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Global Economy
1.1 Global economic growth remained strong
in 2004 (January to December), aided by
expansionary monetary policies and comfortable
financial conditions1. Global growth, which was
robust during the first half of 2004, slowed down
somewhat in the latter part of the year, reflecting
the impact of a sharp rise in commodity prices
and the fear of disorderly movement of currency
adjustments. However, the global economy grew
by nearly 5 per cent in 2004, the highest rate for
nearly three decades. The US and the emerging
Asia accounted for more than half of the increase
in global output. Growth in the euro area and
Japan registered a much lower growth. With
moderation in the global growth in the second half
of 2004, growth differentials among different
regions widened. While the US was able to sustain
its growth on account of increased corporate
spending and stronger job creation, the euro area
and Japan faced renewed weakness. Large and
persistent growth differentials in the growth
pattern in different regions led to a significant
widening of global financial imbalances.
1.2 Global inflation remained at a moderate
level during 2004, despite the sharp increase in
oil and non-oil commodity prices and
accommodative monetary and fiscal policies. The
inflationary impact of rising oil prices was felt
more by the emerging market economies, which
depend heavily on oil than the advanced industrial
economies. This, combined with the impact of a
rise in food prices, resulted in an increase in
headline inflation in Asia from about 3 per cent
at the beginning of 2004 to a peak of almost 5 per
cent in the third quarter. In the advanced
industrial economies, consumer price inflation
increased from 1.5 per cent at the beginning of
2004 to about 2.5 per cent towards the end of the
year. The inflation situation also deteriorated in
the central and eastern Europe following several
years of disinflation. Nevertheless, underlying
inflationary pressures remained generally
contained in most parts of the globe. Core inflation
(excluding food and energy components from
headline inflation) remained broadly stable in
several advanced and emerging market economies.
1.3 Financial markets conditions remained
comfortable with ample liquidity, notwithstanding
reversal of accommodative monetary policy by the
US beginning June 2004. Long-term rates fell in
the US, despite rise in short-term interest rates.
This was in sharp contrast to previous periods of
monetary tightening, when high policy rates were
accompanied by high long-term interest rates. The
same trend was also observed in the UK, Australia,
Canada and Switzerland, where long-term yields
fell despite tightening of monetary policy. As a
result, the yield curve flattened in several
advanced economies. Credit spreads for corporate
and sovereign borrowers declined to historical low
levels, which helped in keeping borrowing costs
down. Equity markets rallied in most of the major
international markets, propelled by expectations
of strong future corporate earnings on the back
of strong economic recovery.
Developments during 2005
1.4 Global economic growth during 2005 is
expected to be moderated. Following a temporary
slowdown in mid-2004, global GDP growth picked
up through the first quarter of 2005, with robust
services sector output more than compensating
slowing global growth in manufacturing. In the
second quarter, however, the growth slackened
reflecting, in part, the impact of higher oil prices
and weakening of leading indicators and business
confidence in most major countries. While global
manufacturing and trade are now strengthening
and leading indicators have shown improvement,
high and volatile oil prices, exacerbated by the
recent catastrophic effects of Hurricane Katrina
continue to affect the growth prospects. The IMF
has estimated the global growth to average 4.3 per
cent in 2005 from 5.1 per cent in 2004. Within
this overall favorable picture, there remain wide
divergences in growth with the US, China and
India continuing to lead global growth