International Monetary Fund Annual Report 2006 : Making the Global Economy Work for All

International Monetary Fund

• Publisher: INTERNATIONAL MONETARY FUND
• eBook ISBN:
  9781589065611
• Year: 2006

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Chapter 1. Overview

The IMF’s 2006 financial year (FY), the period covered by this Annual Report, was significant, as it marked an important turning point in the way the Fund carries out its mandate. The medium-term strategic review set in motion in 2004 by the Managing Director, Rodrigo de Rato, was completed and given broad endorsement by the Fund’s Executive Board and subsequently by the ministerial-level International Monetary and Financial Committee (IMFC), which requested that the Fund move rapidly to implementation. As a result, the IMF embarked on some far-reaching changes in its operations and governance.

The subsequent chapters of this Report set out the Fund’s work during FY2006 in detail. This introductory chapter is intended to provide a brief overview and to set the Fund’s work—including the changes that have been taking place—in the context of global economic developments.

The world economy

Global economic growth reached 4.8 percent in 2005, its third successive year above 4 percent (Figure 1.1), in spite of high oil prices, natural disasters, and continuing geopolitical uncertainties. This expansion has been notable for its pace, duration, and increasing breadth—every region experienced rapid growth in the period covered by this Report. Emerging market economies grew particularly rapidly, supported by benign financial conditions, improved policy frameworks and, in many cases, high commodity prices. Developing countries also expanded solidly, with sub-Saharan Africa’s growth rate exceeding 5 percent for the second consecutive year. The volume of global trade continued to expand rapidly. At the same time, current account imbalances in a number of key economies continued to widen (Figure 1.2). The current account deficit of the United States reached a record 7 percent of GDP in the final quarter of 2005, while oil exporters, Japan, a number of small industrial countries, China, and some other parts of emerging Asia continued to run substantial surpluses.

Figure 1.1 Real GDP growth

(In percent change from a year earlier)

Figure 1.2 Current account balance

(In percent of world GDP)

Growth in the United States remained strong in the second and third quarters of 2005. It slowed temporarily in the fourth quarter because of weak domestic demand—owing, in part, to high gasoline prices after Hurricane Katrina—but rebounded in the first quarter of 2006, with strong consumption and corporate investment compensating for a marked slowdown in residential investment.

Growth in the euro area remained subdued throughout 2005. High-frequency indicators, however, suggest that an investment-led recovery may have gained traction in early 2006, especially in Germany.

Japan’s economy expanded robustly during 2005. The recovery was increasingly driven by robust domestic demand, underpinned by rising employment, and buoyant corporate profits. Importantly, both consumer price inflation and bank credit growth turned positive at the turn of the year after a long period of contraction.

China’s rapid expansion continued unabated; the growth rate was nearly 10 percent in 2005. Recent performance looked even more impressive after GDP data were revised, showing an increase in average annual growth of half a percentage point, to almost 10 percent, between 1993 and 2004. The expansion remained unbalanced, however, driven primarily by investment and net exports.

While the expansion in Latin America moderated somewhat in 2005 (to 4.3 percent from 5.6 percent), growth remained significantly above the long-term average, which is less than 3 percent. The region’s two largest economies—Brazil and Mexico—accounted for most of the slowdown, owing to subdued investment in Brazil and the weaker performance of the agricultural and manufacturing sectors in Mexico. In contrast, growth remained solid or strengthened even further in Argentina, Paraguay, and Uruguay and in the Andean region, notwithstanding political uncertainties in some countries—notably Bolivia and Ecuador.

Growth in emerging Asia excluding China and India eased marginally during the period but remained very strong overall. In the newly industrialized economies (Hong Kong SAR, Korea, Singapore, and Taiwan Province of China), the slowdown was concentrated in the second quarter of 2005 when the information technology sector went through the final phase of a correction. Subsequently, growth accelerated again, supported by stronger investment in industrial countries. The ASEAN-4 economies (Indonesia, Malaysia, the Philippines, and Thailand) also recovered, in spite of periods of financial turbulence in Indonesia and political uncertainties in the Philippines and Thailand. Growth in India remained very rapid, with strong momentum in the manufacturing and services sectors. Although exports performed well, the current account moved into deficit in 2005, as strong domestic demand and high oil prices triggered a surge in imports.

Growth has moderated in central and eastern Europe, but there were important differences between subregions. Very rapid growth in the Baltic countries—almost 9 percent in 2005—contrasted with a more moderate pace of expansion in central and southeastern Europe. In spite of appreciating exchange rates, the region’s average current account deficit fell modestly. In the Baltic countries and some southeastern European countries, current account deficits remained very high, however, driven by soaring private domestic demand and rapid credit growth. While a significant part of these deficits was financed by foreign direct investment, the share of debt financing has increased. In the Commonwealth of Independent States, growth decelerated in 2005. A sharp slowdown in Ukraine accounted for most of this, while growth in Russia was supported by high oil prices.

The Middle East benefited from rising oil prices. High receipts from oil exports fueled average growth of almost 6 percent and a current account surplus of almost 20 percent of GDP in the oil-exporting countries. Even though a large portion of the increase in oil revenues has been saved, domestic demand strengthened. Money and credit growth expanded sharply, and property and equity prices surged, although many stock markets in the region experienced significant corrections in the first quarter of 2006.

Economic activity in Africa continued to expand robustly, supported by generally higher commodity prices and the positive impact of reforms carried out in the 1990s. Some countries were adversely affected by the moderation of prices for food and agricultural raw materials, however, as well as by the removal of textile quotas.

Oil prices remained high and volatile during the period. They reached highs in August 2005 in the wake of hurricanes Katrina and Rita, and again in April 2006 because of geopolitical concerns related to Iran and threats to oil production in Nigeria. Nonfuel commodity prices, especially for metals, also rose strongly. The impact of rising commodity prices, as well as of closing output gaps, on global inflation remained surprisingly modest, however. Headline consumer price inflation picked up somewhat but core inflation remained constrained, and inflationary expectations were well under control.

Monetary policies tightened in most industrial countries, starting to dry up some of the abundant global liquidity. The speed and timing of the tightening differed, however, reflecting the countries’ different cyclical positions. In the United States, the Federal Reserve’s tightening cycle continued, with the federal funds rate rising 175 basis points over the period. The European Central Bank began to raise interest rates at end-2005, and the Bank of Japan ended its longstanding policy of quantitative easing in March 2006, with markets anticipating policy rate hikes later in 2006. Fiscal policies were varied, but little progress was made in industrial countries outside Canada and Japan toward strengthening medium-term fiscal balances (and Japan’s fiscal deficit remains very large).

Despite a growing U.S. current account deficit, the U.S. dollar appreciated somewhat in trade-weighted terms: a depreciation against emerging market currencies was offset by appreciations against the euro and the yen. The dollar remained well supported by continued strong foreign demand, including from oil exporters, for U.S. dollar financial assets (particularly bonds). However, toward the end of the financial year, the dollar began to weaken against other major currencies as it became evident that the yield advantages of dollar-based assets would start to narrow, and as the official sector raised concerns about the need for currency flexibility to help foster adjustment of global imbalances.

Conditions in mature and emerging financial markets remained favorable, supported by sustained and broadening global growth and subdued inflation. High liquidity, in turn, continued to foster a search for yield, notwithstanding the tightening by key central banks and signs that monetary policy would continue to firm. Long-term interest rates rose more modestly, leading to a marked flattening of yield curves, mainly in the United States. Long-term yields were also supported by high institutional investor demand for long-term fixed-income assets. Against this backdrop, financial market volatility, government bond yields in mature markets, and global credit spreads remained low by historical standards.

Global equity markets rallied as strong corporate profitability further strengthened balance sheets globally. In Japan, continuing signs of economic recovery saw the Nikkei index gain 53.6 percent during the financial year. European equities also made steady gains, rising 29.9 percent during the financial year while, in the United States, the S&P 500 rose 13.1 percent (Figure 1.3). Actual market volatility and the expected volatility implied in options prices stayed low. There were signs, particularly toward the end of the period, that the corporate credit cycle had begun to turn. Corporations started to draw down their ample cash balances and increase balance sheet leverage, taking advantage of relatively low long-term yields and spreads. Partly as a result, there was a surge in global mergers and acquisitions.

Figure 1.3 Equity market performance

(May 2005 = 100)

Source: Bloomberg LP.

Emerging market economies continued to enjoy an exceptionally favorable economic and financing environment during the period. Solid global growth boosted export demand and commodity prices. Interest rates and credit spreads remained low, with spreads compressing even as yields in mature markets rose. With abundant liquidity continuing to spur a search for yield, investor appetite for new issues from emerging market borrowers was exceptionally strong. At the same time, the investor base for emerging market assets continued to expand, reflecting past outperformance and the improved credit quality of emerging market borrowers. The market was also supported by emerging economies’ continuing active debt management aimed at reducing the vulnerability of their debt structure. The spread on the EMBIG index declined 205 basis points during the Fund’s financial year, ending the period at a record low of 179 basis points (Figure 1.4). Emerging market bond issuance in the primary market reached record levels in 2005 and totaled some $28 billion in January–April 2006. Nearly one-half of total bond issuance during this period was from nonsovereign entities. Primary issuance of equities in emerging markets was also strong during the financial year and continued to be dominated by Asia, in particular, China.

Figure 1.4 Sovereign spreads

(In basis points)

Source: JPMorgan Emerging Markets Bond Index Global.

Global economic risks

Although growth remained strong in 2005, risks to global growth continued to be slanted to the downside because of rising oil prices, continuing global payments imbalances, and other issues. The problem of global imbalances that was discussed in the Annual Report 2005 continued to raise concerns about the sustainability of global growth. The difficulties in making progress in the Doha Round of multinational trade negotiations raised concerns that the benefits for the world economy of a successful and ambitious outcome to the negotiations would prove elusive. And there was increasing concern about the potential consequences for the global economy of a widespread outbreak of avian flu. These issues were the focus of attention both in the IMF’s discussions with its individual member countries and in the Fund’s multilateral surveillance work, as it assessed the possible global implications. The fact that these risks did not undermine global growth during the year did not alleviate concerns about them.

As global payments imbalances continued to widen during FY2006, discussions about ways to resolve them became more intense. Several factors account for the very large imbalances that were a feature of the global economy during the period covered by this report: low consumption and rising external current account surpluses in much of Asia; the large and growing U.S. current account deficit; sluggish growth in Europe; and rapidly increasing surpluses in the main oil-exporting countries.

For some years the IMF has argued that these imbalances were a global problem and that a multilateral response—a coordinated package of policies across the regions involved—would bring much larger gains than would be possible from unilateral actions. During FY2006 this view gained increasingly broad support, accompanied by growing consensus on the shape of the multilateral response that was needed. This would include increasing consumption and exchange rate flexibility in a number of countries with current account surpluses in emerging Asia; raising national saving in the United States, with measures to reduce the fiscal deficit and spur private saving; implementing structural reforms to increase flexibility and growth in the euro area and several other countries; undertaking fiscal consolidation and further structural reforms in Japan; and promoting the efficient absorption of higher oil revenues in oil-exporting countries with strong macroeconomic policies.

As the imbalances have grown so has the importance of developing a multilateral approach. Unilateral action by any one country or by one group of countries could have negative consequences for the rest of the world. Promoting a multilateral response therefore assumed a high priority for the Fund.

Prospects for a successful and ambitious outcome to the Doha Round also raised concerns, which intensified after the disappointing outcome of the World Trade Organization (WTO) Ministerial Meeting in Hong Kong SAR in December 2005. The Fund continued to support the WTO in its efforts to reach a satisfactory outcome to the negotiations, including through provision of strong support for the Aid for Trade initiative. A successful outcome to the Doha Round would greatly strengthen the multilateral trading system and so strengthen the prospects for global growth. Conversely, failure to reach an agreement, or an unambitious outcome, would act as a brake on global growth and could also fuel protectionist pressures that would further undermine growth prospects.

FY2006 saw much contingency planning for an outbreak of avian flu, with increasing concern about the impact on the world economy of such an outbreak. The IMF played an active role in this process (see Chapter 4).

A period of rapid global growth is perhaps naturally accomp...

Table of contents

• Cover Page
• Title Page
• Contents
• Message from the Managing Director and Chair of the Executive Board
• 1. Overview
• 2. The Medium-Term Strategy
• 3. Surveillance in action during FY2006
• 4. Strengthening surveillance and crisis prevention
• 5. Strengthening IMF program support and crisis resolution
• 6. The IMF’s role in low-income countries
• 7. Technical assistance and training
• 8. Financial operations and policies
• 9. Governance and management of the IMF
• Appendixes
• Footnotes