net8.722.824.240.356.160.763.862.564.150.0
Private portfolio investment, net45.565.00.838.825.916.
Other private capital flows, net−14.8−40.719.0−12.7−11.5−5.5−30.0−29.2−29.3−18.0
Official flows, net29.94.718.63.413.715.
Charge in reserves4−20.74.0−23.3−29.0−−2.9−6.8
Current account5−46.0−52.2−36.5−40.5−67.1−90.7−56.9−43.7−56.0−55.3
Countries in transition
Private capital flows, net319.84.G49.
Private direct investment, net6.05.313.112.415.621.623.422.526.731.5
Private portfolio investment, net8.716.114.613.
Other private capital flows, net5.1−16.821.3−3.5−20.4−4.6−12.4−24.7−22.7−20.0
Official flows, net−1.1−11.2−5.82.632.917.20.5−
Change in reserves4−10.9−5.3−37.8−2.0−9.4−1.6−7.1−21.5−19.7−12.5
Current account5−7.92.3−2.2−16.8−23.9−29.1−−6.0
Private capital flows, net325.419.423.0−7.1−18.1−2.6−23.4−61.1−41.4−27.9
Private capital flows, net3120.2131.8182.7240.3134.972.283.07O.061.587.7

Net capital flows comprise net direct investment, net portfolio investment, and other long- and short-term net investment flows, including official and private borrowing. Emerging markets include developing countries, countries in transition, Korea, Singapore. Taiwan Province of China, and Israel.

Exludes Hong Kong SAR.

because of data limitations, “other net investment” may include some official flows.

A minus sign indicates an increase.

The sum of the current account balance, net private capital flows, net official flows, and the change in reserves equals, with the opposite sign, the sum of the capital account and errors and omissions.

Includes Korea. Singapore, and Taiwan Province of China.

Includes Indonesia. Korea, Malaysia, the Philippines, and Thailand.

includes Israel.

Net capital flows comprise net direct investment, net portfolio investment, and other long- and short-term net investment flows, including official and private borrowing. Emerging markets include developing countries, countries in transition, Korea, Singapore. Taiwan Province of China, and Israel.

Exludes Hong Kong SAR.

because of data limitations, “other net investment” may include some official flows.

A minus sign indicates an increase.

The sum of the current account balance, net private capital flows, net official flows, and the change in reserves equals, with the opposite sign, the sum of the capital account and errors and omissions.

Includes Korea. Singapore, and Taiwan Province of China.

Includes Indonesia. Korea, Malaysia, the Philippines, and Thailand.

includes Israel.

Economic developments in Latin America have been dominated by the financial crisis in Argentina, which in some respects has been brought to a head by the recent turbulence in global financial markets. As discussed in Box 3.4, measures introduced over the past year—including the $29.5 billion debt swap in June, tax reforms in late June that resulted in an effective depreciation of the peso for non-energy trade, the zero deficit law approved in July, and the augmentation of Argentina's program with the IMF in August—failed to produce a sustained improvement in investor sentiment and reduction in interest rates spreads. Instead, the deteriorating economic outlook has heightened financial market concerns about the sustainability of current fiscal, exchange rate, and financing arrangements. Against this background, the Argentine authorities have approached their creditors to negotiate a restructuring of debt. In tandem with appropriate macroeconomic policies, such an arrangement should be designed to restore fiscal solvency and lay the basis for a return to sustainable growth.

Box 3.3.The Effects of the September 11 Attacks on the Caribbean Region

The member countries of the Caribbean Community (CARICOM) are characterized mainly by small size and population, vulnerability to hurricanes, and high production costs in agriculture that stem from relatively high wages and low productivity.1 Social indicators are generally favorable, although unemployment is high, with official rates ranging from 8 percent to 17 percent. Low productivity, and the impending reduction in preferential access for sugar and banana exports to the EU market, have contributed to a downturn in agriculture and increased reliance on tourism, which is the most important source of incomes and economic activity in most countries. The sector's contribution to economic activity ranges from about 7 percent in The Dominican Republic to near 50 percent in The Bahamas, and some estimates indicate that one in four jobs in the region depends on tourism. As a percentage of GDP, tourism earnings range from 15 percent in Belize and Dominica to more than 40 percent for Antigua and Barbuda and St. Lucia (see the figure).

Gross Tourist Receipts in Selected Caribbean Countries, 2000

(Percent of GDP)

Source: IMF staff estimates.

The region's prospects, which already were being adversely affected by the slowdown in the U.S. economy by mid-2001, have worsened considerably following the September 11 attacks. The sharp drop in visitors after September 11 has led to a fall in economic activity and incomes, and increased unemployment and underemployment as some hotels have closed while others have reduced the length of the work week.2 With a weakening of a significant proportion of the revenue base, fiscal and external positions have also begun to deteriorate. Preliminary estimates are that an external financing gap ranging from $1–2 billion (2 percent to 4 percent of GDP) for the region as a whole could emerge in 2002.

The Region's Response

As the crisis developed, efforts were made to develop a prompt, coordinated regional response. In late September, member countries of the Eastern Caribbean Currency Union (ECCU)3 agreed to:

  • restrain the growth of public expenditure, and speed up public sector reforms aimed at greater efficiency;
  • discontinue discretionary tax concessions that are widely used in the region to promote tourism and manufacturing; and
  • convene meetings of labor, business, and government representatives to reach agreement on a framework for prices, wages, and employment.

Also, at the conclusion of an emergency meeting of the Caribbean Community (CARICOM) on October 12, the heads of government reached agreement on (1) approaching the IDB and the European Union (under the ACP-EU Convention), with proposals for emergency financing; (2) allocating additional budgetary resources for tourism promotion, mainly in the U.S., U.K., and Canadian markets; (3) strengthening airport security; and (4) implementing the recent UN Security Council resolution regarding the treatment of funds used to support terrorist activities. In addition, a number of governments in the region have begun approaching the Caribbean Development Bank, the Inter-American Development Bank, and the World Bank for financial assistance.

Governments in a number of countries have announced specific measures to address the deterioration of their economic situation. In many cases these measures comprise expenditure cuts, especially in low-priority capital projects, materials and supplies, government travel, some salaries, and overtime pay. Several countries have also announced freezes in civil service employment and a strengthening of revenue administration. In a few cases, governments have announced plans for a fiscal stimulus package, the relaxation of monetary policy, and borrowing from the international markets or the banking system. Other measures are likely to be announced in the context of the annual budget presentations for a number of countries that will be made in late 2001 and early 2002.

The Response of the IMF

The IMF, jointly with other institutions like the World Bank, the Caribbean Development Bank, and the ECCB, has focused its initial efforts on assessing the macroeconomic impact of the crisis, and working with countries to develop appropriate policy responses. These efforts will be supported by technical assistance from the IMF in fiscal and financial sector policies provided on an ongoing basis through the recently established Caribbean Center for Technical Assistance (CARTAC) that is based in Barbados. IMF staff have also begun to discuss possible financial support through the existing facilities, such as Stand-By Arrangements, and the Compensatory Financing Facility (CFF)—which is designed to provide assistance to cover short-falls in export receipts (including from tourism) stemming from external shocks.

1 Four countries, the Dominican Republic, Haiti, Jamaica, and Trinidad and Tobago, account for about 80 percent of the region's population. The average population of the other 11 countries is about 250,000. These latter countries are the six independent member countries of the ECCU (see footnote 3 below), and The Bahamas, Barbados, Belize, Guyana, Suriname.2 Hotel occupancy rates in some countries have fallen to about 15 percent or less, compared with an average for September-October of about 60 percent.3 The union comprises Anguilla and Montserrat, which are British territories, and Antigua and Barbuda, Dominica, Grenada, St. Kitts and Nevis, St. Lucia, and St. Vincent and the Grenadines. Monetary and exchange rate policies of the Union are administered by the Eastern Caribbean Central Bank (ECCB).

With indicators of production, spending, and confidence registering sharp declines in the third quarter, real GDP in Argentina is now expected to contract by 2¾ percent in 2001, including a fall of over 10 percent in investment spending, lower consumption, and a positive contribution to growth from net exports—largely because of declining imports. Consumer prices are expected to fall by 1 percent in the year as a whole, and producer prices by around 4 percent. Looking ahead, while the situation remains subject to great uncertainty, output is likely to fall in 2002, with deflation continuing (although at a slower rate than in 2001).

Contagion from the most recent financial turmoil in Argentina on other Latin American economies has generally been limited—in part because the latest round of difficulties was well anticipated by financial markets (see Chapter I, Appendix). In Brazil, interest rate spreads, equity markets, and the exchange rate deteriorated sharply immediately after the terrorist attacks in September but, thanks in part to continued strong policy implementation, these variables subsequently more than recovered their earlier losses, despite recent developments in Argentina. The continuing slowdown in the economy—with growth now projected to remain at around 2 percent in 2002—and the earlier depreciation of the real have begun to generate a sizable reduction in the external current account deficit, in turn helping to stabilize exchange rate expectations. Nevertheless, risks remain, both with respect to future developments in Argentina and uncertainties in the runup to next year's presidential election. Continued strong implementation of the policy program therefore remains crucial, including through the maintenance of tight fiscal and monetary policies and further progress with structural reform.

Box 3.4.Argentina: An Uphill Struggle to Regain Confidence

After a decade of high growth, low inflation, and important progress in structural reform following the adoption of the convertibility regime in 1991, the performance of the Argentine economy deteriorated in 1999. This deterioration was partly the result of remaining domestic disequilibria, a weakening of policies, and a worsening of the external environment.

Argentina has continued to battle with a recession since then, reigniting doubts regarding the sustainability of the fiscal position and the exchange rate regime. In December 2000, the Argentine authorities put forward a revamped economic program that sought to bolster economic growth through a modest fiscal expansion and various structural measures, set in a framework that ensured medium-term fiscal sustainability. In support of the program, the IMF approved, in January 2001, an augmentation and front-loading of resources under the Stand By Arrangement that was in place since March 2000.

In the event, the December 2000 program proved unsuccessful in restoring market confidence in Argentina's capacity to grow and maintain fiscal solvency within the framework of the convertibility regime. The authorities took advantage of the favorable market conditions of early 2001 to accelerate the borrowings contemplated in their financing plan; however, clear signs of fiscal strain began to emerge in mid-February after press reports showed that there had been sizable revenue shortfalls and spending overruns in December and January. On March 2, 2001, Economy Minister Jose Luis Machinea resigned amidst strong political resistance to adhere to the fiscal targets agreed with the IMF.

A broadly similar pattern was repeated on several other occasions during the year, notably following the announcement of Economy Minister Ricardo Lopez-Murphy's plan of across-the-board budget cuts in mid-March, of Minister Domingo Cavallo's late March plan of selective tax concessions and higher import tariffs, of the late-May “mega swap,” of the mid-June plan that included further tax cuts and a mechanism to compensate non-energy exporters and importers for the strength of the U.S. dollar vis-à-vis the euro, and of the “zero-deficit” plan of July 11. Each time, the Argentine authorities reiterated their commitment to fiscal prudence, the timely service of government debt, and the convertibility regime, and proposed or adopted measures aimed at bolstering the confidence of domestic and foreign investors, and of the public in general. Although there were reservations about some of the measures, the authorities' resolve to maintain the convertibility regime was supported by the official community, including through the provision of additional financial resources in early September to help dispel concerns about a debt default.

None of these plans, however, proved to be sufficient to restore market confidence on a lasting basis. Following the announcement of the “zero-deficit” plan on July 11, Moody's and Standard & Poor's lowered by one notch their sovereign rating for Argentina, and the country's EMBI spread widened more than 300 basis points (see the figure). The downrating fueled a large withdrawal of bank deposits that put enormous pressure on domestic interest rates and on tax revenues. The withdrawal continued through late August, when the IMF announced its plans to augment Argentina's Stand-By credit by $8 billion. Other confidence indicators also deteriorated during this period: Moody's lowered Argentina's debt rating one more notch on July 26, the consumer confidence index fell sharply, tax revenues plummeted, and private growth forecasts for 2001 were revised downward well into negative territory.

Despite the official backing from Congress to the “zero-deficit plan,” the clear resolve of Finance Minister Cavallo and President de la Rua, progress in reducing discretionary expenditures, and the additional resources provided by the IMF, a recovery in confidence continued to prove elusive following the completion of the fourth review of the Stand-By arrangement on September 7. Although some $2.5 billion of private sector deposits returned to the banking system and domestic interest rates fell markedly, most indicators of confidence for the months of September and October did not show any improvement, and some of them, like the EMBI spread, continued to deteriorate, in part due to global risk aversion following the September 11 attacks. Tax revenues also declined further, in part reflecting declining growth and deteriorating domestic financial conditions. Days before the congressional elections of October 14, Standard & Poor's and Moody's downrated Argentina's debt once again. The outcome of the elections slowed agreement on the spending cuts needed to comply with the zero-deficit plan in the rest of 2001 and 2002, and on the reform of the revenue-sharing agreement with the provinces (although considerable progress was made subsequently). Faced with these constraints, on October 29 the Argentine government announced that it would seek a voluntary restructuring of all its bonded debt (about $100 billion), arguing that it was the only path left to restore fiscal solvency and revive economic growth. One week after the announcement, the EMBI had shot up 500 basis points and Standard & Poor's had placed Argentine debt on its “selective default” category; bank deposits, however, remained relatively stable.

Confidence Indicators

Sources: BCRA (Argentine central bank); J.P. Morgan; Latin American Consensus Forecasts; and IMF staff estimates.

In early November, the government announced that the restructuring of its bonded debt would proceed in two phases. The first phase, designed primarily for local bondholders (banks, pension funds, mutual funds) comprised the exchange of eligible bonds for domestic loans of a lower yield backed by ear-marked tax revenues. Over $50 billion of government bonds (including from the provinces) were swapped for those loans on November 30. The government expects to complete the second phase of the restructuring within the next three months.

The authorities placed a cap on deposit interest rates in late November equivalent to the market average of 12 percent. A few days earlier, a projected fiscal outturn for 2001 that exceeded by more than $1 billion the end-year target contained in the IMF program was announced. The combination dealt another blow to confidence. During the last week of the month, deposit outflows resumed, bank liquidity dried up, interest rates skyrocketed, and the EMBI spread reached an all-time high of more than 3300 basis points. To arrest the outflow of deposits and avoid the collapse of the financial system, on December 1 the authorities introduced wide-ranging controls on banking and foreign exchange transactions. These included setting a monthly limit on withdrawals from individual bank accounts; prohibiting banks from granting loans in pesos and from operating in the peso market; putting a cap on interest rates on peso deposits; and introducing foreign exchange restrictions on travel and transfers abroad. The authorities stressed that all the measures were transitory and aimed at safe-guarding the convertibility of bank deposits, and said that they would be revoked after 90 days, when the next phase of the debt restructuring is finalized.

Given the large uncertainty surrounding Argentina's prospects, economic projections—notably of GDP growth—are particularly problematic. Few doubt that output will fall, for a third year in a row in 2001. At the time of the fourth review (in August), IMF staff projected a mild recovery in 2002 based on the pickup in confidence and bank credit that were to follow from the strict adherence to the zero deficit plan. The picture for 2002 is now much less clear, and the downside risks have increased. Correspondingly, the IMF staff and consensus forecast for 2002 growth in Argentina have been revised downward significantly (see Figure).

Elsewhere in Latin America, relatively high external financing requirements also remain the central vulnerability. These financing needs are typically linked to large public sector deficits and debt, a sizable share of which is linked to foreign currencies. Several countries are also exposed to commodity price risks—including Venezuela and Ecuador (oil), Chile (metals), and Colombia (coffee)—and to adverse developments in the region (Uruguay). While the potential risks vary substantially across countries, policies will need to be geared to maintaining investor confidence. These include a stronger adjustment effort in Venezuela, where the fiscal and external position will be hard hit by lower oil prices—although the oil stabilization fund will help to cushion these effects. Also needed are further progress in banking and fiscal reforms in Ecuador and fiscal tightening and accelerated structural reforms in Uruguay.

The countries of Central and Eastern Europe and the Baltics also face substantial external financing requirements, given the persistently high current account deficits in most of these countries. International economic and financial market sentiment toward these countries appears to have remained generally strong, however, as indicated by robust inflows of direct investment and of other external funding. While these inflows could still be at risk if there is prolonged weakness in global activity, the favorable reaction to date may stem from the general improvements in economic fundamentals among these countries, including through privatization, other structural reforms, and, in most cases, generally sound macroeconomic policies.

As a result, the outlook for this region may in practice be more strongly influenced by its strong trade linkages with Western Europe (Figure 3.3). For example, export growth in the Czech Republic and Hungary is slowing from strong rates earlier this year, and a more generalized slowdown in trade appears likely as the impact of weaker activity in the European Union takes hold. But several factors appear to be contributing to a somewhat more robust outlook for this region than in the advanced economies, although with important divergences among individual countries. On the trade side, for example, the strong competitive position of these economies has enabled them to preserve and gain market share. In addition, structural changes—including recent and continuing inflows of foreign direct investment—have diversified the export base of many countries in this region and may have made exports less cyclically sensitive.

Figure 3.3.Linkages Between Central and Western Europe1

Sources: Direction of Trade Statistics, IMF; and IMF staff estimates.

1 Includes Czech Republic, Hungary, Poland, Slovak Republic, and Slovenia.

2 Foreign direct investment in U.S. dollars; European Union growth rate in percent.

3 Includes Bulgaria, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Slovak Republic, and Slovenia.

Domestic demand growth, supported in part by declining inflation across much of the region, should also help offset potential weaknesses in external trade. Reflecting this, growth of 3 to 3½ percent is expected in 2002 in much of central Europe, and of 4 to 4½ percent in southeastern Europe and the Baltics—only marginally weaker in many countries than in 2001. In Poland, by far the largest country in this region, the macroeconomic policy stance was tightened in 2001 to contain rising inflation pressures, and this contributed to relatively weak growth of 1½ percent this year. Monetary policy has been eased recently, however, and further relaxation is possible given the still high level of real interest rates. These steps are expected to help support a pickup in growth to around 2¼ percent in 2002.

Risks for the region as a whole appear tilted the downside, however, especially in view of the general weakening of global growth. If activity should weaken sharply, there is only limited room for an easing of macroeconomic policies. As just noted, Poland—together with some other countries—has scope to ease monetary conditions, but inflation pressures remain of concern elsewhere (including in Hungary and Romania), and currency board arrangements in the Baltic countries and Bulgaria constrain their scope for independent monetary policy responses. The room for maneuver on fiscal policy is also quite limited, given rising deficits in some countries (Hungary and Poland, for example) and persistently high current account deficits in much of the region.

Economic prospects for Turkey—which had appeared to be improving from early August—have also been set back by the events of September 11 and their aftermath. While increases in interest rates and declines in prices immediately following the attacks have subsequently reversed, Turkey remains vulnerable to further downturns in investor sentiment given its high domestic and external financing requirements. These financing concerns have been heightened by the prospect of lower access to international financial markets, an unfavorable climate for privatization, and weaker growth in export earnings, including from tourism. With economic recovery further delayed, the economy is now projected to contract even more severely in 2001—with output falling by 6 percent—and to pick up more slowly in 2002—with growth reaching around 4 percent. The disinflation process has been hampered in 2001 by a further depreciation of the exchange rate, which has weakened by over 50 percent against the dollar since the beginning of the year; in 2002 inflation is expected to decline but to be substantially higher than projected in the previous World Economic Outlook. In light of this deterioration, the authorities have taken additional measures to ensure that the 2002 fiscal targets are met, and intend to formulate a strengthened adjustment program for 2002 to 2004. This program will build on the progress already made in macroeconomic and financial stabilization, and be accompanied by decisive steps to complete banking sector reform, revitalize privatization and private sector development, and improve public sector governance and efficiency.

Commodity Exporting Countries

The third broadbased influence on economic prospects for many emerging markets comes from developments in commodity prices. The sharp weakening of the outlook for global growth in the aftermath of September 11 has led to a significant decline in oil prices and further falls in prices of most nonfuel commodities. The impact of lower commodity prices will vary significantly, depending on the structure of the economy and the previous stance of policies. In general, oil exporters are likely to be most severely affected, although in a number of countries—particularly in the Middle East—the impact will be cushioned as a result of the relatively conservative policies followed when prices were high. Among nonfuel commodity exporters, the adverse impact will be offset in part by lower oil prices, so that growth for the group as a whole is relatively well sustained. The impact on poverty may be more marked, however, with lower prices for agricultural goods having a particularly strong effect on the poor in rural areas.

Looking first at the oil exporting countries—particularly in the Middle East, Africa, and the Commonwealth of Independent States (CIS)—lower production and prices of oil have contributed to a general weakening of projected growth for 2001 and 2002 compared with the exceptionally strong performance experienced in most of these countries in 2000 (Figure 3.4). With the oil market weakening further since the events of September 11, the 2001–02 growth projections for a number of these countries have been marked down compared with those in the October 2001 World Economic Outlook; in other cases, though, new data or country-specific developments have led to upward revisions to the outlook.

Figure 3.4.Fuel and Nonfuel Commodity Exporting Countries

In the Middle East, the outlook for Saudi Arabia and Kuwait has weakened further in the light of recent oil market developments, with Saudi Arabia expected to grow by just over 1½ percent in 2002 compared with 4½ percent in 2000. Growth in the Islamic Republic of Iran is expected to continue at a relatively firm pace of around 5 percent, however, supported in part by continued recovery in agriculture and strong performance in the construction and manufacturing sectors. The outlook for the Middle East, particularly for nonoil producing countries, is influenced by a range of other pressures. These include increased regional security concerns, which have contributed to a downturn in tourism (of particular importance for Egypt, Israel, and Jordan); continuing weakness in the information technology sector (affecting Israel); and fiscal and external financing difficulties, possibly aggravated by a downturn in remittances from overseas (key risks in Lebanon).

In the CIS, activity in Russia and Kazakhstan is expected to slow somewhat from the strong pace of 2000 and 2001, although it should remain reasonably healthy, with growth of ¾ percent still expected in Russia in 2002 and 7 percent in Kazakhstan. In Russia, the climate for foreign investment appears to have improved, investment spending—particularly on energy-related projects—has been even stronger than earlier expected, and consumer spending has also been strong. While Russia remains vulnerable to lower oil prices, the impact is expected to be manageable unless the decline proves to be significantly deeper and more prolonged than currently anticipated. With growth estimates for 2001 now revised up substantially, the carryover effects of these changes have supported the 2002 outlook as well. The strength of activity in Russia is also contributing to reasonably firm growth among non-oil producing countries in the CIS—especially among countries that are more advanced in the transition process, such as Ukraine.

Among African oil-producing countries, the 2002 outlook for Algeria and Nigeria has been revised down compared with the October World Economic Outlook. In Algeria, the oil stabilization fund built up during the recent period of high oil prices will help cushion the downturn, and growth is expected to be relatively well sustained at around 3½ percent. Weaker growth of under 2 percent is expected in Nigeria, where the economy continues to be dominated by oil and where an effective stabilization mechanism to smooth the effects of oil price fluctuations has not been put in place. Angola is expected to grow by around 11 percent in 2002, supported by a sizable increase in oil production from new offshore fields.

Not surprisingly, the reduction in oil prices has led to a general weakening of current account positions among oil exporters (Figure 3.4). While surpluses are still expected in Algeria, and Venezuela in 2002—albeit much reduced from their recent levels and from earlier projections for 2002—lower oil prices have led to the emergence of external deficits in Saudi Arabia and Kazakhstan rather than previously projected surpluses. Of much more concern is Nigeria, where the current account deficit is expected to reach over 10 percent of GDP in 2002—more than double what is expected in 2001 and what was projected earlier for 2002.

Turning to nonfuel commodities, the further weakening in global economic activity and prospects since September 11 has pushed down the prices of most metals and agricultural commodities—many of which, including coffee, cotton, and copper, were already at depressed levels. These trends have weakened the outlook for many of the poorest countries—mainly in Africa—whose overall economic prospects are often closely tied to export earnings from a small range of nonfuel commodities. At the same time, however, lower oil prices are helping to offset the terms of trade deterioration among energy-importing countries and limiting the increase in their external financing requirements. In particular, while recent commodity price shocks imply additional terms of trade losses equivalent to around 5 to 10 percent of GDP in most of the main oil exporting countries, the impact on nonfuel exporters is much lower—generally in the range of −1 to 1 percent of GDP (see Chapter II).5

Reflecting these developments, growth of 3½ percent is projected for the oil importing countries of Africa in 2002, nearly 1 percentage point lower than in the October World Economic Outlook, but up from growth of 3¼ percent expected in 2001.6 These countries' current account deficits are expected to deteriorate modestly to just under 3 percent of GDP, compared with 2.4 percent in 2001. Prospects for individual countries in this group vary widely, however, reflecting not only their particular mix of commodity trade but also economic policy developments and other country-specific influences. In South Africa, growth is expected to remain at around 2¼ percent, with inflation coming down and the current account in surplus. While the rand has weakened further as a result of regional and domestic factors, the country's vulnerability to external shocks has generally diminished—reflecting strong macroeconomic fundamentals, continuing reductions in the central bank's net open forward position (now at its lowest level in over a decade), and a healthy banking system. Elsewhere, relatively healthy growth in the range of 4 to 6 percent is expected in Cameroon, Ghana, Tanzania, and Uganda, and around 8 percent in Mozambique—countries where macroeconomic and structural policies have generally been sound. In contrast, weaker growth is expected to persist in Kenya, where policy implementation has been mixed; and the ongoing turmoil in Zimbabwe continues to undermine economic activity, with GDP expected to contract by around 6 percent in 2002.

Appendix: Alternative Scenario-Impact of a More Gradual Increase in Confidence and Risk Appetite

The baseline projections envisage that the global economy will start to recover during next year, based in part on an expected rebound in confidence and risk appetite over the course of 2002. However, the world economic outlook is still subject to considerable uncertainty, reflecting both the effects of the September 11 attacks and existing financial in balances. In particular, policymakers need to consider the outcome if the synchronized slowing in output continues through 2002, reflecting a slower-than-anticipated rebound in consumer and business confidence and a more prolonged period of difficult financial market conditions for emerging market economies.

To illustrate some of the downside risks attached to the baseline projections, the alternative scenario assesses the implications if consumer and business confidence and risk appetite do not recover during 2002, using the IMF's multicountry macroeconometric model, MULTIMOD. In addition, results are reported for a separate block that is currently under development for emerging market economies.7

The key assumptions underlying the scenario are that:

  • The lack of recovery in confidence is modeled as a reduction in the propensity to consume relative to baseline that sum to around half of the estimated total impact on GDP if confidence were to remain depressed (see Chapter II), while the other half of the impact is already contained in the baseline scenario as confidence and financing conditions recover only gradually over 2002. In the United States, the marginal propensity to consume is assumed to drop relative to baseline by 1 percent in 2002 and by ½ percent in 2003, before reverting to baseline in 2004. In other industrial countries, the downward corrections to consumption are assumed to be half this size.
  • The more gradual increase in global risk appetite is assumed to reduce equity prices in industrial countries by raising the discount rate on future profits as well as prolong the period during which emerging market economies face elevated risk premia and a curtailment of capital flows relative to the baselines. As a result, the discount rate is assumed to rise by ½ percentage point in the United States and ¼ percentage point else-where in 2002, then taper off. In emerging markets the risk premium is assumed to increase by 1 percentage point in 2002 compared to the baseline, equal to about half of the current impact, as measured by the widening in the EMBI+ spread between September 11 and early November. The risk premium is assumed to be ½ percent above baseline in 2003, before reverting to base-line in 2004.

In the alternative scenario, oil prices are assumed to fall in line with weakening demand. In addition, monetary authorities in both industrial countries and emerging economies are assumed to follow a forward-looking Taylor rule, responding to changes in expected inflation and the current output gap, so that nominal interest rates fall in response to the adverse shocks described above. In Japan, where nominal interest rates are close to their floor, some quantitative easing is also assumed. Finally, fiscal authorities allow automatic stabilizers to operate, but are not assumed to initiate discretionary policies.

The slower reversion of consumer and investor confidence is estimated to reduce global output relative to baseline by about ¾ percent in 2002 and about ¼ percent in 2003 (Table 3.5). In industrial countries, the fall in output is almost 1 percent in 2002, with the distribution across countries and regions depending on the size of the shock and on the room for maneuver on monetary policy. In particular, in Japan, where nominal interest rates are at their floor, deflation accelerates and increases real interest rates by more than ¾ percentage points relative to baseline in 2002, leading to an appreciation of Japan's real effective exchange rate (Figure 3.5). Altogether, the loss in output in 2002 relative to baseline due to the slower rebound in confidence is about 1 percent in the United States, ½ to ¾ percent in the euro area and other industrial country regions, and almost 1½ percent in Japan, even though the initial shock to Japan's domestic demand was assumed to be only half of that in the United States. The impact of weaker domestic demand in industrial countries and tighter foreign financing constraints would reduce output in developing countries as a whole by ¼ percent relative to baseline in 2002 and domestic demand by over 1 percent.

Figure 3.5.Impact of a Delayed Reversion in Global Confidence and Risk Appetite

Source: IMF staff estimates.

Table 3.5.Alternative Scenario: Delayed Strengthening in Consumer Confidence and Risk Appetite(Percent deviation from baseline unless otherwise specified)
World real GDP−0.7−
United States
Real GDP−0.9−
Domestic demand−0.9−
Real effective exchange rate−2.4−1.2−0.10.1
Current account ($billion)1.036.938.917.211.5
CPI Inflation (percentage points)−0.7−0.7−
Short-term interest rate (percentage points)−1.8−1.2−0.3−0.1−0.1
Short-term real interest rate (percentage points)−1.2−0.8−0.2−0.2−0.2
Euro area
Real GDP−
Domestic demand−
Real effective exchange rate0.50.4O.1
Real U.S. dollar exchange rate2.31.20.1−0.1−0.1
Current account ($billion)−7.6−6.73.6−3.4−4.3
CPI inflation (percentage points)−0.9−0.7−
Short-term interest rate (percentage points)−1.4−0.8−O.00.10.1
Short-term real interest rate (percentage points)−0.8−0.5−0.1−0.1−0.1
Real GDP−1.4−0.70.2
Domestic demand−1.1−0.5−0.1
Real effective exchange rate3.
Real U.S. dollar exchange rate4.
Current account ($billion)5.4−10.9−8.3−7.2−5.4
CPI inflation (percentage points)−0.8−0.6−0.2
Short-term interest rate (percentage points)−0.1−
Short-term real interest rate (percentage points)
Other industrial economies
Real GDP−
Real domestic demand−
Current account ($billion)−21.2−20.3−5.6−3.1−3.4
Industrial countries
Real GDP−0.9−
Real domestic demand−
Current account ($billion)−22.4−−1.5
Developing countries
Real GDP−0.3−
Real domestic demand−1.2−
Current account ($billion)22.41.1−28.6−3.51.5
Price of oil−14.9−16.2−9.2−1.5−1.4

The failure of global risk appetite to recover and the fall in external demand from industrial countries is likely to have a particularly significant impact on emerging market economies. This issue is examined in more detail in Table 3.6, which is based on a new block for emerging market economies currently under development, and can be thought of as a model for emerging Latin American and Asian economies, with the important exceptions of China and India.8 The higher risk premium reduces capital inflows to these countries by about $23 billion in 2002 and causes the exchange rate to depreciate. The rise in real interest rates, increase in the value of foreign currency denominated debt, and decline in the stock prices of domestic firms reduce wealth relative to the baseline, which in turn reduces private consumption and investment. However, the impact of the contraction in domestic demand on output is partially offset by an increase in the external balance as imports are reduced and exports boosted. Altogether, the delayed fall in the risk premium would reduce output in emerging market economies by almost 2 percent relative to baseline in 2002 and domestic demand by around 3½ percent (Figure 3.5).9 Such an outcome would reduce global output compared to that reported in the earlier MULTIMOD scenario.

Table 3.6.Alternative Scenario: Delayed Recovery in Financing Flows to Emerging Markets(Percent deviation from baseline unless otherwise specified)
Emerging Market Borrowers
Real GDP−1.8−
Domestic demand−3.4−1.80.3
Real exports1.40.70.1
Real imports−3.8−1.9−0.2−0.2−0.1
Nominal effective exchange rate−4.7−2.4−
Real competitiveness index−2.7−1.3−0.2
Current account ($billion)22.914.
Total wealth−2.2−
Market value of capital stock−8.4−
Real capital stock−0.3−0.1−0.3−0.2−0.2
Domestic private debt (percentage points of GNP)0.30.2−0.7−0.4−0.3
Foreign private debt (percentage points of GNP)2.11.1−0.2−0.2−0.2
DPI inflation (percentage points)0.60.3−0.1−0.1−0.1
Short-term interest rate (percentage points)0.60.3−0.4−0.1
Short-term real interest rate (percentage points)0.50.3−0.5−0.1
Yields on domestic private debt (percentage points)2.31.1−0.3−0.1−0.1
Yields on foreign private debt (percentage points)1.20.6

Given the large uncertainties surrounding the alternative scenario, it may be useful to provide ready reckoners of the individual shocks that comprise the overall scenario, so that the likely impact of alternative assumptions can be constructed. Table 3.7 provides such a breakdown for the three main components of the alternative scenario: lower consumer confidence, higher risk aversion, and a fall in the oil price (the endogenous impact of lower oil prices has been eliminated from the other two ready reckoner calculations). The fall in consumer confidence relative to baseline has a substantial impact on output in 2002, particularly in the United States and Japan, which is then largely reversed in 2003—hence this is best thought of as a large temporary disturbance focused on the industrial countries. By contrast, higher risk aversion has a smaller but more persistent impact in most industrial countries, with the important exception of Japan. The simulation using the emerging market economies block also indicates that it could also have a substantial impact on parts of Asia and Latin America that are relatively open to trade and capital flows. Finally, lower oil prices provide mild support for global activity. Indeed, the effect could be some-what larger than the simulation indicates, as MULTIMOD does not capture the impact of changes in prices of other energy products, such as gas, which tend to follow the price of oil.

Table 3.7.Direct Costs of September 11 Attacks1(Percent deviation from baseline)
Real GDP
Higher risk aversion lower confidence reduces U.S. consumption by 1 percent and ½ percent elsewhere2Reduces U.S. investment by ½ percent and ¼ percent elsewhere3Oil prices lower by 10 percent in 2002 and by 5 percent in 2003
Global economy‒0.4‒0.1‒0.3‒0.20.1
Industrial countries‒0.5‒0.2‒0.3‒0.20.1
United States‒0.6‒0.2‒0.3‒
Euro area‒0.3‒0.1‒0.2‒
Developing countries‒0.1‒0.1‒0.10.1
Emerging markets‒0.1‒1.8‒0.90.101

These results are generated using a version of MULTIMOD that contains a linear relationship between inflation and demand conditions.

In the United States, lower confidence is assumed to reduce the marginal propensity to consume by 1 percent in 2002 and by ½ percent in 2003. before reverting to baseline in 2004. In the other industrial countries, the negative shock to consumption is assumed to be half this size, Developing and emerging economies are not assumed to suffer any direct shock to domestic consumption.

In the United States, the flight to quality is assumed to increase the risk premium on equities in the United States by ½ percent in 2002 and by ¼ percent in 2003, before reverting to baseline in 2004. In the other industrial countries, the increase in the risk premium is assumed to be half this size. Developing economies are not assumed to suffer any direct shock to risk aversion. Emerging markets face a rise in default risk by 1 percent in 2002 and by ½ percent in 2003.

These results are generated using a version of MULTIMOD that contains a linear relationship between inflation and demand conditions.

In the United States, lower confidence is assumed to reduce the marginal propensity to consume by 1 percent in 2002 and by ½ percent in 2003. before reverting to baseline in 2004. In the other industrial countries, the negative shock to consumption is assumed to be half this size, Developing and emerging economies are not assumed to suffer any direct shock to domestic consumption.

In the United States, the flight to quality is assumed to increase the risk premium on equities in the United States by ½ percent in 2002 and by ¼ percent in 2003, before reverting to baseline in 2004. In the other industrial countries, the increase in the risk premium is assumed to be half this size. Developing economies are not assumed to suffer any direct shock to risk aversion. Emerging markets face a rise in default risk by 1 percent in 2002 and by ½ percent in 2003.

These scenarios should be regarded as illustrative of the potential downside risks facing the world economy if the recent deterioration in confidence and increase in global risk aversion are maintained through 2002. The implication is that global growth could fall below 2 percent in 2002, similar to levels experienced in 1975, 1981 and 1991.


    LounganiPrakash2000How Accurate Are Private Sector Forecasts—Cross-Country Evidence from Consensus Forecasts of Output Growth,IMF Working Paper No. 00/77 (Washington: International Monetary Fund).

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1Mark-to-market accounting rules came into effect at the beginning of April 2001 and are reflected for the first time in financial results for the half year ending in September 2001.
2An emergency account amounting to 15 trillion yen is available to ensure the stability of the financial system in case of systemic threat.
3See Box 1.5 in the October 2001 World Economic
4See Chapter II of the October 2001 World Economic Outlook for analysis of these linkages.
5Specifically, these are the terms of trade gains or losses arising under the commodity price baseline used in this interim World Economic Outlook relative to those arising in the baseline used in the October 2001 World Economic Outlook.
6As noted in the October World Economic Outlook, however, the IMF's projections for Africa have tended to be too optimistic, with outturns often lower than expected as a result of adverse shocks, including conflict, and shortfalls in policy implementation (see also Box 3.1).
7The emerging market block uses the results from the MULTIMOD simulation to provide the global environment. The feedback from the new block to the MULTIMOD simulation, however, is limited to the impact on capital flows to developing countries.
8The group comprises about one-third of developing countries' GDP.
9In addition, a change in the risk premium could also have supply-side, credit rationing effects if banks experience a large increase in nonperforming foreign loans.

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