World trade 2007, prospects for 2008

According to the economist of the World Trade Organization,World trade growth has come down to 5.5% in 2007 from 8.5% in 2006 and isexpected to be at 4.5% in 2008 - as sharp economic deceleration in key developedcountries is only partly offset by continuing strong growth in emergingeconomies.

Due to volatile market conditions, the preliminary assessment of 2007 trade figures and forecasts for this year have been unusuallydifficult to gauge, WTO economists cautioned.

The financial market turbulence, which has considerablyreduced economic growth projections for some major developed markets, hasclouded the prospects for world trade in 2008.

The present economic growth forecast for these markets is1.1%. For developing countries, growth is forecast at above 5%. Together thesecould result in world output growth of 2.6% and a global trade expansion ofabout 4.5% in real terms that is, discounting inflation.

 
The preliminary figure of 5.5% trade growth for 2007 is slightly lower than the6% forecast for 2007 this time last year. The global economy and world tradestarted to slow down in 2007 due to the deceleration of demand in the developedregions. North America showed the weakest growth in output, measured as grossdomestic product (GDP).

Developing economies and the Commonwealth of Independent States (CIS) region,however, maintained or strengthened their expansion of output, contributingmore than 40% of world output growth in 2007. Developing countries' share ofworld merchandise trade (exports plus imports) reached a new record level of34% in 2007.

These two groups of countries are expected to record faster growth in importsthan exports; together they are expected to contribute more than one half ofglobal import growth in 2008.

The sharp rise of commodity prices - particularly fuels and metals - greatly improved the financial situation of most developing regions and boosted imports. But, higherenergy and food prices translated into inflationary pressures worldwide.

Significant variations occurred among major currencies, but not all exchangerate movements were helpful to redress global imbalances. While Europeancurrencies appreciated vis-à-vis the US dollar, changes in the currencies ofAsian economies with large current account surpluses had a mixed impact.

The decline of the US dollar in relation to the euro and other Europeancurrencies inflated the dollar values of international trade transactions. Thedollar value of world merchandise exports rose by 15% to $13.6 trillion, andthat of commercial services by 18% to $3.3 trillion in 2007.

In real terms with adjustment for price and exchange rate changes realmerchandise exports were up by 5.5% in 2007 compared to 8.5% in 2006.

Situation in 2007

Growth in world output and trade decelerated in 2007. Weaker demand in the developed economies reduced global economic growth to 3.4% from 3.7%, roughly the average rate recorded over the last decade. At some 7%, growth in the developing regions was nearly three times the rate recorded in the developed regions.

Economic expansion in the least-developed countries fully matched the growth rate recorded by developing countries as a group in 2007, sustaining a pattern that has been maintained since 2000.

The contribution of the developing countries to global output growth in 2007 exceeded 40%. Domestic demand weakened sharply in the United States, which reduced the external deficit and led to the weakest annual GDP growth rate (2.2%) since 2002. A further widening of the external surplus contributed to more than one half of Japan's 2.1% GDP growth rate in 2007.

Europe recorded GDP growth of 2.8% - a somewhat better performance than both Japan and the United States last year. Stimulated by sharply higher export earnings and rising investment, Russias economic growth of 8% was the strongest annual rate since 2000.

In Central and South America, Africa, the Middle East and developing Asia, economic expansion rates showed no signs of deceleration in 2007. The most populous developing countries - China and India - continued to report outstandingly high economic growth.

Investment

The favourable investment climate maintained in developing regions and the Commonwealth of Independent States more than offset the adverse effects of financial market turbulence, especially that arising from the US sub-prime market crisis in the second half of 2007.

Despite the adverse effects of scarce credit on the volume of mergers and acquisitions, global foreign direct investment (FDI) flows continued to rise. The UN Conference in Trade and Development (UNCTAD) provisionally estimated that global FDI inflows rose by 18% to $1.54 trillion in 2007.

Foreign direct investment flows to Latin America (e.g., Brazil, Chile and Mexico) and Russia have been particularly strong (50% and 70% respectively). FDI flows to developing Asia and the new EU member states are estimated to have seen less dynamic growth in FDI inflows in 2007 than in the past.

Exchange rates and inflation

Variations in the exchange rates of major traders in 2007 did not always result in effective exchange rate developments conducive to a reduction in global imbalances.

While the US real effective exchange rate depreciated and contributed to a smaller current account deficit relative to its GDP, the real effective exchange rate of a number of current account surplus economies in East Asia (such as Japan, Chinese Taipei, Hong Kong, China) also decreased, contributing to new peak levels in the ratios of their respective current account surpluses to GDP in 2007. The real effective exchange rates of the Chinese and Singaporean currencies appreciated by 2% and 7% respectively in 2007, without arresting the rise in their respective current account surpluses.

The real appreciation of the euro had differing consequences for the export performances of euro-zone economies. Thanks to a 20% increase in its exports, Germany remained the worlds leading exporter of merchandise.

The length of the global upswing and the strength of economic activity outside the industrial regions contributed to a further rise in the price of fuels and pushed up domestic inflation rates. At the end of 2007 consumer prices in developed and developing economies were increasing faster than at the beginning of the year, by about 1 and 2 percentage points respectively.

Trade

Weaker demand in the developed countries provided a less favorable framework for the expansion of international trade in 2007 than in preceding years. Consequently, world merchandise exports grew in real terms (that is, at constant prices) by only 5.5%, compared to 8.5% in 2006.

Lower import growth than in the preceding year was observed in North America, Europe, Japan and the net oil importing developing countries in Asia. This downward trend outweighed the higher import growth observed in Central and South America, the CIS, Africa and the Middle East. It is estimated that the developing countries as a group accounted for more than one half of the increase in world merchandise imports in 2007.

Among the leading traders, China's (real) merchandise trade expansion remained outstandingly strong in 2007 as lower export growth to the US and Japanese markets was largely offset by higher export growth to Europe and a boom in shipments to the net-oil-exporting regions. Despite a booming domestic economy, weaker demand in some of China's major export markets and a moderate real effective appreciation of the yuan, import growth continued to lag behind export growth.

 
Trade prospects for 2008

Recent developments cloud the near-term prospects for the world economy. Among these developments are widely held expectations of recessionary tendencies in the United States, weaker demand growth in both Europe and Japan, a rise in inflation and depressed global stock markets.

More positive news comes from developing countries and the Commonwealth of Independent States (CIS), where strong output and trade growth are predicted. Uncertainty arises as to how long the developing countries can maintain a strong pace of economic growth in the face of sluggish demand in the major developed markets and rising inflationary pressures.

The central projections retained by major institutional forecasters indicate a further deceleration in world economic growth in 2008. If turbulence in international financial markets could be contained soon, and its impact on the real economy limited, world output could still grow at 2.6% (GDP measured at market exchange rates).

Domestic demand in the United States stagnated in the fourth quarter of 2007 and may shrink in the first half of 2008. Imports of goods and services contracted between the third and fourth quarter in 2007 (seasonally adjusted) and are likely to decrease further quarter-to-quarter in the first half of 2008. Exports, however, are expected to grow, sustained by a strong real effective depreciation and excess capacity in the US economy caused by sluggish domestic demand.

The slowdown in GDP growth in Europe is expected to be less pronounced than in the United States, maintaining developed country economic growth at slightly above 1% in 2008.

Despite signs of weaker demand in the United States and Europe in recent months, commodity prices started to rise faster again, helping to sustain short term growth prospects in most developing regions and the CIS.

In addition, these regions' reliance on developed markets for their exports has markedly decreased over recent years, which should limit the adverse effects of lower import demand from the developed countries. Foreign exchange reserves increased sharply and external debt levels have been reduced.

These trends should help developing countries and the CIS to maintain high investment and consumption levels, even if there is some softening of commodity prices in the second half of 2008. Overall, it is expected that GDP growth in developing countries and the CIS may be maintained at a level above 5% and import growth above 10% in 2008. Broadly, this is a positive picture for developing countries as a whole. But it has to be qualified because the picture is different in many low-income food-deficit countries due to the recent sharp increase in food prices. As the prices of major cereals doubled on international markets between mid-2007 and March 2008 many developing countries are concerned about food security and a sharp rise in their import bill in 2008. Given the large share of food in the consumption of the poor in these countries, there is a risk that higher food prices could lead to an increase in poverty.

The political consequences of higher food prices are already being felt through civil disturbances in some countries. This situation poses grave challenges for governments. On the other hand, the UN Food and Agriculture Organization expects world cereal output to increase by 2.6% this year, which, if realized, could ease the situation somewhat in the second half of the year.

Assuming a basic scenario of global GDP growth between 2.5% and 3%, global merchandise trade could slow down to about 4.5% in 2008, or about 1 percentage point less than in 2007. This estimate is supported by the results of the WTO Secretariat's time series forecasting model which predicts a slowdown in the OECD area's imports of goods and services to 3%, a further 1.5 percentage point decrease from the already subdued rate observed in 2007.

This pessimistic outlook must be seen in the context of further significant downside risks, as foreshadowed by the severe declines in business sentiment captured by the Information and Forschung (IFO) economic climate indices for the euro area and the world as a whole.

Real GDP and trade growth of OECD countries, 2006-07
% changes, year to year

Source: OECD National Accounts

The risks attached to this scenario turn primarily on financial market developments. The repercussions of the dramatic downturn in the US property market has spread to other financial sectors (eg, investment banking), spilled over to the private international banking system, and curtailed bank liquidity as inter-bank lending dwindled to a fraction of the level before the outbreak of the crisis. Some major stock markets have lost about one quarter of market capitalization from their peak in 2007.

A sharp cut in US interest rates brought only short term breathing space for the financial markets but caused havoc on the exchange and commodity markets in the first quarter of 2008 as holders of dollar assets tried to limit their exposure to a likely further decline in the currency. The dollar reached record low levels against major currencies and oil and gold prices attained historic peak levels.

The adverse consequences of turmoil on financial markets will not only affect US demand growth but also lead to further downward revisions in economic growth for Japan and Western Europe. As world trade responds strongly to variations in global economic activity a stronger than projected deceleration in world economic growth could cut trade growth much more sharply, to significantly less than the 4.5% predicted above.

Source: AEPC newsletter