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Critical Challenges for the Global Economy ICRIER New Delhi, India April 20, 2007. India: Difference Over A Decade (Index, 1996 = 100). U$12.4 billion. U$197.3 billion. U$4,159 billion. 48.8 % GDP. U$797. U$41.2 billion. U$1,822 billion. 25.7 % GDP. U$2.5 billion. U$406.

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Critical Challenges for the Global Economy ICRIER New Delhi, India April 20, 2007

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Critical Challenges

for the Global Economy

ICRIER

New Delhi, India

April 20, 2007


India: Difference Over A Decade

(Index, 1996 = 100)

U$12.4 billion

U$197.3 billion

U$4,159 billion

48.8 % GDP

U$797

U$41.2 billion

U$1,822 billion

25.7 % GDP

U$2.5 billion

U$406


Critical Challenges for the Global Economy

  • Coming in for a soft landing?

  • Bumps in the runway:

  • The U.S. housing market

  • Inflation concerns and the oil market

  • Financial risks facing emerging markets

  • Longer-term Challenges:

  • Unwinding global imbalances

  • Sustaining global productivity growth


Baseline GDP Growth Forecast Remains for Continued Strong Growth

(Percent per annum)

2006

2007


The Housing Correction Has Cooled the U.S. Economy

(Percent change from four quarters earlier)

Exports

Residential investment

Investment

Consumption

Non-residential construction

Output

Business investment

2003

04

05

06

2003

04

05

06


...And the Slowdown Has Had Limited Impact on the Rest of the World(Percent change from four quarters earlier)

Rest of the World

United States


Spillovers to the Rest of the World from U.S. Slowdowns Have Been Limited(Change in GDP growth; median for region)


Impact of Growth Declines in the U.S. and Japan (Shading denotes one standard error confidence interval)

Impact of U.S. Growth Declines on Growth in Latin America

Impact of U.S. Growth Declines on Growth in Emerging Asia

Impact of U.S. Growth Declines on Growth in Other Advanced Economies

Impact of Japan’s Growth Declines on Growth in Emerging Asia


Investment and Exports are Strong in the Euro Area, But Consumption Lags

(Percent change from four quarters earlier)

Exports

Investment

Output

Consumption

2003

04

05

06


Japan Remains on Track Despite Mid-06 Dip

(Percent change from four quarters earlier)

Investment

Output

Exports

(left scale)

Consumption

2003

04

05

06


Emerging Market and Developing Country Growth Has Been Strong(Percent; seven-year moving average)

Asia

Middle East

Sub-Saharan Africa

Latin America

Emerging Europe


Growth in China Continues to Boom(Y/Y percent change)

Real GDP Growth

(left scale)

Fixed Asset Investment

(6-month m.a.; right scale)


Growth in India Also Remains Rapid(Y/Y percent change)

Real GDP Growth

Industrial Production Growth


Markets Go Up, Markets Go Down

(Asset class returns; percent change)


But Overall Financial Conditions Remain Supportive of Global Growth

Implied Volatilities (percent; 10-day mma)

Industrial

country

equities

Emerging Market Currencies

Major currencies


Credit Markets Are Pricing in a Soft Landing

Policy Rates

(percent)

Long-Term Rates

(deviations from long-term average)

United

States

Futures rates

as of 4/10/07

United

States

Japan

Euro area

Euro area

Japan


Despite Recent Bad News, Our Forecast For Global Growth Is Now More Evenly Balanced

(Percent)


Upside risk to global growth

Downside risk to global growth

Most Global Risk Factors Have Improved Since September

(Percentage points of global GDP growth over next 12 months)


Critical Challenges for the Global Economy

  • Coming in for a soft landing?

  • Bumps in the runway:

  • The U.S. housing market

  • Inflation concerns and the oil market

  • Financial risks facing emerging markets

  • Longer-term Challenges:

  • Unwinding global imbalances

  • Sustaining global productivity growth


U.S. House Price Increases Have Cooled Fast (Y/Y percent change; relative to CPI)

Existing homes (OFHEO)

Existing homes (NAR)

New homes


Recent Data Paints an Uncertain Outlook for the U.S. Housing Sector

Sales

(units; millions)

Starts and Permits

(units; millions)

Mortgage Applications for Purchase

(index; four week moving average)

Inventories

(months of supply)


...But Problems in the U.S. Sub-Prime Mortgage Market Seem Contained

Spreads

(basis points)

Housing Market Delinquencies

(percent of total residential loans outstanding)


And Household Finances Remain in Good Shape

Household Net Assets

(ratio to disposable income)

Household Liabilities

(percent of disposable income)

06:

Q4

06:

Q4


Housing Is The Tail Not The Dog

(Percent increase on previous year for foreclosures; percent for unemployment rate; 2006Q4)


Critical Challenges for the Global Economy

  • Coming in for a soft landing?

  • Bumps in the runway:

  • The U.S. housing market

  • Inflation concerns and the oil market

  • Financial risks facing emerging markets

  • Longer-term Challenges:

  • Unwinding global imbalances

  • Sustaining global productivity growth


Inflation Risks Are Down as Headline Inflation Has Moderated

(Y/Y percent changes)

Headline inflation

Core inflation

U.S.

(PCE)

U.S.

(PCE)

Euro area (HICP)

Euro area (HICP)

Japan (CPI)

Japan (CPI)

Feb. 07

Feb. 07


The Elephant in the Room:

Rising Levels of Capacity Utilization, Everywhere

Output Gap

(percent of potential GDP)

Non-Fuel Import Prices

(December 2005 = 100)

Advanced

economies

United States

Euro area

World

Japan

Emerging

markets


U.S. Labor Costs Have Accelerated as Productivity Has Slowed

(Non-farm business sector; percent change from four quarters earlier)

Compensation

Productivity

Unit labor costs

1996

98

2000

02

04

06


Unemployment Rates Are Declining Across the Major Advanced Economies

(Percent)

Euro area

United States

Japan

06

1998

2000

04

02


Growth of World Oil Demand and Non-OPEC Supply Are in Better Balance

(2002–06)


But Global Spare Oil Production Capacity Remains Limited

(Millions of barrels a day)


Expected Oil Prices Show Continued Potential for a Spike(From futures options; as of April 2nd 2007; U.S. dollars per barrel)


Critical Challenges for the Global Economy

  • Coming in for a soft landing?

  • Bumps in the runway:

  • The U.S. housing market

  • Inflation concerns and the oil market

  • Financial risks facing emerging markets

  • Longer-term Challenges:

  • Unwinding global imbalances

  • Sustaining global productivity growth


Capital Flows to Emerging Markets Have Been Strong and Spreads Have Continued to Compress

Emerging Market Financing

(billions of U.S. dollars)

EMBI Global Composite

(basis points)

2002

03

04

05

06


Emerging Market Corrections Are Getting Smaller

(Percent)


But Is It Too Good To Be True?

(Billions of U.S. dollars)

Emerging Europe and CIS

Capital Flows –

All Regions

FDI

Flows to the private sector excl. FDI

Flows to the private sector excl. FDI

FDI

Flows to the public sector

Flows to the public sector


If Liquidity Conditions Tighten, Will Capital Flows to Emerging Markets Slow?(Billions of U.S. dollars)

Industrial Country Liquidity Index1

(advanced one year; right scale)

Financial Flows to Emerging Markets

(left scale)

1Computed as the change in base money (measured in U.S. dollars).


Large Current Account Deficits May Be A Source Of Vulnerability

(Emerging market country current accounts in 2006; percent of GDP)


Inward Capital Flows to India and China Are Also Surging

(Billions of U.S. dollars)

Emerging Asia excluding

China and India

Emerging Asia

India

China


Critical Challenges for the Global Economy

  • Coming in for a soft landing?

  • Bumps in the runway:

  • The U.S. housing market

  • Inflation concerns and the oil market

  • Financial risks facing emerging markets

  • Longer-term Challenges:

  • Unwinding global imbalances

  • Sustaining global productivity growth


Global Imbalances Have Widened

(Percent of GDP)

United States

Saudi Arabia

Oil trade

Net income

Oil trade

Net income

Current account

Non-oil trade

Non-oil trade

Current account

Euro Area

China

Non-oil trade

Non-oil trade

Current account

Current account

Net income

Oil trade

Oil trade

Net income


U.S. Dollar Has Depreciated, But No Real Appreciation in Key Surplus Countries

U.S. dollar(2000=100)

Euro

Yen

Renminbi


Global Imbalances Are Likely to Remain Large

(Percent of GDP)

United States

Saudi Arabia

Net income

Oil trade

Oil trade

Net income

Current account

Non-oil trade

Non-oil trade

Current account

Euro Area

China

Current account

Non-oil trade

Current account

Non-oil trade

Net income

Oil trade

Net income

Oil trade


Net Foreign Assets

(Percent of world GDP)

Emerging Asia

Japan

Oil Exporters

euro area

United States


Meeting U.S. Financing Needs

(Four-quarter moving average; percent of GDP)

Foreign private sector

Foreign official sector


Adjustment of Global Imbalances—

How Could India Be Affected?

  • Smooth unwinding led by rebalancing of domestic demand remains the most likely outcome

  • Potential for “disorderly adjustment”—rapid movement in exchange rates worldwide, volatile financial conditions

  • Demand rebalancing in the United States could imply a prolonged period of sub-par global growth

  • Risk of rising protectionist pressures


Critical Challenges for the Global Economy

  • Coming in for a soft landing?

  • Bumps in the runway:

  • The U.S. housing market

  • Inflation concerns and the oil market

  • Financial risks facing emerging markets

  • Longer-term Challenges:

  • Unwinding global imbalances

  • Sustaining global productivity growth


World GDP Growth Remains at the Fastest Sustained Pace Since the Early 1970s

(Annual percent change)

Trend,

1970–2005


Global Productivity Has Accelerated Led by Emerging Market Countries

(Annual percent change; three-year moving average)


And China, India, and Emerging Europe Have Been in Front

(Annual percent increase; three-year moving average)

1 Excludes China and India.


Sources of Growth in Labor Productivity

(Percentage points, per year)

Global, 1970–present

Asia, Since Growth Takeoff


Productivity Growth Has Been Particularly Strong in Industry

(Annual percent change)

Global, 1980–2004

Asia, Since Growth Takeoff


Asia, Since Growth Takeoff: Contribution to Labor Productivity Growth Differential with the United States

(Percentage points per year)


Asian Industry Is Catching Up—But What About Services and Agriculture?

(Percent of U.S. productivity levels; in PPP-terms)


Sectoral Productivity Growth Since Takeoff

(Annual percent change; decades on x-axis)

Services

Industry

Agriculture

China

NIEs

Japan

NIEs

China

India

China

NIEs

India

Japan

ASEAN-4

Japan

ASEAN-4

India

ASEAN-4


Trade/GDP: World and High Growth Countries(Percent)

Note: High growth economies = avg. GDP growth >7% 1980–2006


Sustaining Global Productivity Growth

  • Domestic market reforms can help to sustain rapid productivity growth in emerging market and developing countries

  • Further steps to remove trade barriers—both unilateral and multilateral—are also crucial

  • But greater attention must be paid both in advanced and developing countries to make sure that the fruits of globalization are well distributed


In Conclusion:

  • Notwithstanding recent volatility and U.S. slowdown, continued robust global growth still looks the most likely outcome.

  • Policy makers and financial markets around the world need to be ready for surprises.

  • Take advantage of good times to tackle structural impediments to sustained growth.


Download the WEO

http://www.imf.org/weo


Increasing Trade Integration Has Quadrupled the Effective Global Labor Supply(Index, 1980 = 100)

Global Labor Supply

Export-Weighted Labor Force by Region1

1National labor forces scaled by export-to-GDP ratios.


Emerging Market and Developing Countries Set for Continued Expansion

(Percent change)


Global Savings, Investment, and

Current Accounts

(Percent of world GDP)


Emerging Asia: Balance of Payments and Reserve Accumulation1

(Percent of GDP)

1 Excludes Hong Kong SAR and Singapore.


Savings and Investment in Asia

(Percent of each subregion’s GDP)

East Asia (excl. China)

China

Savings

Current account

(right scale)

Current account

(right scale)

Savings

Investment

Investment

Other Emerging Markets

India

Current account

(right scale)

Current account

(right scale)

Investment

Investment

Savings

Savings


China: GDP and Fixed Asset Investment

(Y/Y percent change)

Real GDP Growth

(left scale)

Fixed Asset Investment

(6-month m.a.; right scale)


Exchange Rate Depreciation Helps to Smooth the Impact of Current Account Adjustment

Average Change in GDP Growth (percent change)

Total Change in REER

(percent)


Advanced Economies: Total Change in Real Effective Exchange Rate and Average Change in GDP Growth During Deficit Reversals

Greece: 1990

Canada: 1981

Germany: 1965

Japan: 1974

Austria: 1977

New Zealand: 1974

Canada: 1993

United States: 1987

Finland: 1991


Advanced Economies: Change in Structural Fiscal Balance During Deficit Reversals(Medians across the two groups of episodes; percent of potential GDP)


Episodes of Surplus Reversals in Emerging Markets

Hong Kong SAR: 1975

South Africa: 1962

Argentina:

2002

Korea: 1988


Emerging Markets: Key Indicators During Surplus Reversals

(Medians across episodes)

Real Effective Exchange Rate

(index, 100 at t = 0)

Real Exports

(annual percent change)

Real GDP Growth

(annual percent change)

Real Imports

(annual percent change)


But the Labor Market Remains Relatively Strong(Change from a quarter ago in nonfarm payrolls)

Mid-cycle pauses

Current cycle

Recessions


The Trade Channel in Action(U.S. real import growth in percent)


Labor Productivity and Employment in the Euro Area are Both Growing(Y/Y percent change)


Growth in Advanced Countries Should Ease to Be Broadly in Line with Potential

(Percent change)


Rising Commodity Prices Have Been An Important Support(2002:Q1 = 100)

Energy

Metals

Beverages

Agricultural Raw

Materials

Food


Sources of Growth in Output Per Capita

(Percentage points, per year)

Global, 1970–present

Asia, Since Growth Takeoff


China: Marginal Revenue Product of Capital by Ownership Relative to Domestic Firms

(Percent)


And 2006 Looks Worse Than 1996

(Emerging market country current accounts in 1996 and 2006; percent of GDP)

1996

2006


Labor Compensation Has Grown Robustly in Advanced and Emerging Countries

Advanced Economies: Labor Compensation

(index, 1980 = 100;weighted)

Emerging Asia: Manufacturing Wages

(percent of U.S.; constant PPP)


But the Share of Income Accruing to Labor Has Declined Especially in Europe(Advanced economies; income share of labor by country groups;percent of GDP)


Technology Had a Bigger Impact on Labor Shares than Globalization(Advanced economies; annual percentage points)

Decomposing Changes

in the Labor Share

Decomposing the Contribution of Labor Globalization

Contribution of labor globalization

Change in the labor share

Contribution of technological change

Contribution of trade prices

Contribution of labor globalization

Contribution of offshoring

Contribution of labor market policies

Contribution of immigration share


Labor Market Reforms Can Help Support the Labor Share (Decomposing changes in the labor share; annual percentage points)

Change in the labor share

Contribution of technological change

Contribution of labor globalization

Contribution of labor market policies


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