Pointers from Unctad

The 2004 trade and development report of the United Nations Conference on Trade and Development (Unctad) is curiously ambivalent in tone. On the one hand, the report says that world growth is expected to accelerate to 3.8 per cent this year from 2.6 per cent in 2003.

On the other, it says that the prospects for a sustained recovery are quite uncertain. The trouble is that while the world economy seems to be in fine fettle today, there are a number of imbalances and concerns that pose a major downside risk to the recovery.

The report points out that the world economy rests on the broad shoulders of the US consumer, and wonders whether her legendary appetite for consumption will continue this year. It says that domestic demand in the euro area continues to be stagnant.

It also says that much of the growth in the US economy so far has been the result of extraordinarily lax monetary and fiscal policies, and the question is whether growth will continue after the effects of these policies wear off.

Unctad points to the build-up of reserves in Asian countries as both cause and effect. Thanks to rising exports from these countries to the US, the reserves generated are invested back in the US by central banks, adding to liquidity and keeping interest rates low.

These low rates spur American consumers to take on more debt, which in turn leads to more exports from Asia. This seems to be a virtuous circle, helping Americans maintain their standard of living while keeping factories busy and adding to jobs in Asia. But it also results in a massive current account deficit for the US.

So far Asian governments have been perfectly content with this tradeoff in spite of a declining dollar. But, as Unctad points out, how long can this trade go on?

The report emphasises that as a result of the rapid accumulation of reserves, last year saw an overall net capital outflow of some $230 billion from developing and transition economies to the developed countries.

Also significant is the UN agency's point about the changing geography of trade. The report says, "A number of developing countries, especially in East and South Asia, are not only expanding their own manufacturing industries at a very rapid pace but also becoming important markets for a wide range of manufactures and commodities. Their growth is more energy-intensive and requires more inputs of metals and agricultural raw materials than growth based on an expansion of the services sector."

That's a concise explanation of why commodity prices, including oil prices, have hit the roof. Unsurprisingly, rising crude prices are yet another risk that Unctad underlines.

Significantly, the markets seem to mirror the ambivalence of the Unctad report. The uncertainty over the recovery has led to confidence that interest rates will rise very slowly in the US""and the result is that money is flowing back in a small way to emerging markets.

US bond yields have fallen, and emerging market currencies are strengthening. At the same time, growth in the US is strong enough to ensure that Asian exports do well.

It remains to be seen, however, whether these conditions will continue. Unctad warns that they cannot, without structural changes in the world economy.