Market in Seoul, Korea: IMF says G-20 economic stimulus critical to support demand while financial issues are addressed (photo: Lee Jae-Won/Reuters)
WORLD ECONOMIC CRISIS
In a note prepared for a meeting of G-20 deputies in London that took place January 31-February 1, the IMF portrayed a grim outlook for the global economy, with growth in 2009 virtually grinding to a halt around the world and contracting in advanced economies.
"The dramatic worsening of the financial crisis since mid-September has generated historic declines in confidence and severe disruptions in credit intermediation. The precipitous decline in activity across the globe is in turn further damaging the financial sector," the IMF said.
Action so far not enough
The 185-member international institution said that wide-ranging policy actions have helped avert a global financial meltdown. But it warned that risks remained substantial and world growth was at its lowest level since World War II.
"The overarching risk revolves around the possibility of further corrosive interaction between more severe contraction in global economic activity and even greater and more prolonged financial strains than currently envisaged, particularly if policy implementation falls short," the IMF note, made public on February 5, said. The IMF cautioned against protectionist solutions to the crisis, saying that raising barriers to imports and subsidizing exports would undermine prospects for global recovery.
The recent London meeting was in preparation for a G-20 summit in London on April 2 to assess progress with implementing an action plan drawn up in Washington last November to counter the crisis.
The G-20 comprises the seven major industrialized nations—Britain, Canada, France, Italy, Japan, Germany, and the United States—plus Argentina, Australia, Brazil, China, India, Indonesia, Mexico, Russia, Saudi Arabia, South Africa, South Korea, and Turkey, along with the European Union. The heads of the United Nations, the IMF, the World Bank, and the Financial Stability Forum also attend the summit.
No decisive breakthrough
In the IMF's assessment, action taken by governments so far had not yet achieved a decisive breakthrough in reversing the crisis. "While there are pockets of improvement in some markets where policy intervention has taken place, financial markets remain under heavy strain and systemic institutions are still perceived as fragile. Challenges persist across a wide range of markets and instruments," it said.
Governments around the world have cut interest rates and introduced fiscal stimulus packages to counter the downturn, triggered by the subprime mortgage crisis that erupted in the United States in mid-2007.
So far, the G-20 countries have adopted or plan to adopt fiscal stimulus measures amounting to, on average, around ½ percent of GDP in 2008, 1½ percent of GDP in 2009, and about 1¼ percent of GDP planned for 2010. But the IMF said this would not be enough.
"More aggressive and concerted policy actions are urgently needed to resolve the crisis and establish a durable turnaround in global activity," the IMF said. To be effective, policies need to be comprehensive and internationally coordinated to limit unintended cross-border effects.
The IMF's analysis showed considerable variation across G-20 countries in the size and composition of stimulus packages announced so far. Revenue measures have focused on cuts in personal income taxes and indirect taxes such as the value-added tax or excise duties, while three-quarters of the G-20 countries have announced plans to increase spending on infrastructure, mostly on transport networks. Other expenditure measures include transfers to states or local governments, support for housing sectors, and aid to small and medium-sized enterprises.
Reviving the damaged financial system
Restoring financial health will require a three-pronged approach, involving the continued provision of ample liquidity and term funding support from central banks, dealing promptly and aggressively with distressed assets, and recapitalizing viable institutions with public funds. Immediate, short-run policies and actions taken need to be consistent with the long-run vision for the structure of a viable financial system and with medium-term fiscal sustainability. If the financial sector is not restored to health, an enduring recovery will not be possible.
Various approaches may be used to resolve distressed assets, tailored to individual institution and country circumstances. Cleaning bank balance sheets—including through a transparent process for valuing distressed assets and putting a ceiling on losses—will be critical to restore confidence in financial institutions and reduce counterparty risk. An approach that would ensure maximum transparency and greatly reduce uncertainty, although entailing high upfront fiscal costs, would be to transfer the assets to a "bad" bank. Such an approach has been tried and tested in previous crises and has yielded generally favorable outcomes.
Recapitalization using public balance sheets should make a clear differentiation between viable and nonviable institutions to enable greater consolidation in the financial sector. Most critically, recapitalization must be of a sufficient size to decisively address solvency concerns, especially by ensuring that it is resilient to further deterioration in bank balance sheets as a result of the worsening macroeconomic environment.
International cooperation on a coherent set of financial policies should receive high priority. The application of substantially different conditions when supporting financial institutions should be avoided in order to prevent unintended consequences that may arise from competitive distortions and regulatory arbitrage. International coordination is also needed to avoid excessive "national bias" to the detriment of other countries.
Avoiding a prolonged recession
Macroeconomic policy stimulus will be critical to support demand while financial issues are addressed and to avoid a deep and prolonged recession. With conventional monetary policy reaching its limits, central banks will need to explore alternative policy approaches with a focus on intervention to unlock key credit markets.
Because of the constraints on the effectiveness of monetary policy, fiscal policy must play a central role in supporting demand, while remaining consistent with medium-term sustainability. A key feature of a fiscal stimulus program is that it should support demand for a prolonged period of time and be applied broadly across countries with policy space to minimize cross-border leakages, the IMF argued.
Policymakers need to be mindful of the importance of maintaining confidence in medium-term fiscal sustainability, the IMF said. Stimulus measures must be accompanied by credible steps to strengthen medium-term fiscal prospects. Fiscal packages should rely on temporary measures and policies should be formulated within credible medium-term fiscal frameworks. These frameworks should entail gradual fiscal corrections as conditions improve.
The IMF suggested that countries facing forthcoming demographic challenges—particularly a shift to a more aged population—should have a clear plan for reform of health and pension entitlements.
Comments on this article should be sent to imfsurvey@imf.org
