The State of Food and Agriculture 1998

WORLD REVIEW

III. OVERALL ECONOMIC ENVIRONMENT AND AGRICULTURE

WORLD ECONOMIC ENVIRONMENT

The sudden, severe and largely unexpected financial crisis that erupted in mid-1997 in East and Southeast Asia has since then been a dominant feature of the current world economic environment.

The crisis first hit several of the fastest-growing economies in the world, more severely Indonesia, the Republic of Korea and Thailand, and to a lesser extent Malaysia and the Philippines (see Regional review, Asia and the Pacific). Underlying the crisis were massive capital inflows into these economies (encouraged by their previous impressive performances and what appeared to be solid exchange rate guarantees), which were inadequately allocated and supervised by the domestic banking systems and authorities.

A re-evaluation by investors of the sustainability of exchange rates in these countries, triggered in particular by mounting current account deficits in several of them, led to a sudden withdrawal of funds and an attack on their currencies. The ensuing crisis deepened throughout the second half of 1997, becoming far more serious than initially expected and spreading negative influences on financial markets, economic activity and trade worldwide. Such influences manifested themselves in the form of reduced private foreign financing, falling stock market prices and pressure on national currencies. For the countries affected, the policy measures adopted to restore market confidence and halt the foreign exchange drain – tighter monetary and fiscal policies – translated into reduced domestic demand and imports, the latter also being negatively affected by currency devaluations. Considerable uncertainty remains over the evolution of the crisis in the countries most affected and the worldwide repercussions it could have.

On the one hand, there are a number of positive features in the overall economic fundamentals. Economic activity has remained dynamic and domestic demand conditions are very favourable in much of the developed world – Japan being the major exception. Only moderate contractionary and disinflationary effects are to be expected from the crisis in the developed countries, with such effects also contributing to a reduced risk of overheating in several of them. In general, the developing countries also showed considerable resilience to the crisis after a severe initial shock for those whose macroeconomic imbalances made their economies vulnerable to speculation. For the five most affected economies, some observers suggest that a reasonably rapid export-led recovery may be expected, given the outstanding record of these countries as successful exporters; their strong currency depreciations; their excess capacity for exports, resulting from depressed domestic demand; and the fact that, for some of these five economies, a large share of total trade is accounted for by foreign multinationals, implying that a large part of their trade is sheltered from the financial turmoil.

On the other hand, fears remain concerning a possible extension of the crisis and, in the longer term, the likelihood of similar situations occurring with increasing frequency as a result of the growing globalization of financial markets and the often overreactive behaviour of investors and speculators. There is a danger that countries threatened by such speculative behaviour might adopt defensive policies countering previous reform efforts, thereby exacerbating the risks of financial turbulence, loss of investor confidence and depressed growth. These risks appear all the more serious for developing countries where the process of economic stabilization and reform is not yet fully consolidated.

Downward revisions of IMF forecasts for world economic growth in 1998 were greater for the developing than for the developed countries.

Largely because of the Asian crisis, prospects for world economic growth have weakened significantly. The International Monetary Fund (IMF) is forecasting world economic growth in 1998 to be barely more than 3 percent (a year earlier, projections for 1998 were 4.25 percent), compared with 4.1 percent in 1997.¹¹

Downward revisions were greater for the developing than for the developed countries, as the former generally suffered more from adverse terms of trade, capital outflows and more restrictive policy stances.
 

FIGURE 14A

GROWTH IN WORLD ECONOMIC OUTPUT
 

FIGURE 14B

ECONOMIC GROWTH IN DEVELOPING COUNTRY REGIONS
 

Despite the trade-depressing effects of the financial turmoil in Asia, according to estimates by the World Trade Organization (WTO), in 1997 the volume of world merchandise trade accelerated to 9.5 percent, the highest rate recorded in more than two decades, with the exception of 1994. Much of this strong increase reflected the dynamism of economies in North and South America. Thus, in line with a well-established historical trend, merchandise exports expanded much faster than world output (see Figure 15). Measured in current dollar terms, however, world trade growth decelerated between 1996 and 1997, from 4 to 3 percent, reflecting the appreciation of the US dollar vis-à-vis the currencies of the major trading nations in Western Europe and Asia.

Growth of world trade is forecast to fall from 9.4 percent in 1997 to 6.4 percent in 1998, with a large decline in the developing countries (from 12.1 to 5.2 percent).

The limited impact of the Asian situation on world trade in 1997 reflected the fact that the crisis only deepened in late 1997 and there had not been time for its effects to filter through to trade developments. Trade prospects for 1998 remain uncertain but a significant slowdown appears likely. IMF forecasts a decline in the growth of world trade (in volume) from 9.4 percent in 1997 to 6.4 percent in 1998, with a large decline in the developing countries (from 12.1 to 5.2 percent). One source of uncertainty is the pace and strength of economic recovery in Japan, a major actor in world trade.

Convergence in the areas of inflation, public finances and interest and exchange rates should help strengthen the economic performance of prospective EMU members.

For the IMF-defined advanced economies, growth in 1997 was 3 percent and is projected to slow down to 2.4 percent in 1998. The United States staged a very favourable economic performance in 1997, with the fastest growth in nine years, the lowest inflation rate in three decades, the lowest unemployment level in over two decades and virtually a federal budget balance for the first time since the early 1970s. Prospects for 1998 are for a deceleration in growth to 2.9 percent from 3.8 percent in 1997. Growth in the EU was less dynamic – 2.6 percent in 1997 and a projected 2.8 percent in 1998 – with wide divergences in cyclical positions. A group of countries, including Denmark, Finland, Ireland, the Netherlands, Norway, Spain and the United Kingdom, achieved fast growth in 1997, while economic activity strengthened only moderately in France, Germany and Italy, where unemployment problems remained serious. The dominant economic issue in Europe is the European Monetary Union (EMU). In May 1998, it was decided that 11 out of the 15 EU Member States would join EMU at its outset in 1999. Stage 3 of EMU is due to begin in January 1999 with the locking of exchange rates. Convergence in the areas of inflation, public finances, interest rates and exchange rates will create a firmer basis for strengthening the economic performance of prospective EMU members, but structural rigidities in labour markets remain a major challenge in several countries.

In Japan, the depressed economic conditions in 1997 are expected to accentuate in 1998, current prospects being for zero growth this year. The signs of recovery that had been seen in Japan in 1996, after four years of stagnation, proved short-lived. A number of largely interrelated factors – fragilities in the financing system, weakening asset prices and budgetary cuts – contributed to this outcome. Reduced demand from, and competitiveness vis-à-vis, neighbouring trading partners affected by the crisis also contributed to a weakening in Japanese exports.
 

FIGURE 15

GROWTH IN WORLD OUTPUT AND VOLUME OF TRADE
 

With the encouraging exception of Africa, the developing countries are expected to share in an estimated deceleration of growth, recording the lowest rate since 1990.

For the developing countries as a whole, growth is estimated to decelerate from a robust 5.8 percent in 1997 to 4.1 percent in 1998, the lowest rate since 1990. All the developing country regions are expected to share in the slowdown, with the notable and encouraging exception of Africa. Other than the Asian economic crisis, negative movements in commodity prices and terms of trade, factors contributing to the slowdown included the effects of the El Niño phenomenon and strengthened measures to stabilize domestic and external balances. Merchandise trade remained dynamic in 1997, growing in volume by nearly 11 percent on the side of exports and by 12 percent on the side of imports. Nevertheless, exports and, more markedly, imports are expected to be less dynamic in 1998, and a deterioration in terms of trade is also expected this year after three years of improvement. After three years of dramatic decline, developing countries’ inflation rates are forecast to increase from 8.5 in 1997 to 10.2 percent in 1998, mainly reflecting  sharp price increases in the Asian countries hit by the crisis. In both Africa and Latin America and the Caribbean, on the other hand, the increase in consumer prices is forecast to decelerate further in 1998. Many developing countries have also achieved considerable progress in restoring fiscal balances; for these countries as a whole, central government deficits fell from more than 3 percent of GDP in the early 1990s to 2.2 percent in 1997, although some increase in the deficits is expected in 1998 (see Regional review).

For the first time in eight years, the economies in transition as a whole showed positive growth in 1998.

The economies in transition also experienced financial market difficulties associated with the Asian crisis, since the currencies of several countries came under attack and required tightened fiscal and monetary measures. The most affected were Estonia, the Russian Federation and Ukraine. However, for the group as a whole, economic activity remained on an upward trend. The Russian Federation and the other economies in transition showed positive growth in 1997 (1.7 percent) for the first time in eight years. Prospects for 1998 are for an acceleration in growth, to around 2.9 percent, with none of these economies experiencing a decline in economic activity. Higher interest rates and reduced access to foreign capital are expected to lower growth in the Russian Federation and Ukraine, but growth prospects appear to have improved in Hungary and Poland, thanks in particular to strong export growth. Consumer price increases are also expected to decelerate further, most dramatically in Bulgaria and Romania, although inflation rates in these and many other transition economies remain very highs.
 
 

Implications for developing countries’ agricultural growth and trade

Developments in East and Southeast Asia are important to agriculture because of their immediate implications for commodity markets.

The above trends and features suggest a generally favourable economic environment for agricultural output and trade. As already mentioned, however, major uncertainties remain regarding the course of events in East and Southeast Asia and repercussions worldwide. Developments in this region are important to agriculture, not only for their indirect effects on world economic activity but also because of their immediate implications for commodity markets. Indeed, the Republic of Korea and ASEAN-4 countries (Indonesia, Malaysia, the Philippines and Thailand) account for a sizeable share of world consumption of some commodities. The general reduction in import demand in these and other countries affected by the crisis, together with higher import costs resulting from devaluations and reduced credit for financing imports, were important factors contributing to the decline in commodity prices during much of 1997/98 (see Current agricultural situation  –  facts and figures, 6. International agricultural prices). Export incentives arising from currency depreciations, along with larger export supplies arising from reduced domestic demand, also affected the supply of certain commodities, exerting downward pressure on prices. The crisis reduced Asian demand in particular for maize, bovine meat, soybean meal, temperate fruits, cotton and hides and skins, while boosting the region’s exports of tropical fruits and rubber (see Regional review, Asia and the Pacific).
 

FIGURE 16

COMPOSITION OF EXTERNAL DEBT OUTSTANDING

Other current features determining the agricultural outlook are the unusual weather conditions that have prevailed during much of 1997/98, largely as a consequence of the El Niño phenomenon, and an agricultural situation characterized by ample supplies in relation to demand for many commodities. The El Niño phenomenon has attracted much media coverage and raised general concern about its immediate and prospective impact on food and agricultural supplies. However, while the phenomenon has caused considerable losses in crop and livestock production and created food emergency situations in various parts of the world, its overall impact on commodity supplies and international prices has been limited. On the contrary, important crops such as grain have benefited from favourable weather conditions in 1997/98 and prospects for 1998/99 also appear favourable, suggesting downward pressure on prices as seen above.

Overall, prices of major foodstuffs and raw materials are likely to be weak throughout 1998, followed by a gradual stabilization of markets and resumption of moderate price increases at a later stage. Prices of coffee are expected to be substantially below the peak levels of 1997 owing to expectations of larger crops in 1998/99; sugar prices could remain relatively low because of an expected increase in production in 1998/99 and slower growth in import demand in some leading Asian markets affected by the financial crisis as well as in major importing countries such as China  and the Russian Federation. However, over the long term, import demand is expected to be stimulated by the lower price levels. Cotton prices, which declined in 1997/98, are expected to stabilize in 1998/99 while natural rubber prices are expected to be depressed in dollar terms, at least in the short term. On the other hand, prices of jute may be expected to rise from the exceptionally low levels of 1997/98 and market conditions should remain generally tight for cocoa.

Over the medium term, the expectations are for a general pattern of economic stability and resumed economic and trade growth.¹²

 Project LINK projections¹³ for agricultural growth and trade for 1998-2002 in the developing country regions suggest the following:

After a temporary slump in 1998, agricultural output in the developing countries is expected to regain dynamism in the coming years.

• After a temporary slump in the course of 1998, agricultural output in the developing countries as a whole is expected to regain dynamism in the coming years. Overall, the average growth rate of agricultural output during the period 1998-2002 is forecast to be about 3.9 percent, close to that of 1991-97 and above longer-term trends (3 percent during the 1970s and 3.5 percent during the 1980s).

• All the developing country regions except Asia and the Pacific are forecast to raise average growth rates above those of the 1990s. The improvement would be more pronounced for Latin America and the Caribbean, where agricultural output would rise by an average yearly rate of nearly 4 percent annually, up from the mediocre 2.8 percent recorded during the period 1990-97. For sub-Saharan Africa, following two bad crop years in 1997 and 1998, production is expected to rebound to rates comparable with those of 1993-96, a period of relatively high growth for the region’s agriculture. Forecasts for the Near East and North Africa region also suggest somewhat better average performances than during 1990-97. For Asia and the Pacific, the projected slowdown to 3.8 percent (from about 4.6 percent during 1991-97) would largely stem from depressed performances in East and Southeast Asia, particularly in 1998 and 1999.

• After having expanded at a vigorous 9 percent yearly rate during the first half of the 1990s, developing countries’ agricultural export earnings are estimated to lose momentum in 1997 and 1998, mainly reflecting weak international commodity prices. Barring unforeseeable economic and market events, agricultural trade is expected to recover to growth rates of about 6 percent yearly over 1999-2002. Nevertheless, agricultural trade growth would continue to lag, by two to three percentage points, behind that of merchandise trade as a whole.

• Prospects for agricultural export growth over 1999-2002 appear particularly favourable for Latin America and the Caribbean, although Asia and the Pacific – especially China – and to a lesser extent Africa would also share in the improved outlook. With agricultural exports and imports following similar trends, no major changes are expected in developing countries’ agricultural trade balances overall. Notably, however, sub-Saharan Africa is expected to strengthen its surplus position somewhat, continuing a trend initiated in 1993 (in 1992 the subregion had actually become a net agricultural importer).

• According to IMF forecasts, developing countries’ total terms of trade may be expected to deteriorate by a cumulative c. 2 percent over 1997 and 1998 and improve somewhat in 1999. LINK forecasts suggest a similar pattern for agricultural terms of trade, which would deteriorate markedly in 1998 and broadly stabilize in the following years up to 2002.
 

LIFDCs with the lowest capacity to finance food imports¹⁴

Economic estimates for the LIFDCs with the lowest capacity to finance food imports indicate a major improvement in their economic situation in recent years which is expected to continue in the short term.

The economic situation and prospects of this group of poor countries, for which food imports represent a particularly high share of total export earnings and total imports, is periodically reviewed in The State of Food and Agriculture. Economic estimates and short-term (1998-99) forecasts for these countries, as prepared for FAO by IMF, indicate a major improvement in their economic situation in recent years which is expected to continue in the short term at least. Taking as a reference the periods 1991-95 and 1998-99, the forecasts point in particular to the following developments:

• An acceleration in GDP growth, from an annual average 3.2 percent in 1991-95 to about 5.5 percent in 1998 and 1999. Such an acceleration would be sustained by a significant increase in gross capital formation, from an equivalent of 17.8 percent of GDP to more than 20 percent during the same period.

• A two-thirds reduction in inflation rates, from 18 to 6 percent.

• Major progress in fiscal stabilization, with deficits in central governments’ fiscal balances falling from an equivalent of 6 percent of GDP to slightly above 3 percent.

• A reduced debt burden, with debt-service payments as a share of total goods and services exports falling from around 29 to 13 percent. This would result both from improvements in export purchasing capacity and from the extension of special debt-relief initiatives, such as that agreed in May 1998 by the Group of Eight (G8) industrialized economies in favour of the world’s poorest countries – several of which are in this group.

 However, the picture appears less bright with regard to external balances. These countries are expected to face increasingly large trade deficits (from $20 billion to $30 billion), which would be only partially compensated by increased aggregate net transfers (largely in the form of net official development finance in favour of African countries in the group). The overall current account balances, which are in chronic deficit in these countries as a whole, would see such deficits rise from an average $6 billion to nearly $13 billion. Nevertheless, they would see their terms of trade stabilize after a long period of unfavourable trends (from 1987 to 1993), while the purchasing power of their exports would continue to expand significantly, thanks to larger export volumes, after the large gains recorded in 1995 and 1997.

Measures aimed at macroeconomic stabilization and reform in some countries and the end of war and civil strife in others have contributed to the improved outlook for these LIFDCs.

After a long period of depressed performances, the improved economic situation and outlook – and therefore food security – of these countries in recent years is most encouraging. That such improvement was achieved, despite the depressing effects of the Asian economic crisis worldwide and less than favourable movements in external accounts, suggests that domestic factors had a strong offsetting impact.¹⁵ These included determined efforts aimed at macroeconomic stabilization and reform – namely in Egypt and the seven CFA countries in the group, where the initial shock of currency devaluation and accompanying measures gave way to a period of rapid growth – and the end of wars and civil strife in countries such as Mozambique, Nicaragua and Rwanda – although the recent armed confrontation between Ethiopia and Eritrea was a warning that conflict may lie latent in countries of this group, which is still afflicted by political tensions, unresolved collective and ethnic identities and economic and social frustration.

The weakening of commodity prices in the wake of the Asian crisis and expectations of continued depressed prices for some commodities will have asymmetric effects on these economies. On the one hand, lower food prices in international markets will have an immediate positive effect on economies heavily dependent on food imports. On the other hand, somewhat paradoxically, the export sector in these countries is also agriculture-based in many cases. For instance, for countries such as Ethiopia, Rwanda and Sierra Leone, where coffee is a major export item, depressed prices of this commodity mean significant losses in export earnings and uncertainties over growth prospects in the short term.