Shoppers in Tokyo, Japan, where the slowdown has affected global growth (photo: Yoshikazu Tsuno/AFP/Getty Images)
WORLD FORECAST
Although the IMF kept its forecast for global growth broadly unchanged at 4.3 percent for this year, rising to 4.5 percent in 2012, the 187-member institution said the mild slowdown in the second quarter of 2011 “is not reassuring.”
While growth in most emerging and developing economies continues to be strong, slowdowns caused by the devastating earthquake and tsunami in Japan, weaker than expected activity in the United States, and shocks to oil supply weighed on the global expansion in the second quarter of the year, the IMF said in an update to its World Economic Outlook (WEO), released in São Paulo, Brazil.
The IMF also released updates to the Global Financial Stability Report (GFSR), which assesses trends in capital markets and the global financial system, and the Fiscal Monitor, which tracks changes in public finance and debt.
“A bump in the road”
Growth in the euro area, powered by more upbeat investment in Germany and France, has been better than expected, but concerns about the depth of fiscal challenges in some European countries have triggered renewed financial volatility.
Speaking about the U.S. slowdown, Olivier Blanchard, the Fund’s Economic Counsellor, said he saw it more as “a bump in the road rather than something more worrisome,” although the U.S. recovery remained weak.
The IMF identified the following regional trends (see table):
• Asia: Growth in emerging Asia will decelerate only slightly from the very high levels of last year. Disruptions to regional production networks due to supply constraints from Japan appear contained, although some sectors, especially automobiles and electronics, could experience strains through the summer.
• Latin America will be bolstered by commodity exports and domestic demand, but the pace of growth will ease in some economies where policies have been tightening more aggressively to reduce risks of overheating.
• Europe: Growth in Europe’s emerging economies is now projected to be higher than previously expected in 2011, followed by a softening in 2012, driven in part by a sharp domestic demand cycle in Turkey.
• Sub-Saharan Africa: Activity is projected to continue strengthening, with domestic demand remaining robust, and commodity exporters benefiting from elevated prices.
• Middle East and North Africa: economic prospects remain clouded by political and social unrest, although the outlook has improved for some oil and mineral exporters.
Risks from overheating
In a number of emerging and developing economies that are already operating at or above precrisis levels of output, the IMF said the priority was to expeditiously tighten macroeconomic policies, and use exchange rate flexibility and macroprudential tools—possibly including capital controls—to help contain risks of boom-bust cycles.
For economies with excessive current account surpluses, particularly in Asia, demand rebalancing—through exchange rate appreciation and structural reforms—remains a top priority for securing balanced growth and employment gains in the medium term.
Financial sector risks rising
In its GFSR Update, the IMF said financial risks have increased since April for three reasons: first, mounting concern about the strength of the global economic recovery; second, worries about political support for adjustment in Europe’s periphery as well as political risks in addressing fiscal adjustment in some advanced economies; and third, spurred by a sustained period of low interest rates in advanced economies, a growing investor search for yield that risks building up future financial imbalances, especially in emerging market countries.
“Policymakers continue to face the possibility of potentially large future shocks to the financial system, with the recent increase in financial risks adding to existing concerns,” said José Viñals, the IMF’s Financial Counsellor and head of the Monetary and Capital Markets Department.
The IMF said that given recent financial market concerns, policymakers need to intensify and accelerate their efforts to tackle the longstanding financial challenges of budget deficits, banking system vulnerabilities and financial sector reform.
There has been some work done to repair bank balance sheets, but progress has been slow. Some banks are still weighed down by lower quality assets, and important funding challenges remain. The results from the new round of European stress tests will mark an important watershed and banks will need to pick up the pace to rebuild their capital.
Tackling fiscal challenges
The United States and Japan are slow to come up with specific plans to bring down their high debt levels, while debt problems in some European countries mean financial markets are charging high rates to lend them money. The IMF said that given recent financial markets’ concerns, policymakers need to speed up efforts to tackle the longstanding financial challenges of government risk, banking system vulnerabilities, and the unintended consequences of low interest rates.
In its latest Fiscal Monitor, the IMF said the United States deficit will be lower in 2011 than forecast in April. This is due to revenue increases, in part because of sizable capital gains in 2010, coupled with lower expenditures. As a result, the planned cutbacks for 2012 will not need to be as steep to meet the targets set by the government.
“What remains missing in the United States, however, is a political consensus on a comprehensive and balanced set of specific measures to underpin a credible medium-term adjustment plan with objectives endorsed by Congress,” said Carlo Cottarelli, head of the IMF’s Fiscal Affairs Department, which produced the report. “Without such a plan, yield on U.S. government paper would start reflecting a risk premium, which would not be good for the U.S. and the world economy.”
Reducing government debts and deficits is proceeding in many advanced economies—notably in most of Europe and in Canada—helped by bright spots of economic activity and growing government revenues.
The key fiscal priority for major advanced economies—especially the United States and Japan—is to implement credible and well-paced consolidation programs focused on bolstering medium-term debt sustainability. For the United States, it is critical to address the debt ceiling and launch a deficit reduction plan that includes entitlement reform and revenue-raising tax reform, the IMF said. In Japan, tax reform should be the centerpiece of a detailed medium-term deficit reduction package.
In emerging and low-income economies, fiscal deficits and debts are being reduced gradually. In several of these economies—including commodity producers benefiting from high export prices—the economic recovery has been faster, and the task is to avoid overheating, including by tightening fiscal policy faster than currently envisaged.
