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IMF forecasts
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IMF forecasts: growth withstanding almost all odds but trade imbalances threatening
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IMF expects growth to continue despite natural disasters and rise in oil prices.
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In its forecasts for the world economy in September, the International Monetary Fund (IMF) held to its growth forecasts for 2006 put at 4.3%. In 2005, growth of 4.3% is also expected. World growth is proving firm, a firmness which is solidly resisting high oil prices and natural disasters such as the tsunami and hurricane Katrina. Manufactures and trade, which were weak at the beginning of 2005, began to recover in the second half-year.
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United States and China act as world engines.
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Nevertheless, this growth is more and more out of balance. The United States and China continue to be the engines of the world economy, even more so than six months ago. For the United States, somewhat lower growth (3.3%) is expected in 2006 with the effects of hurricane Katrina being very limited in 2005 with growth of 3.5% dropping only one decimal compared with that anticipated last April. China is moving ahead more strongly than expected. All other areas have seen growth prospects reduced, with the exception of Japan and India.
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While Spain grows, Europe stagnates.
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While China grows more and more Europe is growing less. Prospects for growth of the euro area have been revised downward both for 2006 (1.8%) and for 2005 which stands at a poor 1.2%. In cases such as France and Italy, the downward revisions are especially drastic. Growth prospects for the United Kingdom have also been revised downward. Spain is one of the exceptions to the slack in Europe and its growth forecast for 2006 remains intact at 3.0%. A figure of 3.2% is expected in 2005 with a rise because of revisions in the preparation of the National Accounts.
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United States
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United States maintains stable growth
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United States grows by 3.6% but expecting some effects of hurricane Katrina on consumption.
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Up until the arrival of hurricane Katrina, the US economy was showing a level of notable activity with maintenance of high growth levels following the peaks seen last year. The manufacturing sector continued to be the weakest in the production fabric. Inflationary pressures increased slightly in August although still far from alarming levels. Few indicators are yet available to evaluate the macroeconomic effects of that disaster but the biggest effect over the short term will be on private consumption.
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In the second quarter, the US economy grew somewhat less than had previously been published. Even so, following the second set of estimates from the Bureau of Economic Analysis, the GDP held to a rate of increase of 3.6% year-to-year. Private consumption and investment continued to show a vigorous trend with very slight decreases from the first estimates. It was the imports component, however, which showed the biggest changes, in this case upward. The sharp decrease in inventory levels and the subsequent need to replace them, made likely an increase in imports which seems to already have begun at the end of the quarter.
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Retail sales continue to grow but Katrina tragedy already affecting confidence indicators.
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On the demand side, many indicators still did not show the effects of the hurricane. Among these indicators, retail sales for August which, while down from July, continued to show a generally very strong level. The month-to-month decrease was due to the poor trend in the erratic motor vehicle sector. Even so, the indicator was 7.9% above sales recorded in the same period last year. The Katrina tragedy could again put US consumer confidence to the test and will likely increase fuel prices bringing about a loss of purchasing power that could have consequences in retail consumption. The fact is that neither high oil prices nor the poor trend in wage purchasing power have reduced consumer strength, probably due to existing borrowing facilities, and the rise in housing prices. In this respect, the consumer confidence index published by the University of Michigan lowered the index level in September to 76.9 points from 89.1 in August. This drastic drop thus reflected the effects of Katrina.
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Industrial production remains weak and manufacturing executives show least optimistic.
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On the supply side, there was a continuation of the poor state of the industrial and manufacturing sector which still represented the weakest point in a generally vigorous economy. In August, industrial production moved up by a meager 3.1% year-to-year, very much along the poor lines seen in recent months. In a similar way, corporate prospects went back to the area of indecision with the manufacturing activity index, put out by the Institute of Supply Management, in August dropping to 53.6 points. This meant a loss of the recovery seen the month before taking it back to close to the 50.0 level, which inicates that there are as many optimists as pessimists. The counterpoint came in the non-manufacturing index which rose sharply to the 65.0 points level.
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Housing remains strong and for some people acts as support for economy giving sensation of wealth while others see it as bubble about to burst.
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The strength of the housing sector deserves separate consideration. For some, it acts as a support for the economy giving a sensation of wealth to homeowners while helping to finance household consumption. For others, it represents a bubble about to burst. The Federal Reserve would look kindly on some moderation in the sector which up until now is very slow in coming. While the sales of existing housing rose by a modest 4.0% year-to-year in July, sales of new housing grew by 27.7%. Existing housing prices also rose strongly by 14.6% year-to-year. Only the early indicator for building permits showed a slight drop.
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Jobs being created but wages remain static.
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The United States continued to create employment in August but the trend in wages remained weak. While new job creation was lower than in the month before, the upward revision of the latter compensated for this. In any case, if we take into consideration the nature of the indicator and the trend in recent months, it may be stated that job creation is in good shape. The situation in purchasing power of wages is somewhat different with a loss of 1.1% in August compared with the same period last year. As a result, the noose on retail sales is getting tighter. Consumers with lower purchasing power end up buying less. If we add to this the foreseeable increase in petrol, worsened by the destruction caused by the hurricane Katrina, at least some US consumers will have lower shopping budgets.
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Energy prices not being felt in rest of economy but concern lies in drop in productivity and increase in unit labour costs.
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Inflation in August continued upward because of energy prices. Nevertheless, the influence of these in other sectors of the economy was quite slight. The general consumer price index rose to 3.6% year-to-year but the index, excluding energy and food, held at 2.2%. If on the consumer prices front things seem to be in order, downward revisions in labour productivity are more troubling. Lower growth in productivity to make a specific product implies increased growth of costs per product unit. As a result, unit labour costs which are being closely watched by the Fed, rose by 4.3% year-to-year, the highest rate since 2000. All of this gives a bigger inflationary bias to the US economy although we still cannot speak of problems in prices.
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Trade deficit takes a short breather while replacement of inventories stands in way of reduction over short term.
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The end of the problems in the foreign sector is still a long way off. While the July trade deficit was slightly lower than that in June, this is still the third month with a higher deficit. The current account balance in the second quarter represented 6.3% of the GDP, somewhat lower than the record for the previous quarter but far from meeting any change in trend. If we take into account the replacing of inventory levels mentioned above, which partly has to come through imports, the reduction of the deficit is still a far-off challenge.
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Japan
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Japan gets going
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2005 is becoming the year of Japan’s recovery. While in 2004 the economy went down, this year the opposite is happening. On top of a situation that is gradually becoming more favourable comes the victory of the reformist ex-prime minister Koizumi which ensures the continuity of structural reforms. Both the IMF and the Japanese Central Bank see the future with some optimism although the average consumer with centuries-old pessimism does not see things that way.
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Japan now growing at 2.2% and victory of reformist Koizumi could give boost to economy.
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In the second revision of Japan’s GDP, growth in the second quarter showed a notable upward revision to reach 2.2% year-to-year. The foreign sector and the change in inventories were the components to contribute to increased growth. Private consumption eased somewhat although it should be remembered that growth of 1.5% year-to-year is still high for an economy such as that of Japan.
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Retail sales remain strong while machinery orders recover from lethargy but industrial production fails to follow.
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The most recent demand indicators show a somewhat more reticient picture of this recovery. Retail sales in July took a breather following three months of very strong activity. Car sales did the same, dropping for the second consecutive month. Even so, in both indicators we continue to see an upward background trend.
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It was on the supply side where the biggest boost to recovery could be seen. Machinery orders, which for the central bank mean the prelude to investment, took off in July with a decided advance on the growth path showing an increase of 7.4% year-to-year, twice the rate for the previous month. The number of companies going bankrupt continued low compared with the average in recent years. The dark cloud in supply showed up in industrial production in July which continued to languish with a drop of 1.1% year-to-year.
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Housing costs beginning to rise.
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The housing market also joined the generally upward trend in August. The number of housing units sold in Tokyo moved upward and average prices especially stepped up sharply. What is notable here is that, particularly in prices, there is now a clear trend to sustained growth which is gradually taking the Japanese economy out of one of its most fearful phases in the recent past when the weakness in the real estate market played a very important role in the stagnation dominating a large part of the Nineties.
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Shadow of deflation remains in spite of good prospects.
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Another problem in the Japanese economy that has still not completely disappeared is deflation, the downward trend in prices with the effect of inhibiting spending. Many experts agree that by the end of the year prices will be rising but for the moment prices in July continued to drop by a mere 0.3% year-to-year.
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Unemployment low but productivity improvement also poor.
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In the labour market, the unemployment rate stood at 4.4% of the labour force. This indicator has a positive note but the poor trend in labour productivity is troubling. In July, this again was down to stand at clearly lower levels than at the beginning of 2004.
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Trade surplus continues to drop because of lower demand from China.
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The final doubt in this positive picture comes in Japan’s trade surplus which, in July, continued to move down. This worse situation was practically entirely due to the reduction in exports to China and not to any weakness in Japan’s competitive situation. Services and inflows from foreign investment, on the other hand, helped to compensate this reduction until things improved.
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Oil and growth
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What impact do higher oil prices have on the GDP and inflation?
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Conventional economic wisdom on the expected impact on a rise in the price of oil maintains that the two most immediate consequences for countries importing crude oil are a reduction of income and an increase in inflation. Up to this point, practically all economists would be in agreement. Now, the most interesting question lies in quantitatively expressing that impact on both variables. In this respect, two of the international institutions with the most proven world macroeconomic models, the International Monetary Fund (IMF) and the Organization for Economic Cooperation and Development (OECD), have carried out simulations setting out the impact numerically.
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In both cases, the level of the gross domestic product (GDP) in real terms and inflation (measured by the consumer price index – CPI) are compared with and without an increase in the price of oil. In the case of the IMF (see table) the simulation contemplates a rise of 20% in the price of oil compared with a starting situation and the effects over a period of five years are simulated, whereas the OECD supposes a variable behaviour in oil prices for the three years of the scenario but overall supposes growth of approximately 10%.
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If we look at the comparison for United States, Japan and the euro area, the results of the simulations by both institutions are similar. The IMF estimates that the increase of 20% in oil prices in the first year, on average for the five periods considered, would generate a reduction in the real GDP of 0.3% a year and an increase of 0.4% in the CPI both in the United States and the euro area, with Japan, as will be explained later, falling outside this pattern.
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In spite of the fact that the performance of both the United States and the euro area is similar, what is significant is the time difference. Whereas the US economy suffers a greater initial impact on income and prices than the euro area, over the whole scenario that impact eases with greater speed. On the other hand, in the euro area, the effect is lower at the initial moment but more persistent over time. Behind this different behaviour lies the greater flexibility of the US economy and more specifically the role of taxes on energy and fuels which are substantially higher on the Old Continent.
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Still much more different is the case of Japan, where the impact is substantially less, so that the reduction in the GDP and the rise in inflation are approximately half that in the other two economies. This is the result of the higher energy efficiency of Japan’s economy which is more than twice that of the United States and nearly 90% higher than that of the European Union.
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Let us now move from the simulation to reality going back a year and putting ourselves in the autumn of 2004. At this time, the IMF forecast that in 2005 the United States would grow by 3.5% and that inflation would be 3.0%. The oil price considered in that forecast was 37.3 dollars a barrel. One year later, the IMF revised its forecast. It now estimates that in 2005 the per barrel price will be 54.2 dollars, a rise of 46% compared with that initially foreseen.
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If we use the figures of the simulation given earlier we may conclude that the upward shift in crude oil prices would mean growth of less than 7 decimals for the current year and an increase in inflation of more than 1.8 percentage points, that is to say, the US GDP would grow by 2.8% and inflation would be 4.9%, always taking as reference the IMF estimates made in the autumn of 2004. On the other hand, what are the latest IMF forecasts? The United States will grow by 3.5% in 2005, that is to say, without any change compared with what was expected a year ago while inflation will be 3.1%, only one decimal higher. Apparently, oil has not taken its toll on income and inflation.
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While it may be argued that the utilization of the IMF simulations reviewed here suffer from some degree of simplification (in fact, a proportional effect is given to the starting figures), the truth is the distance between reality and simulation is too wide to justify it only in these terms. Something more is taking place and the models, which only take advantage of available statistical history and therefore the past, do not adequately reflect this fact.
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What is radically new in the macroeconomic picture now that was not present in the two previous oil crises? Basically, the way in which companies and consumers construct their inflation expectations. In contrast to the Seventies and Eighties of last century, the institutional design of the central banks (now highly independent) and the processes for setting wages (with the practical disappearance of wage indexing) ensure background stability in inflation which avoids the oil shock from bringing about a general increase in price levels in the economy.
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In addition, two factors end up bringing about a lower than expected impact. In the first place, the progressive opening up of international trade is facilitating the taking advantage of productivity gains in those countries where these are happening and their shift in the form of cheaper marketable goods to most economies on the planet. A second element is the current high volume of liquidity which makes it possible to maintain a level of spending which more than compensates for the effect on our income of more onerous oil imports. Unfortunately, this is a circumstantial factor which may thus stop acting as temporary relief from the shock of oil prices. Should the stage of expensive oil continue, the adjustment on income and inflation will tend to approximate what the economists’ models imply but still fail to meet.
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China and the three myths
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Surplus of the three myths and how China is now making watches
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If for macroeconomics there were to be an annual prize for the most outstanding figure, the trade balance of the People’s Republic of China would win in 2005. People attribute China with the disorder in raw materials and foreign exchange markets, responsibility for the US trade imbalance and crises in specific sectors, and on top of this the blow from the effect of flotation of the renminbi in terms of the dollar.
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It is understandable. China has burst into the global village. Up until June 2004, China’s trade surplus was showing a slight downward trend in keeping with the fact that, with its move into the World Trade Organization, foreign products would be able to enter its market with fewer difficulties. Since that moment the opposite has happened. The cumulative trade balance for 12 months between June 2004 and August 2005 multiplied by seven, an increase of 74.03 billion dollars. The distribution of this increase, both because of changes in China’s bilateral balance with various countries and because of products, presents us with three surprises: it is not only a question of the United States, nor of Chinese exports, nor of raw materials.
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By country and geographical area, the worsening of the US bilateral deficit with China would explain 46.4% of the increase in China’s trade balance. The first surprise, however, is that Europe would account for the same amount – another 46.0%. If we add 7.1% for the reduction of the surplus which Japan had with China, the increase is fully explained. The case of Germany deserves special mention because it alone accounts for 10.4% of the increase in the balance.
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The second surprise is that the main engine of the explosive increase in the surplus is the slowdown in Chinese imports and not an increase in its exports. The emphasis in the press on aggressive competitiveness coming from China’s exports, while not incorrect, hides the real cause of the increase in the surplus which lies not in what China is selling but in what it is not buying from the developed world.
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The third surprise comes from the fact that the slowdown in imports is due mainly to a drop in manufacturing imports. It is not that imports are down but that they are increasing to a lesser degree. In the twelve months ended in July 2005, China imported 65.7 billion dollars more in manufactures than in the same period the year before but in 2004 the increase had been 107.4 billion dollars, a much greater increase. In raw materials, in both cases, we are talking about figures close to 35 billion dollars.
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But there is still more. The manufactures which China is failing to buy are those with value added which supports the hypothesis that something is changing in China’s production fabric. The old idea about cheap labour and nothing else must be changed to cheap labour and something more. China had bilateral deficits with Germany and Japan, countries specializing in manufactures of high value added, as well as with South Korea which exports cheaper manufactures. In one year, the deficit from the first two has been drastically reduced and in the case of Germany has disappeared but the deficit with South Korea has risen sharply.
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Supporting this thesis, the sharpest decreases came in imports of precision instruments, musical instruments and watches, electronic equipment, high technology products and, deserving special mention, transportation equipment, imports of which are now dropping. As a result, the figures suggest that China is now beginning to make its own watches and cars, a situation very different from that China presented in the past.
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Brazil
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Brazil continues boom growth
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Brazil growing by 3.7% unaffected by political crisis.
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The severe political corruption crisis in Brazil for the moment is not affecting growth. The good news for the economy, however, comes in the foreign debt and the interest this generates, a constant sword of Damocles. The negative side is that the political crisis could weaken the government’s capacity to undertake reform. Latest monthly indicators have been weak but do not cloud the generally positive picture.
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Retail sales and industrial production scarcely grow.
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Brazil’s economy grew by 3.7% year-to-year in the second quarter leaving behind the slight gap shown at the beginning of the year. On top of relatively strong private consumption, recovering investment and a very favourable foreign sector came more vigorous public consumption which is regaining growth rates not seen since 2000.
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Brazil’s problem: it is obliged to grow for two basic reasons – to pay off its debt and maintain political and social stability.
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Nevertheless, recent monthly indicators for supply and demand make it necessary to view this positive trend in the national accounts with some caution. On the demand side, retail sales in July merely maintained their level and car sales were down in the same period. On the supply side, industrial production in July was practically stagnant with growth of 0.5% year-to-year. This clear slowdown puts the indicator back to the worst levels in 2003 and this is now following a downward trend. Industrial production of capital goods dropped and is showing a similar profile. Brazil’s problem is that it is obliged to grow for two key reasons: to pay its debt and maintain some political and social stability.
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On a more positive note, inflationary trends seem to be more and more under control with inflation in August easing to 5.0% year-to-year. Wholesale prices, in turn, held at 1.2%. While price moderation is no longer new, this does not mean it is less welcome in an economy in which average inflation in 2003 went above two digits and only a decade earlier was recording hyper-inflation. On the other hand, unemployment continued at 17.5% of the labour force and is still showing downward resistance.
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Brazil’s foreign sector continued to shine in August with a trade balance for the past twelve months close to 40 billion dollars, the biggest in the whole Latin American continent. Taking advantage of the improvement of the sector, direct investment, which had hit bottom in 2004, in July continued to show marked recovery.
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Primary fiscal surplus maintained but interest on public debt is major burden.
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Also showing positive, the primary balance for the public sector in the first quarter, which excludes payment of interest on the public debt, showed a surplus of 4.9% of the GDP. Nevertheless, if we add interest payments, the public sector showed a deficit of 2.6% of the GDP (which also meant an improvement over the past), this shows the enormous importance for Brazil of servicing its debt (7.5% of the GDP). As corollary to this improvement in the fundamentals of borrowing conditions, the initiative taken in issuing bonds denominated in reals and not in US dollars (as has been the case) is significant. In this way, currency risk is eliminated for the lender who holds both asset and liability in the same currency.
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Argentina
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Argentina running at top speed
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Argentina growing by 10% with strong investment and private consumption...
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Argentina is the country in Latin America growing most rapidly. The quick recovery of domestic demand coexists with a trade surplus and this represents an important success. Argentina’s two weaknesses are its foreign debt and the rise in inflation which now is close to two digits.
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...but foreign debt and inflation are to be watched.
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In the second quarter, Argentina grew by 10.1% year-to-year. Private consumption and exports are showing strong but the most significant component was investment which reported growth of 24.4% year-to-year. Argentina is a country in special need of investment and the fact that in the past quarter this component, for the first time, went above the high investment figures reached before the crisis is good news which should continue.
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Retail sales up 33% confirming recovery.
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Demand indicators show the spectacular recovery of Argentina’s economy. Retail sales in the Buenos Aires area grew by 33.6% year-to-year in July. Supermarket sales and car sales also showed strong growth although not as marked. With these growth rates, retail consumption now stands close to levels before the 2002 crisis and in the case of the Buenos Aires area has gone well above.
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Industrial production up by 6% and withstanding drop in steel.
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Supply indicators continued their upward path but less so than those for demand. Even so, industrial production grew by 6.4% in July. The mining industry and metals were the leaders and it should be borne in mind that, in recent months, steel production has dropped notably as a result of swings in world demand. The fact that industry is continuing to grow without hesitation in spite of the weakness of a component that had been very solid all through 2004 is another sign of the strength of the Argentine cycle. The unemployment rate in the second quarter dropped to 12.1%, a relatively high figure but far from the highs in 2002.
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As mentioned. consumer products are one of the clouds showing over this drive. In August, year-to-year inflation reached 9.7%, spurred on by energy and food prices. The concern is more for the trend than for the level. At this time. the Argentine figures are high and comparison with the inflation reached in 2002 could make the present figure seem rather small. Nevertheless, in the present context, in which inflationary pressures in the area are a thing of the past, the competition for foreign investment is rough and interest on the public debt weighs heavily, inflationary risks are a poor companion.
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The trade surplus is showing a halt in its downward move. In the twelve months up to July it stood at 11.17 billion dollars, which was below previous highs. However, in view of the strength of domestic demand which is pushing imports up, the very fact of having a surplus is already in itself a success.
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Raw materials
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Oil very close to all-time highs
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aOil stabilizes at 64 dollars a barrel in September, a level still too close to all-time highs, due to supply difficulties in ensuring delivery in a stage of strong demand.
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Following the sharp boost in prices in July and August, when they went up by 6% and 11% respectively, oil has now stabilized and in September swung in the range of 63-64 dollars a barrel for Brent quality oil. In any case, these levels are close to the all-time high recorded on September 1 (67.48 dollars). What is more important, there is still uncertainty about the capacity of supply to adequately satisfy the strong demand.
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As a result, even when the International Energy Agency reduced its estimates of demand for 2005 as a whole, which in principle should have partially relieved pressure on prices, other events counteracted this news. In the first place, there were doubts about the impact of the new hurricane Rita which could again have affected refineries in the Gulf of Mexico. At the same time, the decision of the Organization of Petroleum Exporting Countries (OPEC) to maintain present official production quotas ended up convincing economic players that conditions in the oil market are continuing the trend to increase prices.
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With metals in lead, other raw material prices also showing drive in demand.
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Other raw materials are showing a similar profile although not going to the same levels as oil. Raw material prices as a whole, measured by «The Economist» index in dollars, was 8% high in September than one year earlier. The group to rise most was metals with growth more than double the global index. At the opposite extreme we find non-food agricultural raw materials with growth of only 2% year-to-year. Behind this trend we basically see the sharp increase in demand coming from a world economy which clearly continues to grow.
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