I. Global Assessment and Outlook
After a remarkable performance during the expansionary phase of the global business cycle, the major industrial countries led by the United States appear to experienced uneven declines from their cyclical peaks that reached in the first half of 2000. The disparities in the current economic weakening among industrial countries have increased uncertainty and, consequently, instability in the financial markets. In the United States, the business and policy environment supporting investments in information technology at a rapid pace reached its cyclical high in 2000. With a year lag, the rest of the world, in particular the industrial countries, underwent the US-led technology transformation with restructuring and adjustments at a slower than the United States pace resulting in divergent productivity gains and economic growth developments.
The extent and the timing of the current global slowdown have not yet been well identified because of the lag in the availability of overall economic data such as GDP. The current assessment of the situation by businesses and policy makers relies on monthly data. In the United States, several indicators such as the National Association of Purchasing Managers (NAPM) index, the Conference Board's leading indicator and consumer confidence are falling to cyclical lows and point to a substantial economic slowdown or even a recession. It is widely accepted that the manufacturing sector of the United States economy has been already in a recessionary phase of the cycle. Similarly, in the Euro Area overall economic growth weakened in the second half of 2000. Monthly industrial production indicators declined and leading confidence indicators for consumers and businesses have been falling pointing to a deterioration of the European economic conditions.
The current slowdown has its roots in structural, cyclical and policy elements of the business cycle. The uneven and desynchronized technology stimulus has generated the structural forces that partially have shaped the current path of the global economic slowdown. The cyclical factors of the lead/lag relationship of investment, profits, consumer expenditures and inventories have substantially contributed to the recent phase of the cycle. An investment-led growth has been the characteristic of the last United States economic boom. Another important factor that identifies each country's strength and position in the global cycle is economic policy, particularly monetary policy, and its relation to domestic and external imbalances.
There were two important factors under consideration in building the baseline forecast for the global economy:
Will investment growth stagnate? The recent economic boom has been driven by a remarkable growth in investment, especially in the technology area. Declines in investment, caused by a profits slowdown and/or unrealistic and unsustainable high investment levels in the recent past, will have serious consequences on the overall economic activity and may lead to recessions in several countries.
What will be the monetary policy? Central banks have the ability to quickly react to economic conditions. The effects of monetary policy appear on the economy with a lag of about one-year.
It is, therefore, apparent that an assessment of current economic conditions and an evaluation of the anticipated design of monetary policy will be of enormous importance for the short-term forecast of the global economy.
About 700 business executives from around the world have provided an input to answer these two questions. Looking at Table 4, the business experts from all geographic areas except in the United States and Canada have evaluated investment capital expenditures - to have increased in the first quarter of 2001 compared to the same quarter in 2000. When the business executives were asked to anticipate capital expenditures in the next two quarters, they projected declines from current levels, with the exception of the developing countries in Africa and the countries-in-transition Eastern Europe and the former states of the Soviet Union, the Confederation of Independent States (CIS).
The targets of monetary policy directly or indirectly through money supply control - are short-term interest rates. The effectiveness of monetary policy is evaluated by the lead relationship between interest rates and overall economic activity, measured by GDP or any other comprehensive monthly statistic. Evidence from many countries is supportive of a strong relation between real economic activity and short-term interest rates. Given the historical trends in the conduct of monetary policy in each country, the monetary policy outlook is anticipated by expectations of short-term interest rates by market participants, the monetary target. As can be seen in Table 4, in all geographic areas, with the exception of Africa, the business experts expect short-term rates to decline, which, consequently, imply that the global outlook for monetary policy is money easing.
Given the analysis of monetary policy and assuming no oil shocks over the forecast horizon, the baseline scenario calls for a short-lived global slowdown followed by a rebound at the end of this year. The United States that first went into a dramatic slowdown will lead the business rebound followed by Europe and the other emerging economies. In Japan, which was in a moderate growth path from the last recession, an export-driven economic weakening will temporarily bring a pause to its road to economic recovery.
An additional factor supporting the forecast scenario of a global temporary economic slowdown is the anticipation of fiscal policy from tax cuts that are expected during the summer of 2001 to go into effect in the United States and the European Area. The combination of monetary easing with expansionary fiscal policy will provide a stimulus for increases in both investment and consumption expenditures.
II. Short-term Indicators and Forecasts
The baseline forecast of the world economy is in line with the major findings of the current Economic Survey International conducted by the Ifo Institute. About 720 executives from 78 countries anticipate a continuation in the decline of the global economic climate, which reached the cycle peak in the second quarter of 2000. An analysis of the major findings of the quarterly survey is as follows:
* The overall indicator of global economic activity declined for a third consecutive quarter and is about 20% below its recent peak reached in the second quarter of 2000. Comparing the current reading of the global indicator with its historical behavior, it is apparent that the world economy at this point is not heading towards recession.
The decline in the global indicator, a composite of current conditions and expectations, was caused by less optimistic assessments of the current economic situation and to a lesser degree by pessimistic expectations.
In Europe, the current economic upturn is losing its momentum. According to European executives, both the current economic situation and two-quarter expectations have deteriorated. The expected economic slowdown is particularly pronounced in Portugal and Austria. The European economic weakening is driven by slowing business investment, while private consumption is expected on the average for all countries to hold at its current levels.
Private consumption is expected to increase over the two quarters in Germany and France because of the anticipated effects of tax cuts. The most optimistic assessment of the current economic situation came from business experts in Ireland and Finland.
In Asia, the executives polled have assessed a further decline in the current economic situation below the satisfactory level. The undergoing slowdown is expected to continue in the next two quarters. On a comparative country basis, the economic climate was favorable in Singapore, Hong Kong and China and less favorable in the Philippines and Taiwan. In Japan, expectations about further improvement, which were positive in the previous surveys, slipped this quarter into the negative performance area.
Both in Australia and New Zealand, the current economic situation is regarded as satisfactory. In the next two quarters the economic outlook is expected to weaken in Australia and improve in New Zealand.
In Latin America, the business executives evaluated both the current economic situation and the outlook over the next two quarters as better than the first quarter of 2000. Economic developments are very favorable in Mexico, Brazil and Chile. Although present economic conditions are not currently satisfactory in the other major countries, their recoveries from the 1999 recession are expected to continue over the next two quarters.
From the countries in transition, the economies of Eastern Europe have been assessed to perform favorably for both the current economic conditions and the outlook over the next two quarters. The overall economic climate has markedly improved in Hungary, Poland and the Czech Republic. The experts have again assessed the current economic situation in Russia as improving above the satisfactory level.
In Africa, the current economic situation in most countries remained at the unsatisfactory level of the previous quarter and expectations point to a weak recovery. The current economic situation in South Africa has improved and the assessment of experts has now reached the satisfactory level. Expectations over the next two quarters point to a further improvement in the economy.
Using the results of the Ifo survey, a global business activity index is constructed by Infometrica to evaluate and forecast the short-term global business cycle. The global business activity index, which uses 1995:Q3 as base of 100, decreased in the first quarter of 2001 to 113.2, a 19 point decline from the all-time high reading of 132.1 in the last quarter. It is apparent that the world economy has entered a downswing phase of its growth business cycle. Based on a dynamic analysis of the expectations of the Ifo Survey's business executives, the global business activity index is forecast to decline and reach 84.9 in the third quarter of 2001 (see attached graph). The industrial countries' component of the global index is expected to decline and the emerging economies' component is expected to increase. Given the market size of the two groups and their degree of change, the overall global index is expected to decline.
III. Regional and Country Outlook
In the September forecast last year, we predicted "a soft landing" scenario for the United States economy with declining growth rates in output. Last December, we pointed out that the "probability of a mini recession has, however, increased to 55%."
Despite declines in consumer confidence and business executives' expectations, a full blast recession is not in the picture. Consumer Climate, our long-term leading indicator, has been increasing in the last two months pointing to an economic rebound as the year winds down. The probability of a mini recession has, however, increased to 75%. When the final GDP readings for the first quarter are released, late in the summer, they will show a negative growth rate for GDP. The administration's tax-cut proposal is expected to pass as a timely fiscal policy action and the Federal Reserve is expected to follow a monetary easing policy during 2001. Short-term rates will decline and the yield curve will take its upward shape in the first half of the year. The current annual forecast for the United States, derived within the global economic and financial environment, shows the economy to grow by 1.6% in 2001 and 2.3% in 2002, while inflation will stabilize at the 3 % rate during the forecast horizon.
In Japan, economic growth will not accelerate this year. There are three factors behind this year's slowdown in Japan's path to recovery: First, Prime Minister Mori's administration is involved in political scandals generating uncertainty until the new elections in the summer of 2001. Second, the current decline in the Nikkei stock market will affect companies' balance sheets that evaluate shareholdings at market prices. Third, the current global economic weakening is expected to slowdown the export-driven Japanese business activity. In 2002, the economy will move forward again into its recovery phase led by business investment and exports. Following a 6.1 % decline in 1999 and an estimated increase of 6.6% in 2000, business investment is anticipated to advance by an average growth rate of 6.5 % during 2001-02. After an estimated advance at an exceptionally high rate of 11.1% in 2000, export growth is forecast to slow down to 2.5% in 2001 and to accelerate to 5% in 2002. From a surplus in 1992, Japan's government deficit as percent of GDP was 5.3% in 1998, 9.5% in 1999 and peaked in 2000 to 10.4%. The deficit-to-GDP ratio is forecast to decline over the forecast horizon reaching 7.5 % in 2002. The unemployment rate also has peaked in 2000 at 4.7%. It is expected, the unemployment rate to slightly decline to 4.6% in 2001 and reach 4.2% by the end of 2002.
In the Euro Area economic growth slowed in the last two quarters of 2000 because of higher energy prices, increasing interest rates and financial market volatility.
The economic slowing is forecast to continue in the first half of 2001 because of a decline in export growth resulting from a weakening in foreign demand, especially from the United States. The European economy will experience a below longterm average growth in output in the first two quarters of 2001, followed by a rebound over the second half of the year. There are three factors that are expected to drive the European economy out of this temporary slowdown: First, investment in new capital will remain strong as a part of the technology modernization process that started three years ago. Second, monetary policy is expected to be easing up and the ECB will follow the Federal Reserve in cutting interest rates. Third, fiscal policy will be expansionary in a timely way, as the tax cuts will go into effect during the summer. Although the overall government budget may turn to an estimated surplus, for the first time in decades, budget deficits are expected over the next two years because of the initial revenue-reducing effects of the tax cuts and the current increasing growth in spending from a slowing economy. The unemployment rate is expected to continue its decline from 10.0% in 1999 and 9.1% in 2000 to 8.7% in 2001 and 8.3% in 2002. Even though inflation remains above the ECB's 2% target, the slowing economy has resulted in decreased growth in demand and softening in wage increase demands by unions. Combining these demand and supply effects with stable oil prices, the European inflation is forecast to slightly decline and stay around the ECB's target of 2% over the next two years.
In the Asia / Pacific region, output growth in 2001 will follow a process of moderation driven by external factors. A weakening of the high tech cycle and the slowdown in the United States and Europe will ease external demand. Next year, the industrial countries' expected economic rebound would positively contribute to the export-led growth of the region. Economic growth in the emerging countries of the region is forecast to ease to 4.2% in 2001 from 7% in 2000, and then to rise to 5.8% in 2001.
Economic recovery in Latin America has spread across the region. It is estimated that the output for the region has grown by 4.2% in 2000, compared to 0.1 % in 1999.
The weakening of economic activity in the United States and Europe will have some negative effects on foreign demand. The exception of this growth pattern is Mexico because of its NAFTA relation with the United States. Unlike the other Latin America countries, which experienced negative or moderate output growth in 1999, Mexico's economic growth was a robust 3.7%. The Mexican economy, like the United States, peaked in 2000 at an estimated output growth rate of 7.0% and is forecast to ease to 3.8% in 2001, followed by a rebound in 2002 at a growth rate of 5%.
After hitting a business cycle trough in 1998 and early 1999 from the Russian financial crisis, the countries-in-transition have entered the recovery phase of their business cycle with an estimated output growth of 5.2% in 2000. Since the onset of the transition process, all the countries in the group are estimated to record positive growth rates in output and the forecast calls for an average output growth rate of 3.8% in 2001 and 4.7% in 2002. Another important characteristic of the transformation process in the counties-in-- transition is the policy mix for a reduction in the high inflation rates that were a part of the learning process. The overall inflation rate for the group has been declining, particularly in Russia and Romania, where inflation rates in 1999 were 85.7% and 45.8% respectively.
IV. Financial Markets
Among the three major financial centers, the United States is leading the current economic slowdown followed by Europe, where the economic slowing is not as severe as in the United States. In Japan, the business cycle laggard, the recovery phase will be temporarily placed on hold because of a slowdown in foreign demand caused by the cycle leaders. The three major economic groups will finally synchronize their business growth cycle early in 2002. This synchronization in growth outlook among the three areas has set the scene of economic fundamentals for the financial markets. It is expected that interest rates will continue to fall in the United States, followed by declines in Europe and moderate increases in Japan.
Therefore, the inverted United States' yield curve is forecast to become positive in the spring, the European yield curve from almost flat will experience an increase in its positive slope, and the Japanese yield curve will maintain its current upward shape. The implication for the foreign exchange markets of such an interest rate and growth scenario is that the euro and the yen, to lesser extent, will appreciate against the dollar.
In the current Economic Survey International, business executives expressed the following views about inflationary expectations and developments in the financial markets:
On a worldwide basis, inflation is expected to decline from 3.6% in 2000 to 3.3% in 2001. Outlook remains benign. Business executives polled expect 2001 inflation in the industrial countries to stay at the 2000 levels and 2001 inflation will improve in emerging economies and in the countries in transition.
Short-term interest rates are expected to decline in all areas except in Africa. Long-term rates are also expected to decline. The downward trend in interest rates is pronounced in the United States and the United Kingdom.
The euro remains undervalued. Despite the current correction, the Euro is still seen as clearly undervalued against all currencies. Both the United States dollar and the British pound and the Japanese yen appear to be overvalued in the majority of countries.
A correction in the overvalued United States dollar is expected over the next two quarters, particularly against European currencies, and the Canadian and Australian dollars. In Asia, the United States dollar is expected to keep its value in relation to national currencies. In Latin America and in Africa, the United States dollar is expected to appreciate over the next two quarters. In the countries-in-- transition in Eastern Europe and the CIS countries, the dollar is expected to gain value over the next two quarters.
Evangelos Otto Simos, Ph.D.
Editor - International Economic Affairs.
Dr. Simos is Director of forecasting at eforecasting.com, a division of Infometrica' s Data Center, 65 Newmarket Road, Durham, NH 03824, U.S.A. Web Site:www.infometrica.com, email:email@example.com. This report does not purport to be a complete description of global
economic conditions and financial markets. Neither the Journal nor Infometrica, Inc. guarantee the accuracy of the projections, nor do they warrant in any way that the use of information or data appearing herein will enhance operational or investment performance of individuals or companies who use it.
The views presented here are those of the author, and in no way represent the views, analyses or models of Infometrica, Inc. and any organization that the author may be associated with.…