Initial estimates for economic growth in the first quarter (Jan-Mar) of calendar 2003 do not bring much cheer. Gross domestic product in the US grew 1.9 per cent (with respect to the previous quarter), fuelled mostly by personal consumption and residential fixed investment. But business investment continues to contract and inventories remain drawn down. Early estimates show that both the Eurozone and the European Union (EU-15) did not grow in the first quarter of 2003. Considerable differences, however, obtained across individual countries.
Greece registered rapid growth, and the UK posted modest growth of about 1 per cent. But Germany, the largest economy in Europe, contracted at an annual rate of nearly 1 per cent, although growth had been positive in the previous quarter. Likewise, Italy contracted somewhat, although it had expanded in the previous quarter. In the Netherlands however, a contraction in the first quarter has succeeded upon a contraction in the previous quarter.
The Japanese economy in the first quarter of 2003 registered growth that was just marginally positive. Personal consumption, business and government consumption all rose. On the other hand, residential and public investment declined, as did private inventories. Exports fell while imports rose. With the strengthening of the yen vis-a-vis the dollar, exports are likely to remain under pressure. However, consistent growth over the previous year in private business investment and personal consumption could provide adequate impetus to prevent the economy from sliding into contraction.
As against this outcome in the first quarter, it is worth recollecting that multilateral agencies had estimated growth for 2003, of between 2.2 and 2.5 per cent for the US, of 1.1 to 1.2 per cent for the Eurozone, and 0.6 to 1 per cent for Japan. At the time that these projections were being prepared, the Iraq war was looming large and oil prices were well above $30 per barrel. The underlying geo-political conditions are more favourable today, but the economic outcome is not. The only possible conclusion is that, the underlying weakness of the economic dynamics of the advanced world was more acute than was appreciated.
The US government has committed itself to fiscal stimulus through large tax cuts, which might generate growth and attendant fiscal revenues, but will certainly produce a large deficit in the near term. The EU is caught up in the tensions of its treaty arrangements, the co-ordination problem which at one time seemed easier to handle than it is now. One early development has been the constraint that has in consequence attached itself to the European Central Bank (ECB), which has found itself unable to aggressively cut key interest rates in the manner of the US Federal Reserve. Thus, the US Fed has slashed the federal fund rate between January 2001 and November 2002, from 6.5 to 1.25 per cent, a cumulative cut of 525 basis points (bps).
In contrast, the ECB has reduced its marginal lending facility from 5.75 per cent in May 2001 to 3.5 per cent in March 2003, a cumulative cut of 225 bps, still leaving the rate much higher than US short-term rates. The compulsion was the greater commitment of the ECB to inflation containment, unlike the US Fed which operates on a more flexible charter, and the strained finances of key EU governments.
It is a moot issue today whether more aggressive cuts by the ECB might have created more helpful conditions for economic recovery in the Eurozone. It is, however, certain that the extent to which the Euro has appreciated (and is likely to further appreciate in future) vis-a-vis the US dollar would have been less had the ECB rate cuts been more aggressive. It is also certain that this outcome will make the task of economic recovery in the Eurozone that much more difficult. It is more likely than not that the growth outcome in the advanced economies might under-perform even the modest projections made by multilaterals just a few months ago.
The only region to continue experiencing significant growth is Asia, where expansion of domestic consumption and investment demand will have to be the principal driving force in the current year and perhaps in much of 2004 as well.
The author is economic advisor to ICRA (Investment Information and Credit Rating Agency)