IMF downgrades global growth forecast by 0.5%

Pic and text by Deepal

V. Perera reporting from Washington

The International Monetary Fund (IMF) in its latest report outlining the performances of global economies said yesterday that a dangerous new phase was emerging, where the world is experiencing greater risks due to weak and uneven growth.  

IMF Economic Counsellor Oliver Blanchard told media yesterday that downside risks had increased sharply and called for stronger policies to improve the outlook and reduce risks.

“Growth, which had been strong in 2010, decreased in 2011. We had forecast some slowdown, due mainly to fiscal consolidation. One-time events, such as the tragic earthquake in Japan, offered plausible explanations for a further slowdown. The initial US data also understated the size of the slowdown. Now that the numbers are in, it is clear that more was going on,” he said.

He added that the rebalancing acts of top world economies needed to happen for strong, balanced and sustainable growth.

“What is needed to sustain growth is for household and firms to increase their demand as fiscal deficits are being rolled back. This is not going well, for various reasons. Tight bank lending, the legacy of the housing boom and high-level leverage for many households all turn out to be putting stronger brakes on the recovery than we anticipated.”

Accordingly, the IMF announcing its forecast for 2011 and 2012 said the world economy would grow by 4% which is a reduction of 0.5% from previous forecasts. In the case of the emerging markets, the IMF predicted that they were expected grow by 6.4% and advanced economies were expected to grow by 1.6%

Commenting on developing countries, Blanchard insisted that so far these countries had been largely immune to global adverse developments.

“They have had to deal with volatile capital flows, but in general have continued to sustain high growth. Looking forward, however, they may have well face more difficult environment, with more adverse export conditions and even more volatile capital flows,” Blanchard cautioned.

He also said that that in light of the low base and the high risks, strong policy action was essential.

“Fiscal consolidation cannot be too fast as it would kill growth. It cannot be too slow as it would kill credibility. The speed must vary across countries: the key continues to be credible medium term consolidation. Going beyond fiscal policy, measures to prop domestic demand ranging from continued low interest rates to increased bank lending to resolution programmes for housing are also of the essence.”

The IMF acknowledged that fiscal uncertainty would not go away overnight and even under the most optimistic assumptions, growth in advanced countries would remain low for some time. During that time banks must be made stronger not only to increase bank lending but also to reduce risks of vicious feedback loops.

Given the need for external rebalancing, the IMF said that it was hard to see how even with the right policy measures, US domestic demand could by itself ensure sufficient growth. Thus, the US must rely more on foreign demand or in other words reduce its current account deficit.

A number of Asian countries with large current account surpluses, in particular China, have announced plans to rebalance from foreign to domestic demand. These plans cannot be implemented overnight, but they must be implemented as fast as can be, the IMF stressed.