The Organisation for Economic Co-operation and Development (OECD) said in its eagerly anticipated Economic Outlook published on November 25 that many of the downside risks it had feared came to pass and so it has substantially revised downward its outlook for the world's major economies.
"Many OECD economies are in or are on the verge of a protracted recession of a magnitude not experienced since the early 1980s," the organisation said, which has 30 countries as members. "As a result, the number of unemployed in the OECD area could rise by 8m over the next two years. At the same time, inflation will abate in all OECD countries and some even face a risk, albeit small, of deflation."
While emphasising that the uncertainties associated with this "Economic Outlook" are exceptionally large, the OECD said the abrupt slowdown in many of the world's largest economies would be followed by an extended period of financial headwinds through late 2009, with a gradual normalisation thereafter.
The effect of the credit slowdown will be compounded by negative wealth effects from the sharp decline in equity prices through 2008 as well as past and ongoing falls in house prices. "These will represent a substantial drag on consumption growth over the next couple of years, although there will be differences in the magnitude of these effects across countries. For the US, 'back-of-the envelope' estimates suggest that wealth effects will build up, eventually subtracting as much as 11/2 to 2% from annualised consumption growth towards the end of 2009 and early in 2010, dissipating only gradually thereafter. Estimates for the euro area suggest a similar timing, but a smaller subtraction to annual consumption growth of between 0.5-0.75%," it said.
In the Eurozone, which has a big bearing on the outlook for Central Europe's economies, activity will fall over the next six months as tighter financial conditions, subdued income growth and negative wealth effects from lower equity and house prices damp consumption and investment. "Economic activity then gradually recovers as monetary easing gains traction and the effects of global financial market turbulence dissipate. Inflation will ease considerably, to reach a level by early next year that is consistent with the ECB's inflation target," it said. "Euro area GDP declined in both the second and third quarters and is likely to fall also in the fourth. Private consumption has been weak, damped by subdued real income growth caused by high headline inflation."
Other OECD countries where the economic downturn will be severe include Hungary, Iceland, Ireland, Luxembourg, Spain, Turkey and the UK. "These economies are most directly affected by the financial crisis, which in some cases has exposed other vulnerabilities, or by severe housing downturns," it said.
Against the backdrop of a deep economic downturn, the OECD argues that additional macroeconomic stimulus is needed. "In normal times, monetary rather than fiscal policy would be the instrument of choice for macroeconomic stabilisation. But these are not normal times. Current conditions of extreme financial stress have weakened the monetary transmission mechanism. Moreover, in some countries the scope for further reductions in policy rates is limited. In this unusual situation, fiscal policy stimulus over and above the support provided through automatic stabilisers has an important role to play. Fiscal stimulus packages, however, need to be evaluated on a case-by-case basis in those countries where room for budgetary manoeuvre exists," it said.
Emerging markets, although not directly hit by exposure to the toxic mortgage-linked asset losses that set off the current crisis, have been affected through contagion. "Countries with large external financing needs, reliance on crisis-hit banks in Europe, dependence on commodity exports, high foreign currency loan exposure or high exposure to exchange rate risk via derivative contracts have been particularly hard hit. The provision of government lending and deposit guarantees in the advanced OECD economies has also contributed to capital flight away from emerging markets. Investors, increasingly concerned about economic prospects, have sold-off equities and currencies in emerging markets across the world. Indeed, as the financial crisis has worsened, the fall in emerging market equity prices has exceeded that in the advanced economies; the Morgan Stanley Capital International (MSCI) dollar index of emerging market equity prices fell about 40% between the beginning of September and the first week of November, compared to a fall in the MSCI global dollar index of about 30%. Bond spreads for emerging market countries have also increased sharply since mid-2008 to their highest level since 2003. However, a return to historical highs is unlikely without a reversal of improved fundamentals (including lower inflation and debt), which has been an important reason for the reduction in emerging market bond spreads in recent years," it said.
Below are some of the OECD's outlooks for specific CEE countries:
Russia: The fallout from the global financial crisis will sharply reduce real GDP growth in Russia through 2009, with a pick-up expected in 2010. With a reversal in the substantial rise in oil and metal prices, the pattern of terms of trade gains fuelling rapid growth in domestic demand has come to an end. Inflation has risen strongly, but may now have peaked and should decline in 2009-10. Fiscal and current account balances are expected to worsen sharply. Policy challenges will multiply in a new environment of more binding fiscal constraints. At a minimum, less economically efficient forms of stimulus, like reducing the rate of value-added tax, should be resisted. As to monetary policy, countering the effects of short-term speculative capital outflows on the exchange rate is justifiable, but reserves should not be run down to postpone adjustments warranted by fundamentals. The authorities have responded decisively to threats to banking system stability, but further action, including improved coordination with foreign regulators given the global scale of the problem, may be needed.
Czech Republic: Growth slowed in the first half of 2008 and is not expected to return to trend again until 2010. The slowdown started with weaker domestic demand in 2008, as the inflation spike eroded consumers' purchasing power, and will continue as export market growth slows. The rebound is projected to be driven by both private consumption and exports. Inflation is expected to decelerate substantially in 2009 as the impact of one-off government measures wears off and global energy and commodity prices fall. The key impediment to continued high trend growth is a shortage of labour and skills. The government could ease this shortage by further reducing marginal income tax rates and increasing graduation rates from tertiary education. Additional reforms of health care and pension systems are needed to ensure fiscal sustainability and enhance efficiency of public spending.
Hungary: Against the background of global financial turbulence, economic activity is set to decline in 2009, before picking up with the recovery in world trade and with higher confidence following international financing support. Inflation should decelerate towards the 3% target as wage growth remains moderate. The current account deficit should narrow. Controlling financial vulnerabilities is a key policy priority. The most urgent challenge is to move forward with announced measures to improve banks' risk management (including strengthening stress testing), particularly regarding households' large foreign currency exposure. Efforts to restore the sustainability of public finances should continue and past profligacy in election years avoided, so as to provide room for reducing tax and social security wedges when the financial crisis subsides.
Poland: The pace of expansion decelerated moderately in the first half of 2008 and recent data point to a further weakening of activity. Amidst the global slowdown, growth is projected to fall below potential, although income tax cuts should support private consumption. With declining oil prices and persisting, albeit abating, demand pressures in labour and product markets, core inflation is expected to subside more gradually than headline inflation. Fiscal policy has been somewhat expansionary in 2008, though significant underspending on infrastructure investment has led to an unexpectedly low central government budget deficit. The debate over the adoption of the single currency has intensified. A structural improvement in the fiscal balance and a permanent reduction in inflation are key hurdles en route to meeting the Maastricht criteria.
Slovakia: Although the Slovak Republic will continue to maintain the highest growth rate among OECD countries over the next two years, activity is expected to decelerate significantly in 2009. In particular investment spending and trade growth are likely to be adversely affected by the effects of the financial crisis. Growth is envisaged to return to close to its potential rate towards the end of the projection horizon. Inflation rates should decline from their currently high levels, but to stay above euro area levels. Dealing with the adoption of the euro, which will take place on 1st January 2009, will determine policy priorities. Although the expected slowdown will damp the danger of a boom-bust cycle induced by low real interest rates, fiscal policy should be used cautiously. Rising house prices and household indebtedness should be closely watched.
Slovenia: Economic activity is likely to slow significantly in 2009, driven in particular by a sharp deceleration in investment in construction. The following year, economic growth should return toward trend as both investment and private consumption recover. Headline inflation is expected to subside due to falling commodity prices, although planned public wage increases will exert upward pressure on core inflation. With European Central Bank monetary policy likely to remain accommodating for Slovenia during the projection period, the fiscal policy stance should remain at least neutral to avoid adding to inflationary pressures. Competition in product markets needs to be nurtured to help reduce prices and improve productivity.
Turkey: The economy slowed in 2008 as weakness in domestic demand was compounded by the international slowdown in the wake of financial market turbulence. Growth is expected to decline to below 2% in 2009 before recovering to 4 1/4% in 2010, in line with the global recovery. As the current account deficit is large and the volatility of the exchange rate has considerably increased, supporting investor confidence is crucial. Fuller fiscal transparency and implementing credible spending rules would facilitate the operation of automatic stabilisers without undermining confidence. If systemic liquidity risks emerge in the financial system, the government should be prepared to introduce contingency support mechanisms to preserve the hard-won stability of the financial sector.
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