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Tuesday, Feb 08, 2005

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WORLD ECONOMY IN 2005

A REPORT PREPARED jointly by the United Nation's Department of Economic and Social Affairs and the U.N. Conference on Trade and Development (UNCTAD) expects world economic growth to slow down to 3.25 per cent this year. 2004 was an especially good year for the less-developed countries. The cycle of economic growth peaked at an impressive 4 per cent, despite the uncertainty caused by the oil price shock and growing concerns over the U.S. Government's trade and budgetary deficits. As for the immediate outlook for the world economy, the report titled World Economic Situation and Prospects 2005 cautions that even its more moderate growth forecast for this year "may be hostage to how the U.S. dollar and global imbalances unwind." This is by no means an isolated assessment. As the second Bush administration prepares to unveil its economic policies, there is a feeling everywhere that happenings in the U.S. will have a more critical impact on the global economy than ever before.

For developing countries, the possibility of an abrupt and globally damaging correction persists. This despite the fact the global economy adjusted itself surprisingly well to sharply higher oil prices from the middle of 2004. Core inflation did not go up in the developed world. Developing countries such as India too have managed the transition to the new regime reasonably well. Many of them could offset their high costs of petroleum imports against higher export realisations from metals and minerals at a time when prices of many commodities moved up in tandem with those of petroleum. For example, the Indian steel industry benefited from a surge in the demand for its products from China and a few other countries. The Indian Government's package for steel helped in insulating domestic consumers from the vagaries of global commodity prices. Significantly inflation, which peaked in August 2004 at 8.75 per cent, has been on the decline since December. Yet as the U.N. report points out, the battle in India and most other developing countries to contain imported commodity-led inflation is far from over. The prognosis on oil is not encouraging. Given the demand-supply mismatch over the medium term, oil prices are unlikely to go down to their 2003 levels. Besides, geo-political and other non-economic factors could disrupt oil supplies this year.

More problematical for the rest of the world is the uncertainty caused by the Bush administration's policy in relation to record U.S. trade and budget deficits. A major contradiction has come to the fore on the world stage: it is between consumption and debt in the U.S., and the ever-growing surpluses of many of its trading partners. Japan and China head a list that includes India, which now faces a problem of abundance with its burgeoning foreign exchange reserves. Unfortunately, there is no consensus among nations on measures to minimise the pain caused by the imbalance. Revaluation of the currencies of America's major trading partners has long been advocated as a possible remedy. Aside from the practical difficulties involved, the U.N. report, citing expert studies, makes the point that currency changes, especially bilateral manipulations, will not resolve the problem and can create new ones. The only solution acceptable to most countries is stimulating domestic demand in economies with large external surpluses, and towards that end directing investment resources to them. The large reconstruction efforts in the wake of Asia's tsunami calamity, which have showcased international efforts at directing large investments into Asia, point to an effective way of correcting the imbalances.

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