SUNS4512 Tuesday 21 September 1999

Development: Tackle 'hot money' at source, says Ricupero

Geneva, 20 Sep (Chakravarthi Raghavan) -- Although the worst fears of global recession have subsided, the world economy in 1999 will simply repeat last year's poor performance and, neither the return to stability in crisis-hit Asian economies nor containment of the Brazilian crisis to neighbours "should hide the immediate downside risks facing the global economy over the near future," says the UN Conference on Trade and Development.

In an assessment of the world economy in 1999, in its Trade and Development Report 1999, UNCTAD warns that the stabilization of conditions in emerging markets does not mean that underlying problems have disappeared.

"There is no ground for complacency, since the systemic forces responsible for the recent turmoil are still present," UNCTAD warns and says that the continued dependence of so many developing countries on highly volatile capital inflows is a major cause for concern.

Though the crisis that broke out in July 1997 in Bangkok seems to have become one of a "historical nature", a thing of the past, it is not a time for complacency, and the ball is in the court of industrialized countries to make the world economy grow faster, Ricupero said in launching the report in Geneva.

The underlying elements of the crisis are very much there - the volatility of international capital markets and particularly short-term flows. Everyone recognized it, and yet nothing seems to be done. And as Asian Development Bank has pointed out, the social impact of the crisis on the countries hit in Asia is very much there and the worst is yet to come.

"I have no doubt that a new crisis will come and will be as destructive as this one, and the only question is when and where," Ricupero said. The industrialized countries, particularly Europe and Japan, who are surplus countries and who have the power to make decisions need to act to stimulate growth worldwide. The US economy which has provided import demand has begun to slow down, and it is for EU and Japan to impart some stimulus to the world economy.

Some of the problems of the "hot money" and volatile capital inflows could be tackled in the recipient countries, but they could be also more easily addressed by regulatory measures in the industrialized world, Ricupero stressed.

All projections and estimations suggest that developing countries need to grow at an annual six percent to tackle their unemployment and catch up with the industrial world. This would enormous inputs of capital, and more than 40 to 50 percent of the needs cannot be found from the current private capital markets.

It is necessary to find these resources by enabling the developing world to export and earn, that is to rely on trade and not hot money, and for the surplus countries like the EU and Japan to directly inject liquidity into these countries, where the propensity for consumption is much higher, and it would have a beneficial effect on growth in the world economy, says TDR-99.

TDR-99 notes that the world economy grew by a 2% in 1998, and about the same is expected in 1999. Unacceptably in itself, the 2% growth hides a growing rift between developed and developing world. Output in the latter in 1998, at an average 1.8% was lower than population growth and, for the first time in 10 years, the developing world grew more slowly than the industrial (2.2%).

Asia's growth continues to depend on how the crisis and its aftermath are managed. The speed and sustainability of recoveries are varied and uncertain, and for the region as a whole, much will depend on developments in China and Japan.

China's exports have slowed down, but the momentum of the economy has been kept through heavy public expenditure. But if prospects worsen significantly, devaluation may become more attractive, and "the consequential risk of broader currency realignment across the region remains a worry."

Despite continued pursuit of structural reforms, Latin America has suffered a serious setback, with growth peaking at 5.4 percent in 1997. All the major economies have been affected. And despite poor growth, all the major economies in the region are running external deficits above the critical level of 4% of GDP. External indebtedness and dependence on foreign capital flows are again on the rise, and the region is vulnerable to a loss of investor confidence and/or a hike in US interest rates.

The much-hoped-for take-off has not happened in Africa, and the growth rate in 1998 was well below that in 1996, and has hardly kept pace with population growth. "And 1999, is unlikely to see any significant improvement". The continued burden of Africa's external debt and reliance on commodity exports are a heavy
constraint on faster growth in Africa.

As for the transition economies, the Russian crisis in the second half of 1998 hit them badly, and the region as a whole registered negative growth rates. With macroeconomic turmoil continuing in 1999, a further drop in output is expected across most of the region, current account deficits are rising everywhere, and the region remains vulnerable to external shocks.

The US has continued to post a four percent growth rate. But there are question marks about the ability of the US economy to bring about a smooth adjustment towards a more sustainable rate of growth, and of the European Union and Japan to achieve a stable recovery, according to TDR-99.

So far, rapid growth in the US at 4% has been a bulwark against global recession. But this year growth is expected to drop closer to 3 percent. With inflation fears on the rise, a tightening of monetary policy may trigger a large equity market correction. But since boom in equity prices have played a role in private spending, a fall could produce a harder landing than desired - jeopardising recovery elsewhere. The policy shift could also lead to higher trade deficits and mounting protectionist pressures. And if a hard landing is avoided by raising interest rates, it would create problems for financing needs and trade of developing countries.

The anticipated recovery in Japan is still just that, says UNCTAD, and negative growth is still the likely outcome for 1999. And given the widespread excess capacity and weak balance sheets in the private sector, growth in the longer term will depend on further structural reforms.

The EU too is unlikely to give much of a boost to the world economy, with 11 of its Euro-land members facing internal challenges from the adoption of a single currency. The EU recovery so far has been by an unhealthy reliance on exports. And the European Central Bank is confronted with the dilemma of pursuing a monetary policy for economies still exhibiting considerable variation in growth rates. While many of the
difficulties of the euro may be due to the cyclical asymmetry between the US and the EU, the euro's strength over the longer term depends on industrial restructuring in the EU, similar to that of the US in the 1990s.

And if recovery in the EU and Japan be delayed for any reason, the stimulus to the world economy has to come from developing countries. But faced with external financial difficulties and domestic restructuring, they have little room to use traditional fiscal policy measures for fear of losing confidence of capital markets, while monetary policy is constrained by the foreign exchange markets.

Given the limited capacity of developing countries to pursue counter-cyclical macro-economic policies, an alternative UNCTAD suggests would be direct injection of liquidity into these countries through official channels to raise demand, imports and growth.