UNECE launches its Economic Survey of Europe 2005 No. 2
July 21 2005
Press Release – UNECE Economic Analysis Division
Geneva – This issue of the Survey provides an assessment of the
macroeconomic situation and the short-term outlook in the summer
2005. It updates the assessment made in the Economic Survey of Europe
2005 No. 1, which was finalized in late January this year. In addition,
this Survey contains a study on the issue how to sustain growth in a
resource-based economy using the specific case of Russia, which was
prepared for the UNECE Spring Seminar held in February.
A balancing act – global recovery continues …
In mid-2005, the consensus of forecasters is for continued robust
global economic expansion in 2005, albeit at a somewhat lower rate
than in 2004. World output is expected to increase by 4 per cent. The
continued expansion will be supported by favourable financing
conditions, with long-term interest rates expected to rise only
slightly. The difference between growth in the United States and
in the other major industrialized economies, however, will widen in
2005. Modest growth prospects in western Europe continue to contrast
with the persistent economic dynamism of eastern Europe and the CIS.
In the United States, real GDP is forecast to increase on average by
3.5 per cent in 2005, about a percentage point less than in 2004.
With the United States continuing to act as a “locomotive” for
the world economy (given weak domestic demand in the other major
advanced economies), the large current account deficit is set to
deteriorate further. The expansion remains very dependent on household
consumption spending, which will be supported by rising real incomes,
a stronger demand for labour, and increased net wealth resulting from
the surge in house prices. The Federal Reserve is expected to continue
its gradual tightening of monetary policy towards a neutral stance,
which will tend to dampen economic growth. The expansion is currently
expected to continue at a rate close to trend in 2006 as well.
… but important global downside risks have not diminished.
The pattern of downside risks to this overall favourable global
outlook has, however, changed for the worse during the first half of
2005 in comparison with the assessment made at the beginning of the
year. These risks centre around the developments in the oil markets;
the further widening of global external imbalances; a sudden and
sharp reversal of the rise in house prices in many countries, where
they have reached levels regarded as out of line with “fundamentals”;
and a stronger than anticipated rise in long-term interest rates from
their current unusually low levels.
Although the adverse economic impact of higher oil prices has so
far been relatively small, the large cumulative increase over the
past two years must inevitably bring them closer to a point at which
the economic pain for households and end-users in industry will be
increasingly felt. In any case, further rises in oil prices will
increase the risk of dampening and even choking off economic growth
in the oil importing countries.
A persistent challenge remains the orderly reversal of the
unprecedented global imbalances, with rising current account deficits
in the United States mirrored in rising surpluses in the rest of the
world, notably Asia. There is still a risk that a change in financial
market sentiment could suddenly trigger a sharp and sustained decline
of the dollar, with concomitant upward pressures on inflation and
interest rates in the United States and adverse spillover effects on
other asset markets and regions in the global economy.
The strength of the dollar from the second quarter of 2005 means
that exchange rates are moving in the opposite direction required
for dealing with the global imbalances, which means that the risk of
a sharp adjustment at a later stage could be increasing.
Euro area: The lean years
In the euro area, growth forecasts have again been lowered. Real GDP
is now expected to increase by only 1.3 per cent in 2005. (In January
of this year the consensus was for a growth rate of 1.7 per cent.)
The continued rise of oil prices in 2005 has curbed the purchasing
power of private households, at a time when consumer confidence was
already low due to uncertainties about employment and the impact of
intensified international competition. Exports have been held back
by the lagged effects of the strong euro and the slower growth of
global demand.
The recent weakening of the euro has only partially offset the large
appreciation against the dollar since early 2002 and, if not reversed,
will have a positive effect on economic activity.
The persistent sluggishness of aggregate domestic demand, which now
has spread to all three major economies, remains the key problem
of the euro area. On current forecasts, economic activity might gain
slightly more momentum in 2006, but this will depend on the development
of the global economy and on the price of oil.
Growth rates are set to continue to diverge significantly among the
twelve economies in 2005, with the average for the euro area being
pulled down by the weakness of the three major economies. Real GDP is
forecast to (at best) stagnate in Italy and to increase only moderately
in Germany (0.9 per cent) and France (1.6 per cent). Among the smaller
economies, sluggish activity in the Netherlands and Portugal contrasts
with continued solid growth in most of the other countries.
Finding the appropriate policy mix
The persistent sluggishness of economic activity in the euro area, in
combination with a widening output gap and persistently high rates of
unemployment point to the need for a cut in the ECB’s main official
interest rate, which has been at 2 per cent since June 2003. On
current forecasts, moreover, inflation will fall below the ECB’s 2
per cent ceiling in 2005 and 2006. But the euro area may now well be
on the edge of a Keynesian liquidity trap.
While lower interest rates may be desirable they are unlikely to
provide much of a boost to economic growth given that such a move would
hardly lead to a further significant lowering of long-term interest
rates, which are already at exceptionally low levels. Nevertheless,
even if the additional monetary stimulus were small, it would send a
signal to economic agents that the ECB is also concerned about raising
growth and employment, as in fact it should be, as mandated by the
Treaty of Amsterdam. There has been progress in structural reforms
in recent years and much more will undoubtedly have to be done – but
it is in the very nature of these reforms that their growth effects
will generally appear only with a relatively long lag. Finding an
appropriate macroeconomic policy mix, with a supportive role to be
played by fiscal policy, is now the major challenge.
The economies of new EU member states preserve their dynamism
The short-term outlook for the new EU member states from central
Europe and the Baltic region remains generally favourable. Both in
2005 and 2006 the average rate of growth of these subregions, as
well as the GDP growth rates in most countries are likely to remain
significantly higher that those of the old EU member states.
Restructuring and economic modernization (on the supply side)
together with strong investor and consumer confidence (on the demand
side) will remain the principal engines of growth in the short run.
Macroeconomic policy in the new EU member states is set to remain
moderately supportive of economic growth, and will benefit from the
recent changes in the rules of the EU’s Stability and Growth Pact,
which provide for increased policy flexibility. On the downside,
the forecasts of GDP growth are subject to the risk of weakening
external demand, especially in western Europe that absorbs the bulk
of regional exports.
The re-appearance of high rates of inflation is unlikely in any
of the EU-10 countries, but their rates are still generally higher
than in the old EU member states. Large fiscal deficits are another
problem, especially in the central European economies. Regardless of
the desired timing of their accession to the EMU, these issues will
remain the focus of macroeconomic policy in the EU-10 in the short-
to medium term.
South-east Europe: the large current account deficits are in the
focus of macroeconomic policy
With domestic demand outpacing aggregate output throughout south-east
Europe, the external imbalances of many countries are escalating.
These large current account deficits are risky for immature market
economies that are susceptible to external shocks. Policy makers in
south-east Europe have undertaken various measures to curb the growth
of domestic demand in an effort to halt the further expansion of these
deficits. However, the ongoing general tightening of macroeconomic
policies may have adverse effects on the growth of domestic output
in the short run.
Nevertheless, in most parts of south-east Europe, economic growth is
expected to remain relatively strong, but at a slightly lower rate
than in 2004. The fact that the region’s aggregate GDP growth rate in
2005 will be more than 2½ percentage points lower than in 2004 mainly
reflects the slowdown from exceptionally high rates in the two largest
economies, Turkey and Romania. GDP in most of south-east Europe is
expected to grow at rates between 4 and 6 per cent through 2006.
Despite some slowdown, strong economic performance will prevail in
the CIS
Economic growth in the CIS region is generally set to remain
relatively strong through 2005 but its pace is slowing down in some
economies. Commodity exporters (especially those specialized in
hydrocarbons) continue to benefit from high world market prices and
robust demand in some of their main markets. Current trends suggest
a continuing rise in real disposable incomes, which are underpinning
buoyant domestic demand. Macroeconomic policies are generally set to
remain expansionary, providing further support to the growth of the
output and real incomes. This, however, is also a source of downside
risk, as the loosening of macroeconomic policy (which in some cases
has been under way for several years) is not sustainable and has
already led to rising inflationary pressures in a number of countries.
The outlook for the Russian economy hinges on the balance of divergent
trends in some key industries. Thus, while rapid growth continues
in some sectors of the economy, particularly in market services
(underpinned by strong consumer spending), other industries, such
as manufacturing, have slowed down considerably (partly as a result
of the losses in competitiveness due to the persistent appreciation
of the rouble’s real exchange rate). As to domestic demand, Russian
consumers continue to be the mainstay of the economic expansion,
whereas investment activity has weakened markedly. Macroeconomic
policy in Russia remains beset with consistency problems: the monetary
authorities in fact face a trilemma, as they are not only struggling
to balance the mutually exclusive goals of targeting both the exchange
rate and the inflation rate under the pressure of sizeable inflows
of foreign exchange, but at the same time they are having to cope
with the inflationary consequences of a continuing fiscal loosening.
The marked slowdown in Ukraine’s economy in the early months of 2005
will affect the average performance for the year as a whole. As
the demand for Ukraine’s exports is likely to deteriorate further
(especially for steel), this implies that net exports will have a
diminishing influence on output growth. This shift in the sources
of economic growth is expected to lead to a further deceleration
in the rate of output growth for the year as a whole. As a result
of the drastic deterioration in the government’s financial balance,
which was associated with the 2004 presidential election campaign and
has led to a resurgence of inflation, Ukraine now faces the need for
a major effort at fiscal consolidation.
In contrast, economic growth is likely to maintain its momentum
in the two other large CIS economies, Kazakhstan and Belarus. In
Kazakhstan, strong domestic demand should continue to provide the
main impetus for economic activity and GDP is forecast to grow by
some 8 per cent in 2005. One of the downside risks arises from the
pre-election fiscal loosening (reflected in a sizeable increase in
social spending), which may lead to higher inflation and prompt a
tightening of monetary policy. Rapid economic growth is also expected
to continue in Belarus, with GDP forecast to grow by close to 10 per
cent in 2005. Accommodative monetary policies and strong import demand
in its main export market, Russia, should continue to support activity,
at least in the short run.
In the Caucasian Rim, economic growth should remain strong in Armenia
and, especially, in Azerbaijan, where the new Baku-Ceyhan-Tbilisi
pipeline should start operating at full capacity before the end of
2005. A rapid economic recovery is expected to continue in Tajikistan,
but some moderation of output growth is expected in the other central
Asian CIS economies. The downside risks to the economic outlook in
Kyrgyzstan have increased considerably since the beginning of 2005 due
to the political turmoil in the country and newly emerging problems
with gold production.
A gradual economic slowdown is likely to continue in 2006 in the
CIS as a whole, as well as in some of the largest economies. While
total output in the region will continue to grow at relatively high
rates, sustaining these in the medium and longer run will require an
acceleration in the process of systemic and structural reform.
–Boundary_(ID_D1oUQn9MI4gqSvl/xhVAqg)–