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Statement 3: Economic Outlook

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Part II: The outlook for the international economy

The world economy grew by an estimated 4.8 per cent in 2000, up from 3.5 per cent growth in 1999 and well above long-term average growth rates. However, economic growth slowed through the second half of 2000 and is expected to be significantly weaker in 2001 at about 3¼ per cent, although this is only a little below the long-run historical average. The pace of growth is expected to pick up later in 2001 and increase to around 4 per cent in 2002 (Chart 1).

Chart 1: Annual growth in world GDP(a)

Chart 1:  Annual growth in world GDP(a)

(a) World GDP growth rates are calculated using GDP weights based on purchasing power parity.

Source: Various national statistical publications, International Monetary Fund (IMF) and Treasury.

The slowing in world economic growth in the second half of 2000 reflected the restraining influence of earlier monetary tightenings, the rise in oil prices that reduced business and household purchasing power, and falls in equity prices, particularly in high-technology stocks.

The slowing in growth was particularly pronounced in the US. Following very rapid growth in the first half of 2000, household consumption slowed and production and investment eased in manufacturing industries following the build-up of inventories and capacity earlier in the year. Growth also softened in Europe, and the nascent recovery in Japan stalled. Activity in non-Japan East Asia was adversely affected by slowing US growth as the year ended.

World growth is expected to pick up as 2001 progresses, supported by a recovery in the US economy over the course of the year, solid growth in Europe and continued, albeit slower, growth in East Asian economies, particularly China. With the Japanese economy remaining sluggish, economic growth in Australia's main export markets is expected to be around 2¾ per cent in 2001, down sharply from 5 per cent in 2000, but well above the fall of 0.5 per cent recorded in 1998, during the Asian financial crisis.

In 2002, world growth is expected to rise to around 4 per cent, underpinned by gathering momentum in the US and stronger growth in the East Asian economies. However, the slow pace of growth expected in Japan points to Australia's export market growth being around 3½ per cent.

World inflation is expected to remain subdued with slower growth in the major economies easing capacity constraints and moderating price pressures. Ongoing productivity gains and increasingly competitive trading environments should also help contain inflation as growth picks up in 2002.

World oil prices have declined significantly over the past six months, suggesting that the risks to world activity and inflation from this source have abated somewhat. Prices are expected to continue to ease, in line with the weaker outlook for the world economy in 2001. Crude oil prices are now expected to decline from a world trade weighted1 average of US$27.6 per barrel in 2000 to around US$23¼ per barrel in 2001, and US$22 per barrel in 2002.

Oil prices are likely to remain volatile in the short term, reflecting uncertainty about the action of key producers and the strength of world demand. In particular, the actions of the Organisation of Petroleum Exporting Countries - which has already cut production by 2.5 million barrels per day thus far in 2001 - in the face of falling demand and prices, create some uncertainty around the forecast.

Growth in the United States was 5 per cent in 2000, although the rapid growth of the first half gave way abruptly to very modest rates in the second half of the year. Growth is expected to average around 1½ per cent in 2001 before rising to around 3¼ per cent in 2002.

The first half of 2000 was marked by a surge in business and consumer spending and a continuation of the same supply-side forces that have propelled the economy over the past few years: ongoing realisation of synergies from new technology and improved business practices, high levels of investment and elevated rates of productivity growth. In the second half of 2000, the situation changed. Equity markets adjusted downwards (particularly in high technology), consumption slowed, inventories grew, production weakened particularly in the manufacturing sector, and some capital spending was put on hold. The new technologies and business practices, which had underpinned the expansion, appeared to contribute to a more rapid pass through of the change in conditions than in the past.

The extent and duration of the slowdown in the US is expected to be mild compared with previous episodes, moderated by relatively sound underlying macroeconomic conditions and supportive policy settings. Growth is expected to be weak in the first half of 2001 as inventories and excess capacity in some industries are worked off, but should recover quickly in the second half of the year and into 2002. Consumer spending is expected to be supported by ongoing growth in income, still relatively high levels of consumer confidence, and by recent interest rate cuts and the prospect of tax cuts later in the year. Investment in housing appears to have picked up in the first part of 2001 and other investment should be supported in the longer term by productivity growth and prospects of attractive returns on high-tech investment. Nevertheless, risks around the US growth forecasts are substantial, with any significant deviations in US growth from the forecast levels having the potential to markedly affect overall world growth (Box 1).

Table 2: Annual growth in GDP for selected countries and groupings(a)(b)

Table 2:  Annual growth in GDP for selected countries and groupings(a)

(a) Percentage change on previous year.

(b) Growth rates for the World, the Organisation for Economic Co-operation and Development (OECD), the European Union (EU), and non-Japan East Asia are calculated using GDP weights based on purchasing power parity.

(c) Treasury estimates of World, OECD and EU growth rates.

(d) The OECD comprises the United States, Japan, Germany, France, Italy, the United Kingdom, Canada, Australia, Austria, Belgium, the Czech Republic, Denmark, Finland, Greece, Hungary, Iceland, Ireland, Korea, Luxembourg, Mexico, the Netherlands, New Zealand, Norway, Poland, Portugal, Spain, Sweden, Switzerland, Turkey and includes Slovakia from 2001.

(e) Export trade-weighted basis.

(f) Non-Japan East Asia comprises Korea, Singapore, Taiwan, Hong Kong, China, Indonesia, Malaysia, Thailand, and the Philippines.

Source: Various national statistical publications, IMF and Treasury.

Japan's economy grew by 1.7 per cent in 2000, although uncertainty about the sustainability of the expansion remains. Growth is expected to be uneven in 2001 with last year's fiscal package likely to raise public investment during the first half of the year, but with the boost to activity tapering off in the second half of the year as public spending declines. Consumption is likely to remain subdued and investment is expected to ease through 2001 as slower world growth and weaker demand for high-tech products reduce exports and weaken the outlook for corporate profits. The sharp decline in equity prices over the past year is also likely to undermine business confidence and the investment outlook. For 2001 as a whole, growth is expected to average around ¾ per cent, before picking up to around 1½ per cent in 2002 as the global economy strengthens. Sustained recovery in Japan continues to be constrained by high levels of bad debts in the banking system. The new Government has expressed a commitment to progressing further reforms, including in the financial sector.

Growth in the euro area strengthened in 2000, rising to 3.4 per cent, buoyed by strong domestic and external demand. For 2001, growth is expected to moderate in the face of a less supportive global environment. However, the euro area appears to be less affected by the downturn in the US than some other regions and the effects are likely to be more muted. Consumption is expected to be underpinned by rising incomes, recent tax cuts and relatively high levels of consumer confidence. Investment, although adversely affected by weaker export earnings and higher energy prices, is likely to be supported by recent corporate tax cuts and relatively high levels of capacity utilisation. In 2001, growth in the euro area is expected to be around 2½ per cent, with slightly higher growth expected in 2002 at around 2¾ per cent, as world economic conditions improve. Growth in the United Kingdom is expected to be more affected by the slowdown in the US and problems associated with foot and mouth disease, with growth slowing to 2¼ per cent in 2001, before picking up to 2¾ per cent in 2002 on the back of stronger world growth and supportive macroeconomic policy.

The non-Japan East Asia region grew strongly in 2000, supported by strong export demand and rising domestic demand. The region benefited from the strong growth in the world economy and particularly from the upturn in demand for electronics in the US, Europe and Japan.

Growth is expected to slow in 2001 with the slowdown in the US and continued weakness in Japan expected to reduce demand for exports, particularly electronics, industrial machinery and automobiles which have been a cornerstone of the expansion. The impact is likely to be more pronounced for countries such as Taiwan, Singapore and Korea which have a high electronics component in their export base.

Unfavourable domestic factors are also likely to weigh heavily on the immediate outlook for the region, particularly in Indonesia, Thailand and the Philippines. However, foreign exchange reserves are generally higher than immediately preceding the Asian crisis, external positions have improved, and speculative capital inflow has been limited, leaving countries less vulnerable to unfavourable shifts of sentiment and capital flight.

Growth in non-Japan East Asia is forecast to decline from 7.4 per cent in 2000 to around 5¾ per cent in 2001 before picking up to 6½ per cent in 2002, in line with the expected recovery in the US. Excluding China (which continues to grow strongly), growth in the region is forecast to be 3½ per cent in 2001 before rising to 4¾ per cent in 2002.

Other emerging market economies grew strongly in 2000, but growth is likely to moderate in 2001. Financial and economic conditions remain fragile and they remain vulnerable to any further weakening in global conditions and/or a deterioration in sentiment towards emerging markets.

Box 1: Risks to the US and global outlook

The path of the global economy over the next year depends heavily on developments in the US economy. The most likely outcome in the US is that growth will slow through the first half of 2001 as excess inventories are reduced and surplus capital stock is unwound through lower investment and modest growth, but pick up strongly in the latter part of the year. This relatively benign outcome would be consistent with the generally sound underlying fundamentals of the US economy and the stimulative impact of lower interest rates and foreshadowed tax cuts.

It is possible, however, that business conditions and business and consumer confidence will fall further during the adjustment process leading to a deeper and more prolonged slowdown than currently envisaged. Energy prices have risen sharply in the US reflecting in part domestic capacity constraints in the energy sector which could put further pressure on prices and incomes. Other factors, including a reassessment of the wealth and income gains from investment in new technology areas, could also adversely affect incomes and sentiment.

In these circumstances, there would likely be a sharp reduction in consumption and investment spending. Increased uncertainty with respect to employment and incomes would see consumption weaken, and this would be reflected in lower profit prospects and a further decline in equity prices. With household debt already at high levels and savings rates low, household consumption would likely be pared back further. Reduced sales and earnings prospects and increased risk would also likely see firms delay investment, using funds to repair extended balance sheets instead. In this scenario, equity returns would fall, capital inflows would ease, the large current account deficit would unwind, and the exchange rate would depreciate.

A weaker US economy accompanied by a rapid adjustment in financial markets would adversely affect other countries, including East Asian economies. The outlook for Japan has already deteriorated, partly as a result of weaker global conditions, but also due to domestic factors including weak consumer and business confidence and unresolved problems in the financial sector. Further deterioration in the economy and weaker confidence would expose vulnerabilities in the financial and corporate sectors, exacerbating the adverse affects of weaker external conditions. Both Japan and other East Asian economies are particularly vulnerable to a more severe downturn in the US because of their specialisation in electronic products. However, there could be some offsetting effects from lower interest rates, lower exchange rates, and increased capital inflow where attractive investment opportunities arise.

Other countries would also be adversely affected by further weakness in the US and Japan, through the usual trade linkages and through confidence effects.

On the upside, recent policy adjustments in several countries may forestall a further downturn. If confidence were to turn up quickly there may be some upside risks to the forecasts.

1 The world trade weighted oil price is the average of the contract price of different types of oil, weighted by their share of the world oil trade (that is, between countries).

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