RAWALPINDI, Sept 6: The financial turmoil that erupted in August 2007, the unprecedented oil price increases and the possibility of tighter monetary policy in a number of countries presage difficulties for the world economy in 2008 and 2009, the UN Conference on Trade and Development (Unctad) says in a new report.

The situation could become even more difficult if large movements in the exchange rates of major currencies add to the turmoil in the financial markets, a risk that has increased in the first half of 2008, says the ‘Trade and Development report 2008’ released on Friday.

In this highly uncertain environment, output in the world economy as a whole is expected to grow by around 3 per cent in 2008, almost one percentage point less than in 2007, and in developed countries as a group, GDP growth is likely to fall to about half this rate.

By contrast, growth in developing countries as a group can be expected to remain quite robust, at more than 6 per cent, as a result of the relatively stable dynamics of domestic demand in a number of large developing economies.

However, possible restrictive monetary policy responses to increasing pressure on the overall price index from higher commodity prices could well lead to a further deceleration of growth in developed and developing countries alike, the report says. For a large number of developing countries, the outlook depends primarily on future trends in the prices of their primary commodity exports. Although several structural factors support the expectation that prices will remain at a higher level than over the past 20 years, cyclical factors and delayed supply responses could well cause a weakening of some commodity prices, especially when the impact of speculation is taken into account.

The meltdown in the sub-prime mortgage segment of the most sophisticated financial market in the world has exposed the fragility of today’s global financial sector. Instead of reducing risk, complex financial instruments have served to spread the impact of risky investments across countries and markets.

The Unctad annual report says the current international framework for monetary and exchange-rate policies offers opportunities for speculative activities that are highly profitable for a limited period of time, but ultimately destabilise the entire system. The rapid unwinding of “carry trade” activities, aimed at extracting gains from nominal interest rate differentials, presents another threat for the global financial system.

The financial turbulence, the speculative forces contributing to commodity price hikes and instability, and the apparent failure of foreign-exchange markets to bring about changes in exchange rates that reflect current-account trends suggest that there is an urgent need for reviewing the institutional framework of the global economy.

An adjustment of some of the current-account imbalances that have shaped the world economy over many years is now under way. But a continuation of this trend hinges almost entirely on a slowdown of the United States economy and a depreciation of the dollar, while the adjustment process can only be painless for the world economy as a whole if domestic spending and imports in the surplus economies rise.

At more than 140 dollars per barrel in mid-2008, the price of oil reached a new peak in nominal and real terms. Oil price hikes in recent years have been accompanied by a sharp increase in the prices of most other primary commodities, and this has prompted calls for central banks to take strong action to prevent an acceleration of inflation.

In the current fragile condition of the global economy, measures to tighten monetary policy would exacerbate the global slowdown.

The Unctad says developing countries could consider combining a broader range of policy instruments in responding to increasing food and energy costs, which are a much heavier burden on most household budgets in these countries than in developed countries and create an understandably strong pressure for wage increases.

Indeed, the dramatic social and humanitarian consequences of the surge in food prices in some countries are jeopardising progress towards meeting the Millennium Development Goals (MDGs), especially that of halving poverty by 2015.