BP1ST2 - International Economy

International Economy

The world economy is experiencing a conjunction of favourable effects which should be supportive of the Australian economy in the year ahead. This reflects:

a favourable convergence in the cyclical positions of the major economies, as increasingly strong growth in the private sector in Japan and slowly improving prospects for Europe support continuing strong growth in the United States and in the East Asian region (see below);
the importance of the high growth Asian economies for Australia's exports; [2]
the absence of inflationary pressures in most countries, reflecting the judicious use of monetary policy and greater competitive pressures more generally; and
the adoption of budget deficit reduction plans by most major economies, which should help reduce world real long-term interest rates and sustain investment.

Overall, GDP in Australia's major trading partners (MTP) [3] is expected to expand by 4½ per cent in 1997-98, while their inflation is expected to average around 3 per cent, with a subdued inflation outlook across the industrial world. [4]

Unemployment remains very high in many industrial countries and sustained growth will be fundamental to tackling that problem. On that score, analysis by the OECD and International Monetary Fund (IMF) points to the importance of not only macroeconomic stability but of pursuing structural reforms on a wide front. In a wide range of countries, it has been structural rigidities within the control of governments which have constituted the greatest impediments to improved productivity, economic growth and job creation. [5] Many countries are now seeking to introduce reforms to reduce structural rigidities and increase longer-term growth rates.

Table 2: Economic Indicators for Selected Countries and Groupings^(a)

(a) Total and East Asian MTP GDP growth are calculated using Australian merchandise export trade weights. The other MTP series are weighted by total Australian merchandise trade weights.

(b) The GDP deflator in the case of the OECD.

(c) General government financial balance (as a per cent of nominal GDP) in the case of the OECD. Taiwan is excluded from East Asian MTP.

(d) Indonesia is excluded from East Asian MTP.

(e) Forecasts.

(f) The OECD comprises Austria, Australia, Belgium, Canada, the Czech Republic, Denmark, Finland, France, Germany, Greece, Hungary, Iceland, Ireland, Italy, Japan, Luxembourg, Mexico, Netherlands, New Zealand, Norway, Poland, Portugal, South Korea, Spain, Sweden, Switzerland, Turkey, the United Kingdom and the United States. However, the OECD has not yet commenced publishing economic indicators which include South Korea.

(g) Australia's East Asian MTP are China, Hong Kong, Indonesia, Malaysia, the Philippines, Singapore, South Korea, Taiwan and Thailand.

(h) In addition to Australia's East Asian MTP, Canada, France, Germany, Italy, Japan, New Zealand, the United Kingdom and the United States comprise Australia's total MTP.

Source: GDP growth and inflation data are from individual country statistical publications with Treasury estimates for 1997. The exceptions are the OECD series, which are from the OECD's Economic Outlook 60. General government balance and unemployment rate data and estimates are from individual country statistical publications, Treasury and the IMF's May 1997 World Economic Outlook.

The economic performance of the United States has been highly impressive over recent years. The current upswing is well into its sixth year and the economy has been operating for over 18 months at or above what most observers had considered to be full capacity. Despite this, inflation remains low. To sustain this performance, the Federal Reserve acted pre-emptively to tighten monetary policy slightly in March 1997. The major policy challenge for the United States, however, is to reduce the Federal fiscal deficit. The Administration has announced a plan to balance the budget by the year 2002, although most of the cuts in expenditure are not planned to take effect until after the year 2000.

Economic recovery is continuing in Japan with the private sector replacing the earlier high levels of public expenditure as the main source of growth. Fiscal policy has been tightened sharply in 1997 to improve the underlying fiscal position, but private sector activity (supported by continuing accommodative monetary policy and a weaker yen) should help maintain the recovery's momentum. Overall, growth is expected to weaken in the first half of 1997, before accelerating later in the year.

Economic growth in Continental Western Europe is expected to improve but remain patchy in the face of substantial regulatory structural rigidities and a concerted focus on substantial fiscal consolidation. High public sector debt levels and large fiscal imbalances prevailing across Europe through the 1990s require fiscal consolidation in most countries, with the extent and timing of the adjustment undertaken being influenced by requirements to meet the Maastricht criteria for European Monetary Union. As a result, business and consumer confidence is likely to remain subdued. The United Kingdom is expected to continue to outperform its continental neighbours.

Growth in East Asia is likely to strengthen slightly in 1997-98, reflecting a recovery from the export slowdown that affected most of the region in the latter part of 1996 and early 1997 and some easing in monetary policies. The Chinese economy is expected to remain a driving force; double-digit growth is likely to continue through stronger growth in consumption, investment and net exports. In contrast, growth is likely to moderate in South Korea as private consumption and investment growth slows further.

Strong investment is likely to support continued buoyant conditions in Malaysia and Indonesia and continued steady growth in the Philippines. Growth in Singapore has been affected by weakness in the electronics-based export sector, which is not expected to recover until around the middle of 1997. The short and medium-term outlook for Thailand will depend on the speed and effectiveness of the authorities' response to the considerable financial sector instability that occurred during the first few months of 1997.

Looking at the world economy as a whole, there are few signs of the tensions and imbalances that usually foreshadow significant downturns in the world economy - but there are, as always, some points that bear watching. For example:

the possibility of significantly higher interest rates in the United States which might slow the economy more than anticipated and reduce capital flows to other countries with possible interest rate and exchange rate implications;
- while the probability of that seems low, there is a possibility that, as the United States enters a period of monetary tightening, increasing interest rate differentials between the United States and Japan could exacerbate movements in exchange rates between those countries and widen external imbalances, possibly leading to trade frictions;
uncertainties about the timing and strength of the pick-up in private sector activity in Japan in the face of the need for consolidation of both government finances and financial sector balance sheets; and
unavoidable uncertainties surrounding the European Monetary Union and, particularly, which countries will meet the requirements for membership under the Maastricht criteria. The possibility of policy shifts associated with such uncertainties could contribute to volatility in financial markets.