core sector communique

WORLD ECONOMIC OUTLOOK

Global Economy Remains Fragile, Says IMF

IMF Survey online

September 6, 2010

• Unemployment remains major economic, social challenge
• Need to revive private sector growth in advanced economies, while rolling back large fiscal deficits
• Emerging markets should shift toward more domestic-led growth

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 precrisis 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 nontradable 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.