Emerging economies dominate world economic growth – IMF

• Developed economies failed to perform to their fullest potential, states 2011 World Economic Outlook

Deepal V. Perera reporting from IMF Head Office in Washington DC

The International Monetary Fund (IMF), releasing its annual World Economic Outlook (WEO), said yesterday that the economies of the world were recovering as expected, but that the developed economies failed to perform to their fullest potentiasl.

      

It noted that emerging economies in the Asian region powered by China and India continued to dominate world economic growth.

Economic Counsellor and Director of the Research Department of the IMF Olivier Blanchard told media yesterday here in Washington DC that the world economic recovery was gaining strength but remained unbalanced.

“Three numbers tell the story. We expect the world economy to grow at about 4.5% a year in both 2011 and 2012, but with advanced economies growing at only 2.5%, while emerging and developing economies grow at a much higher 6.5%,” Blanchard said.

He said that the main worry was that in advanced economies, after an initial recovery driven by the inventory cycle and fiscal stimulus, growth would fizzle. The inventory cycle is now largely over; fiscal stimulus has turned to fiscal consolidation but private demand has for the most part taken the relay.

Commenting on the economic performance in the Asian region, which is referred as emerging markets, Blanchard said that in emerging market countries, by contrast, the crisis has not left lasting wounds.

“Their fiscal and financial positions were typically stronger to start and adverse effects of the crisis more muted. High underlying growth and low interest rates are making fiscal adjustment much easier. Exports have largely recovered and whatever shortfall in external demand they experienced has typically been made up through an increase in domestic demand. Capital outflows have turned into capital inflows due to both better growth prospects and higher interest rates than in advanced countries.”

He said that challenge for the most emerging countries is thus quite different from that of advanced countries, namely how to avoid overheating in the face of closing output gaps and higher capital flows.

Their response should be twofold: First, to rely on a combination of higher interest rates and fiscal consolidation to maintain output at potential; second, to use a capital controls to avoid increases in systemic risk stemming from inflows.

Countries are often tempted to resist the exchange rate appreciation which is likely to come with higher interstates and higher inflows, but appreciation which increases real income is part of the desirable adjustment and should not be resisted.

Commenting on the overall macro policy agenda for the world, Blanchard said that the macro policy agenda for the world economy remains the same. But with the passage of time, it is more urgent.

For the recovery to be sustained, advanced countries must achieve fiscal consolidation. To do so and maintain growth, they need to rely more on external demand. Symmetrically emerging market countries must rely less on external demand and more on domestic demand.

Application of emerging market countries’ currencies relative to advanced countries’ currencies is an important key to this global adjustment. The need for careful design of polices at national level and coordination at global level may be as important today as they were at the peak of the crisis two years ago, he said.

It was pointed out that the recovery is gaining strength, but unemployment remains high in advanced economies and new macroeconomic risks are building in emerging market economies. In advanced economies, the handoff from public to private demand is advancing, reducing concerns that diminishing fiscal policy support might cause a “double-dip” recession.

He said that broad-based recovery is continuing in most Asian economies, supported by strong export performance, buoyant private domestic demand, and in some cases rapid credit growth. Even though growth has moderated from cyclical highs to more sustainable rates, Asia continues to outpace other regions. With the notable exception of Japan, output gaps in much of the region have closed or are quickly closing, inflation is on the rise and overheating is becoming a concern.

At the same time, limited progress has been made on external rebalancing in emerging Asia. Signs of overheating are starting to materialise in a number of economies. Continued high growth has meant that some economies in the region are now operating at or above potential. Credit growth is accelerating in some economies (Hong Kong SAR, India, Indonesia) and it remains high in China.

Most of the increase in headline inflation in recent months has been due to a spike in food prices, but core inflation has also been increasing in a number of economies, most notably India. Furthermore, real estate prices have been rising at double-digit rates in a number of economies. Concerns that inflation pressures may induce authorities to tighten the policy stance more rapidly than previously planned may have contributed to recent declines in equity and bond markets.

Against this backdrop, Asia is projected to continue expanding rapidly this year and next. Export growth is expected to moderate from last year’s very rapid pace but will remain robust as gains in market share and increased intraregional trade partially offset the weakness in final demand from advanced economies. Capital flows to Asia are likely to continue, driven by both cyclical and structural factors.

Autonomous private consumption growth should remain strong, supported by still-rich asset valuations and improved labour market conditions. After growing by 10 per cent in 2010, China’s growth is expected to remain robust at nine per cent this year and next, with the drivers of growth shifting increasingly from public to private demand.

Consumption will be buttressed by rapid credit growth, supportive labour market conditions and continued policy efforts to raise household disposable income. Growth in India is expected to moderate but remain above trend, with GDP growth projected at eight per cent in 2011 and seven per cent in 2012.

The IMF in its year 2011 World Economic Outlook said that the financial conditions continue to improve, although they remain unusually fragile. In many emerging market economies, demand is robust and overheating is a growing policy concern.

Developing economies, particularly in sub-Saharan Africa, have also resumed fast and sustainable growth. Rising food and commodity prices pose a threat to poor households, adding to social and economic tensions, notably in the Middle East and North Africa.

Oil price increases since January 2011 and information on supply, including on spare capacity, suggest that the disruptions so far would have only mild effects on economic activity. An earthquake in Japan has exacted a terrible human toll. Its macroeconomic impact is projected to be limited, although uncertainty remains elevated. Overall, with the recovery stronger on the one hand but oil supply growth lower on the other, projections for global real GDP growth in 2011–12 are little changed from the January 2011 WEO Update.

But downside risks have risen. World real GDP growth is forecast to be about 4.5 per cent in 2011 and 2012, down modestly from five per cent in 2010. Real GDP in advanced economies and emerging and developing economies is expected to expand by about 2.5 per cent and 6.5 per cent, respectively.

Downside risks continue to outweigh upside risks. In advanced economies, weak sovereign balance sheets and still-moribund real estate markets continue to present major concerns, especially in certain euro area economies; financial risks are also to the downside as a result of the high funding requirements of banks and sovereigns.

New downside risks are building on account of commodity prices, notably for oil, and, related, geopolitical uncertainty, as well as overheating and booming asset markets in emerging market economies.