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WEO/GFSR UPDATES

World Recovery Continues, But Risks Increase, Says IMF

By Jeremy Clift
IMF Survey online

July 8, 2010

  • IMF forecasts continuing global recovery
  • But renewed financial turbulence and euro area problems cloud the outlook
  • Fiscal consolidation should be based on credible medium-term plans

Balancing the strong growth numbers for the first half of 2010 and the adverse impact of increased financial turbulence, the IMF forecasts world growth to rise to 4 ½ percent this year, before falling somewhat to 4 ¼ percent in 2011—with the world average masking large differences around the globe.

But despite the stronger than expected first half recovery, the IMF warned that uncertainties surrounding sovereign and financial sector risks in parts of the euro area could spread more widely, posing difficulties for both financial stability and the economic outlook.

“While we predict the recovery will continue, it is clear that downside risks have risen sharply,” Olivier Blanchard, the IMF’s chief economist, told reporters. Blanchard and José Viñals, respectively the Fund’s Economic and Financial Counselors, launched updates to the IMF’s World Economic Outlook (WEO) and Global Financial Stability Report (GFSR) in Hong Kong for the first time.

Differences in performance

As always, these world growth rates hide a large difference between and within advanced and emerging and developing economies, with the United States expected to grow at about 3 ¼ percent in 2010, the euro area at 1 percent, Japan at close to 2 ½ percent, and emerging and developing economies averaging about 6 ¾ percent (see table below).

Also, the overall numbers do not reveal an important difference between the first and the second half of this year. For advanced countries for example, growth in the first half is forecast to be 3 percent, while growth in the second half of the year is forecast to be only 2 percent, reflecting a slowdown in private demand growth, Blanchard pointed out.

Viñals--speaking to journalists at a press conference hosted by the Hong Kong Monetary Authority on the 56th floor of the International Finance Center overlooking the spectacular Hong Kong harbor--emphasized that “progress toward global financial stability has recently experienced a setback.” Sovereign risks have materialized in parts of Europe, especially Greece, that have eroded confidence in the soundness of banks in some euro area countries, resulting in an increase in funding and liquidity stress in interbank markets because banks are less willing to lend of each other.

Spotlight on policy implementation

In its market update to the GFSR, the IMF points to restoring progress toward financial stability to contain the risks and keep the economic recovery on track. Rapid implementation of stabilization measures taken by the euro area government authorities will be a key component in calming financial markets.

More generally, government policies in advanced economies should focus on credible fiscal consolidation—notably measures to enhance medium-run growth prospects, such as reforms to entitlement and tax systems.

“Supported by accommodative monetary conditions, fiscal actions should be complemented by financial sector reform and structural reforms to enhance growth and competitiveness,” the WEO update said. “Policies in emerging economies should also help rebalance global demand, including through structural reforms and, in some cases, greater exchange rate flexibility.”

“While we remain cautiously optimistic about the pace of recovery, there are clearly dangers ahead,” said Blanchard. “How Europe deals with fiscal and financial problems, how advanced countries proceed with fiscal consolidation, and how emerging market countries rebalance their economies, will determine the outcome.”

Drivers of Asian growth

The IMF launched the updates to its previous forecast and analysis in Hong Kong ahead of a high-level conference on Asia on July 12-13 in Daejeon, Korea sponsored by the Korean government and the IMF to assess lessons from the crisis and revive the Fund’s involvement in the dynamic region. “Even though there are some parts of Asia which are doing better than others, there are different kinds of assistance, advice that we can provide to different countries,” IMF Managing Director Dominique Strauss-Kahn said—including technical assistance, funding, and policy advice.

The IMF forecast said Asia’s strong recovery from the global financial crisis continued in the first half of 2010, despite renewed tension in global financial markets. GDP results for the first quarter were generally stronger than anticipated at the time of the last forecast made in April 2010, and high-frequency indicators suggest that economic activity remained brisk during the second quarter.

Economic activity in the region has been sustained by continued buoyancy in exports and private domestic demand. Exports have been boosted by the global and domestic inventory cycles and by recovery of final demand in some advanced economies. Private fixed investment has strengthened on the back of higher capacity utilization and the still relatively low cost of capital in Asia.

Against this background, the IMF’s GDP growth forecasts for Asia have been revised upward for 2010, from about 7 percent in the April WEO to about 7 ½ percent. For 2011, when the inventory cycle will have run its full course and the stimulus is withdrawn in several countries, Asia’s GDP growth overall is expected to settle to a more moderate but also more sustainable rate of about 6 ¾ percent.

Along with the rest of Asia, Korea, which is taking over leadership of the Group of Twenty (G-20) industrialized and emerging market countries this year, has staged an impressive recovery from the global crisis and is expected to grow 5 ¾ percent this year, according to the IMF.

Risks on the rise

Both the WEO and GFSR updates said that risks have risen markedly. In the near term, the main risk is an escalation of financial stress and contagion, prompted by rising concern over sovereign risk. “This could lead to additional increases in funding costs and weaker bank balance sheets, and hence to tighter lending conditions, declining business and consumer confidence, and abrupt changes in exchange rates,” according to the WEO update.

Because of this uncertain backdrop, the overarching policy challenge is to restore financial market confidence without choking the recovery.

Making the new European Stabilization Mechanism fully operational, resolving uncertainty about bank exposures (including to sovereign debt), ensuring that European banks have adequate capital buffers, and continuing liquidity support are identified in the Global Financial Stability Report market update as immediate priorities in the financial sphere.

The update also calls for greater clarity on the details and timing of intended regulatory reforms, as uncertainty surrounding a final set of reforms is making it difficult for banks to take business decisions and constraining their willingness to lend.

Policies should be determined by country circumstances, the IMF said. Most advanced economies do not need to tighten before 2011 because tightening sooner could undermine the fledgling recovery, but they should not stimulate their economies more. Current fiscal consolidation plans for 2011 in large advanced economies that envisage a fiscal retrenchment corresponding to an average change in the structural balance of the economy of 1¼ percentage points of GDP are broadly appropriate.

At a global level, the IMF said policies should focus on implementing credible plans to lower fiscal deficits over the medium term while maintaining supportive monetary conditions, accelerating financial sector reform, and rebalancing global demand.