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IMF US Trade deficit, October 1998
Asia's financial crisis has contributed to a dramatic widening in the current account imbalances of the world's largest economies, the International Monetary Fund argued in its World Economic Outlook. If investors were suddenly to question the sustainability of these imbalances, the consequences for financial markets and the world economy could be alarming.
The IMF predicts that the US current account deficit will exceed $290bn next year, 3,3 per cent of national income and almost double the figure recorded in 1997.
This highlights the degree to which the US has had to shoulder the trade adjustment prompted by Asia's economic meltdown. Over the same period the current account surplus of Europe's putative single currency area is predicted to shrink by less than $4bn to more than $l08bn, while Japan's surplus rises from $94bn to more than $l35bn.
The Fund argues that the shift in current account positions brought about by the problems in emerging markets has been inevitable and to some extent desirable. It has cushioned the contraction in the crisis economies and helped reduce the risk of overheating in the US and UK.
"However, these adjust ments will eventually need to be reversed through a process that is likely to involve shifts in relative cyclical positions, changes in the pattern of the global flow of funds, and exchange rate changes," it says.
What matters is the manner in which the reversal takes place. The benign scenario involves
- confidence in emerging markets gradually returning, boosting demand in the crisis economies and reducing the current account surpluses they have been forced to build up.
- A long-awaited recovery in Japan reduces its surplus, as does above-trend growth in Europe, while cyclical slow downs in the US and UK shrink their deficits.
- The dollar and sterling depreciate in orderly fashion against the euro, while stronger growth in Asia ends the weakness of commodity prices to the ben efits of developing country producers.
"However, the adjustment process might proceed less smoothly if the return of confidence in emerging markets were significantly delayed and if financial markets eventually were to question the sustainability of the large current account deficit of the US, which appears to be the main counterpart of the sharp shifts into surplus of the crisis countries," the Fund warns.
The current account balances of the five Asian crisis economies are forecast to show a $110bn swing from the red to the black between 1996 and 1998, with $l00bn reflecting lower imports and $l0bn higher exports.
Under this scenario imbalances get worse before they get better, "with a risk that subsequent market reactions would be more abrupt and with potentiall adverse effects on the exchange rates of the major currencies, inflation, interest rates and stock markets".
If this happens then global growth may end up significantly weaker, especially if adjustment is hindered by protectionism or competitive devaluation. This "wider crisis scenario" might also spread via the banking system, where exposure to the Russian crisis is less than $1bn each in the US and Japan, but as high as $7bn in the US and $30bn in Germany.
"It is therefore important to ensure that domestic policies in the three large currency areas during the period ahead are consistent with the need to gradually reduce external imbalances over the next several years while minimising the risk of excessive exchange rate volatility," the Fund said. Michael Mussa, the Fund's chief economist, warned that "target zones" for the dollar, yen and euro — mooted by the new German government — might obstruct adjustment and would also require a willingness that was not yet apparent on either side of the Atlantic to shift the policy focus away from domestic priorities.
Understandably, as it would not wish to precipitate a further worsening in the crisis simply by predicting it, the Fund's central forecast reflects the more benign adjustment scenario. World growth is predicted to accelerate from 2 per cent this year to 2.5 per cent in 1999, with world trade growth edging up from 3.cent to 4.6 per cent over the same period after the sharp slowdown seen over the past year. But Mr Mussa made it clear that the risks to the growth forecasts were predominantly on the downside.
The Fund expects growth in the US economy to slow from 3.5 per cent this year to 2 per cent in 1999, while growth in the European single currency area slows from 3 to 2.8 per cent. Meanwhile, the Japanese economy is expected to grow by 0.5 per cent next year, an outcome that several of the IMF's executive directors characterise as wishful thinking. World inflation is expected to remain stable at 1.7 per cent, while unemployment should drop a little below 7 per cent of the global workforce.