Global economy will continue the moderated upward trajectory of 2005 in the new year
In 2005, world economic growth decelerated modestly in contrast to the robust performance of the previous year, due to repeated spikes in oil prices and a battery of interest rate hikes by the U.S. Federal Reserve.
The growth momentum, however, remained substantial thanks to the increased stability and sustainability of economic growth. A report entitled World Economic Outlook, issued by International Monetary Fund (IMF) in September 2005, projected a 4.3- percent growth for the world economy in 2005. Although this figure is lower than the historical high of 5.1 percent in 2004, it is still encouraging when compared to the 4-percent growth in 2003 and the 3.6-percent average annual growth between 1995 and 2002.
Regarding the world’s three largest economies, the GDP growth of the United States has eased moderately under the adverse impact of high oil prices and steady rises of interest rates. However, an admirable projected growth rate of 3.5 percent has been underpinned by the steady climb of personal consumption and corporate investment in fixed assets, turnaround of the employment situation and mild inflation.
Japanese economic recovery has been gathering momentum, driven by personal consumption and an increase in companies’ investment in equipment. With the employment situation continuing to improve, and inflation and non-performing loans further contained, Japan is projected to register a 2-percent growth in 2005.
In contrast, the picture in the euro area is less optimistic amid sluggish domestic demand and insufficient contribution from net exports and high unemployment rates. The GDP growth for the euro area is expected to fall to 1.2 percent.
Among emerging industrialized regions, Asia continues to lead the world in terms of growth rate despite a slowdown. China and India have sustained the robust growth momentum, which plays a bigger role in driving up world economic growth.
In general, expansion remained largely on track in 2005 although the upswing has been flattened compared to the previous year. Positive indicators include benign financial market conditions with long-term interest rates at a low level, contained inflationary pressure across the world and ease of monetary policies.
Looking ahead, most countries and regions will maintain the strong growth momentum throughout 2006. Against this background, the IMF projects that the growth rate of the global economy will average 4.3 percent.
While the global economy expands at a rapid rate, the rising level of global imbalances poses a serious challenge to underlying vulnerabilities and long-term growth.
First, the largest economies of the United States, the euro area and Japan have developed at uneven rates, with excessive reliance on the United States as the main growth engine.
Second, the global current account imbalances continue to enlarge, with U.S. current account deficits further widening. This scenario could jeopardize stability of capital flows and trigger a new wave of protectionism, which is harmful to the steady development of world economy and trade.
Third, high and volatile oil prices remain a significant global risk to adversely affect the steady growth of the world economy and exacerbate the economic imbalances between oil importers and exporters.
Slowing of world trade
Alongside the moderate slowdown of world economic expansion in 2005 is the substantially slowed growth in world trade, from a 10.3-percent increase in 2004 to a projected 7.0-percent rise for 2005.
The key factor behind the decelerated momentum is moderated economic growth in industrialized countries, which leads to a decrease in import demand. Other factors that have a negative bearing on the pickup of world trade include price hikes in the international energy market, declining demand for IT products in a boom-bust cycle, slow progress in global multilateral trade negotiations and rising trade protectionism.
Looking ahead to 2006, the import demand in industrialized countries is expected to rebound thanks to positive expectations for world economic growth and the regaining momentum for increase in the euro area and Japan. The IMF projects that global trade in goods and services will develop by 7.4 percent in 2006, edging slightly upward from the level of 2005.
In the meantime, global current account imbalances, a key risk to the steady growth of world trade and stability of the international financial market, are expected to increase yet again. IMF predicts that the current account deficits of industrialized countries will widen from $451.1 billion in 2005 to $499 billion, while the current account surpluses of emerging markets and developing countries in aggregate will reach $493.6 billion in 2006.
Foreign direct investment climbs
After falling three years in a row, global foreign direct investment (FDI) finally saw an upturn in 2004.
The latest trend in FDI is the growing magnet for developing countries, especially emerging markets in Asia, Central and East Europe and Latin America, due to their rapid economic growth, stable monetary and financial situations, benign investment environments and edges in production costs and proximity to markets.
In contrast, capital is more inclined to flow out of rather than flow into industrialized countries amid a lack of economic vigor, volatile stock markets, line-up of corporate financial scandals and sweeping industrial restructuring.
With regards to the structure of FDI from industrialized countries, due to worldwide overproductivity in the manufacturing sector, there is a gradual shift from pooling into traditional manufacturing industries to hi-tech and service sectors, such as IT, bio-tech and new material industries, and financial, insurance, telecom and consultancy sectors.
The service sector in developing countries has shown positive growth momentum as those countries foster their openness to the outside world and accelerate integration into the world economy. The ongoing international industrial reconfiguration will strengthen economic interdependence among countries and benefit world economic growth in the long run by allowing for the free flow of the means of production, such as capital, labor and technology.
Benign international financial market
During 2005, international financial market conditions remained largely benign, which helped to sustain world economic growth.
While the Federal Reserve raised the U.S. short-term interest rate 12 times in a row, the euro area and Japan have maintained their short-term policy interest rates at a relatively low level.
Other emerging markets and developing countries have moderated their short-term interest rates, however, their long-term interest rates, while volatile, remain well below historical averages. All the above indicators show that inflationary expectations remain reasonably well anchored.
Global equity markets have remained resilient, supported by strong corporate profits and increasingly solid balance sheets. In addition, exchange rates between dominant currencies have been basically stable.
Looking ahead, the stability of the international financial market is projected to continue, but there are factors of uncertainty at play.
First, the continuing buildup of U.S. current account deficits has exerted mounting pressure for the depreciation of U.S. dollars. Second, rising oil prices may eventually drive up inflationary expectations. Add to that the rise of U.S. short-term interest rates, and it would put emerging market countries under exacerbating appreciation pressure.
Last but not least, unpredictable disasters such as terrorist attacks, regional conflicts and catastrophic natural disasters also might hinder the stability of the international financial market.
All these factors brew the risk of financial market volatility.
Spike in oil prices
International oil prices have experienced substantial jumps since the beginning of 2005.
Oil futures hit a benchmark of $70 per barrel in late August due to the damage of Hurricane Katrina to oil infrastructure in America’s major oil production base in the Gulf of Mexico. According to World Bank projections, crude oil prices at West Texas, Brent and Dubai averaged $53.6 per barrel in 2005, up 42.1 percent year on year.
Oil price increases last year exerted only a mild bearing on the world economy and a limited impact on inflation. However, soaring oil prices struck the world economy in the following aspects. First, world economic growth slowed and some countries will be plagued with mounting inflationary pressure in response to oil price hikes.
Second, growth in developing countries, especially in emerging Asia with its heavy reliance on oil imports, will be greatly undercut by hikes in oil prices. Not only will soaring oil prices make inroads in trade conditions and national revenue, but they will also boost prices of different energies and raw materials, which might fuel cost-driven inflation. Third, high oil prices will exacerbate imbalances in the global economy. Fourth, enormous financial risks are shrouded in high oil prices. Once oil prices collapse, financial institutions dealing in futures trade of oil will be exposed to great financial risks. And a volatile futures market would land a sweeping strike on the stability of the world economy.
Picture in China
China’s economic growth has remained robust and smooth, with GDP growth rate forecast at 9 percent. The increase of consumer goods prices has moderated, and export continues its rapid growth. Foreign investment has maintained an upward inflow. Uncertainties in economic growth have been well anchored. China’s lasting economic expansion alongside its booming imports has increasingly become the main growth engine for the neighboring region and world economy at large.
Looking ahead to 2006, external conditions will help to maintain China’s solid economic growth.
First of all, the robust growth momentum in the global economy and international trade and the prospect of a benign international financial market create a favorable external environment for China’s growth. In particular, of China’s major trade partners, the United States has continued its robust growth momentum, the euro area and Japan are expected to rebound strongly, while other Asian countries will continue a sharp economic upturn. This will help to keep China’s export growth on the fast track.
Second, as global industrial restructuring continues its momentum, industrialized countries continue to export hi-tech industries and service industries, and transnational direct investment regains its growth momentum. Emerging market countries, holding market and cost advantages, are the major beneficiaries. Such a background will prompt China to update its manufacturing industry, develop the service sector and climb up the value-added industrial ladder by capitalizing on competitive advantages in low labor costs, huge market size and sound infrastructure.
There are still factors posing risks to the long-term outlook. With the expansion of China’s foreign trade scale and trade surpluses, the country has been under mounting protectionist pressures from major surplus sources, such as the United States and European Union countries. These governments are more likely to wield measures such as anti-dumping and technical barriers to contain China’s exports.
Meanwhile, they will exert stronger pressure against China on issues of currency regime reform, intellectual property rights protection, market accession and special safeguards. As countermeasures, China must deepen the reform of its trade system related to foreign trade, regulate export trade, strive to diversify export destinations and accelerate the construction of free trade areas.
The repeated ascents of oil prices in the international market have not only increased China’s production costs, but also enlarged potential inflationary expectations. Therefore, China should be committed to guaranteeing sufficient supply while stabilizing the price of refined oil products in case high oil prices undercut its economic growth.
Meanwhile, substantial attention must be paid to difficulties for oil refinery companies inflicted by the price inversion between crude oil and refined product. On the one hand, China has to take active measures to push forward pricing mechanism reform of refined oil products. On the other hand, from a long-term perspective, China should speed up the transformation of its economic growth model in concert with requirements of the concept of scientific development while enhancing energy efficiency.
By building an energy-thrifty society, China should gradually put its economic development in line with the requirements of the era of high oil prices.