Global economy remains fragile – IMF

The world economy, led by emerging market and developing countries, is forecast to grow by 4.8 percent in 2010 before falling back to 4.2 percent next year, but a sharper global slowdown is unlikely, the IMF says in its latest forecast.

With the world still trying to bounce back from the global economic crisis, the IMF says in its latest World Economic Outlook that the recovery remains fragile and uneven. Unemployment remains a major economic and social challenge.

More than 210 million people across the globe may be unemployed, an increase of more than 30 million since 2007. Three-fourths of the increase has occurred in advanced economies, the IMF said.

“The world economic recovery is proceeding,” IMF Chief Economist Olivier Blanchard told a press conference. “But it is an unbalanced recovery, sluggish in advanced countries, much stronger in emerging and developing countries.”

Achieving more balance

The key policy challenge is to effect a smooth transition from public to private sector-led growth in many advanced economies, and from external to domestically driven growth in key emerging economies.

While short-term macroeconomic policies are broadly appropriate, completing the two rebalancing acts will require tackling the medium-term fiscal, financial, and structural challenges raised by the crisis.

Blanchard said that the pieces of the global economy were interconnected and countries should act in coordination. “Unless advanced countries can count on stronger private demand, both domestic and foreign, they will find it difficult to achieve fiscal consolidation. And worries about sovereign risks can easily derail growth,” he warned.

 “If growth were to slow or even stop in advanced countries, emerging market countries would have a hard time decoupling. The need for careful design at the national level, and coordination at the global level, may be even more important today than they were at the peak of the crisis a year and a half ago.”

Different speeds

The report notes that economies are recovering at different speeds and intensities (see table). Recoveries in most advanced and a few emerging economies are moving at a sluggish pace and unemployment is high, holding back consumption.

Improvements in business investment in the hard-hit economies have not translated into substantially lower unemployment. Financial sector weaknesses remain largely unresolved, undermining credit provision. By contrast, many emerging and developing economies, which did not have major financial excesses prior to the Great Recession, are again seeing strong output and employment growth.

Global activity is forecast to expand by 4.8 percent in 2010 and 4.2 percent in 2011, broadly in line with earlier IMF staff projections. In advanced economies, growth is projected at 2.7 percent in 2010 and 2.2 percent in 2011, with some economies slowing noticeably during the second half of 2010 and the first half of 2011. As a result, economic slack will remain substantial and unemployment persistently high for some time.

Prospects are better for emerging and developing economies, which are projected to expand at rates of 7.1 percent and 6.4 percent for 2010 and 2011. Inflation is projected to stay generally low, amid continued excess capacity and high unemployment, with a few exceptions among the emerging economies.

Need for coordinated policies

To spur a stronger recovery and more employment growth, government policies need to become more proactive and coordinated to achieve the internal and external rebalancing required for robust real GDP and employment growth.

“Historical evidence suggests that countries hit by financial crises typically suffer permanent output losses relative to pre-crisis trends,” the report says. “However, outcomes after individual crises have varied widely, depending on the policy responses.”

Households and companies have already scaled back expectations for growth over the next one or two years. Policymakers must avoid paralysis and put in place policies to strengthen medium-term prospects.

“The challenge ahead if for policymakers to put in place, in a coordinated manner, policies that support the fundamental adjustments needed for a return to healthy medium-term growth,” the report states.

The IMF has warned that the financial sector remains the Achilles’ heel of the recovery. The global crisis was rooted primarily in the financial sector and the failure of policymakers to grasp the depth and breadth of ways in which financial shocks could be amplified across financial institutions and economies.

Ensuring that a still-damaged financial sector does not act as a drag on activity requires:

restructuring or resolving weak banks;

enhancing banks’ capital adequacy and liquidity buffers;

pursuing orderly and globally consistent regulatory reform; and

strengthening supervision and oversight of the financial system.

Monetary and fiscal responses

Monetary policy should stay highly accommodative to support activity and help bring down unemployment, but fiscal consolidation needs to start in 2011 in the advanced economies. If global growth threatens to slow appreciably more than expected, countries with budgetary room could postpone some of the planned consolidation.

One of the most urgent challenges for advanced economies is to adopt plans that help achieve sustainable fiscal positions before the end of the decade. This task is now more pressing than it was six months ago to rebuild room for fiscal policy maneuver in the face of still volatile sovereign debt markets. Such room could be needed because monetary policy alone might not be able to provide sufficient support to counter a threat for a markedly more pronounced-than-expected weakening of activity.

Emerging economies that relied heavily on demand from advanced economies will have to rebalance growth further toward domestic sources to achieve growth rates similar to those before the crisis. In economies with excessive external surpluses, removing distortions that drive high household or corporate saving rates and deter investment in non-tradable sectors would facilitate the rebalancing of growth to domestic sources. Such rebalancing will also require further deregulation and reform of financial sectors and corporate governance, as well as stronger social safety nets in key Asian economies.

IMF stepping up focus on global systemic stability

The IMF will step up its focus on global systemic stability and is closer to wrapping up a package of reforms that will make the 187-member institution more representative and better able to tackle the economic problems facing a globalised and interconnected economy, IMF Managing Director Dominique Strauss-Kahn said.

At the end of a meeting of the IMF’s policy steering committee, the Managing Director expressed optimism about completing a series of reforms that will make the IMF more reflective of the new global economy by increasing the say in the institution of the dynamic emerging markets now leading the world out of recession.

“We have gone extensively into reform of the IMF — quotas, governance with all its components, the composition and size of the Executive Board,” said Youssef Boutros-Ghali, the Egyptian Finance Minister who is head of the International Monetary and Financial Committee (IMFC) of the Fund.

“There has been extensive progress. All of the parties involved are converging toward a package that we think will move the institution toward a new level, make it more adaptable and capable of dealing with the problems that have become multilateral in most of their features,” Boutros-Ghali said.

The meeting was part of the IMF-World Bank Annual Meetings in Washington that have gathered around 10,000 central bankers, ministers of finance and development, private sector executives, labor leaders, civil society representatives, and academics to discuss issues of global concern, including the world economic outlook, poverty eradication, economic development, and aid effectiveness.

Uneven global recovery

In a communiqué, the IMFC said that the economic recovery around the world was proceeding, but remains fragile and uneven across the membership.

“Faced with this source of potential stress, we underscore our strong commitment to continue working collaboratively to secure strong, sustainable, and balanced growth and to refrain from policy actions that would detract from this shared goal,” the communiqué said.

Ministers said their priorities were to address remaining financial sector fragilities; ensure strong growth in private sector demand and job creation; secure sound public finances and debt sustainability; work toward a more balanced pattern of global growth, recognising the responsibilities of surplus and deficit countries; and address the challenges of large and volatile capital movements, which can be disruptive.

They said rejection of protectionism in all its forms must remain a key element of a coordinated response to the crisis and renewed efforts were urgently needed to bring the Doha trade talks to a successful conclusion.

Urgently action was also needed to reinforce the IMF’s role and effectiveness as a global body for macro-financial surveillance and policy collaboration.

IMF reform

Strauss-Kahn, who throughout the meetings has stressed the need for renewed cooperation to tackle global problems, told reporters that he expected IMF members to agree in either days or weeks on needed reform of the institution. We are still not there, but not far off.”

“Still some divergent views, but I am used to this. I think we are on the right track.”

The aim is for a shift in quota share to dynamic emerging market and developing countries of at least five percent from over-represented to under-represented countries by January 2011. In addition, there is a commitment to protecting the voting share of the poorest members.

But Strauss-Kahn emphasised that countries getting an increased quota share needed to play a correspondingly bigger role in stabilising the global economic system. “They cannot be at the center and be a free rider. The more they are at the center, then you need to take part in stabilising the system. That is the logic.”

Boutros-Ghali said that the quota and voice reforms, coupled with improvements in how the IMF monitors the global economy, would make the institution better able to face the future.

Strauss-Kahn said that systemic stability was an issue of paramount importance, and the IMF is the institution best placed to address it. The IMF was introducing new “Spillover Reports” that would assess the impact of policy actions in major economies for other parts of the world.

As a sign of the importance attached to these issues, the Managing Director said he will attend the concluding meetings of the annual Article IV surveillance missions to each of the systemic countries or regions—the United States, the United kingdom, the Euro area, China, and Japan. These are first steps, and other tools are being developed and refined.

The IMFC said that stronger and evenhanded surveillance to uncover vulnerabilities in large advanced economies is a priority. Surveillance should also be better focused on financial stability issues and their macroeconomic linkages, and more attentive to cross-border spillovers.