A protest on Wall Street. Confidence has fallen and the risks are on the downside, the IMF said in its half-yearly report. Photograph: Keystone/Rex Features
The International Monetary Fund warned on Tuesday that the United States and the eurozone risk being plunged back into recession unless policymakers tackle the problems facing the world’s two biggest economic forces.
In its half-yearly health check, the Washington-based fund said the global economy was “in a dangerous place” and that its forecast of a slow, bumpy recovery would be jeopardised by a deepening of Europe’s sovereign debt crisis or over-hasty attempts to rein in America’s budget deficit.
“Global activity has weakened and become more uneven, confidence has fallen sharply recently, and downside risks are growing,” the IMF said as it cut its global growth forecast for both 2011 and 2012.
The IMF also cut its growth forecasts for the UK economy and advised George Osborne to ease the pace of deficit reduction in the event of any further downturn in activity.
The IMF’s World Economic Outlook cited the Japanese tsunami and the rise in oil prices prompted by the unrest in north Africa and the Middle East as two of a “barrage” of shocks to hit the international economy in 2011. It said it now expected the global economy to expand by 4% in both 2011 and 2012, cuts of 0.3 points and 0.5 points since it last published forecasts three months ago.
“The structural problems facing the crisis-hit advanced economies have proven even more intractable than expected, and the process of devising and implementing reforms even more complicated. The outlook for these economies is thus for a continuing, but weak and bumpy, expansion,” the IMF said.
Speaking at a press conference in Washington, Olivier Blanchard, the IMF’s economic counsellor, said there was “a widespread perception” that policymakers in the euro area had lost control of the crisis.
“Europe must get its act together,” Blanchard said, adding that it was “absolutely essential” that measures agreed by policymakers in July, including a bigger role for the European Financial Stability Fund (EFSF), should be made operational soon.
“The eurozone is a major source of worry. This is a call to arms,” he said.
Blanchard said the fund was cutting its growth forecasts because the two balancing acts needed to ensure recovery from the recession of 2008-09 have stalled. Governments were cutting budget deficits but the private sector was failing to make up for the lost demand. Meanwhile, the global imbalances between deficit countries such as the US and surplus countries such as China looked like getting worse rather than better.
“Markets have become more sceptical about the ability of governments to stabilise their public debt. Worries have spread from countries on the periphery of Europe to countries in the core, and to others, including Japan and the US, Blanchard said.
He added that there was a risk of low growth, fiscal, and financial weaknesses could easily feed on each other.
“Lower growth makes fiscal consolidation harder. And fiscal consolidation may lead to even lower growth. Lower growth weakens banks. And weaker banks lead to tighter bank lending and lower growth.” As a result, there were “clear downside risks” to the fund’s new forecasts.
Developing nations lead the way
In its report, the IMF said it expected the strong performance of the leading emerging nations to be the main driving force behind growth in the world economy. China’s growth rate is forecast to ease back slightly, from 9.5% in 2011 to 9% in 2012, while India is predicted to expand by 7.5% in 2012 after 7.8% growth in 2011.
Sub-Saharan Africa is expected to continue to post robust growth, up from 5.2% in 2011 to 5.8% in 2012.
The rich developed countries, by contrast, are forecast to grow by just under 2%, slightly faster than the 1.6% pencilled in by the IMF for 2011.
“However, this assumes that European policymakers contain the crisis in the euro periphery area, that US policymakers strike a judicious balance between support for the economy and medium-term fiscal consolidation, and that volatility in global financial markets does not escalate.”
“The risks are clearly to the downside,” the IMF added, pointing to two particular concerns – that policymakers in the eurozone lose control of the sovereign debt crisis, and that the US economy could weaken as a result of political impasse in Washington, a deteriorating housing market or a slide in shares on Wall Street. It said the European Central Bank should consider cutting interest rates and that the Federal Reserve should stand ready to provide more “unconventional support”.
It said: “Either of these two eventualities would have severe implications for global growth. The renewed stress could undermine financial markets and institutions in advanced economies, which remain unusually vulnerable. Commodity prices and global trade and capital flows would likely decline abruptly, dragging down growth in developing countries.”
The IMF said that in its downside scenario, the eurozone and the US could fall back into recession, with activity some three percentage points lower in 2012 than envisaged. Currently, the fund is expecting the US to grow by 1.8% in 2012 and the eurozone by 1.1%.
“In the euro area, the adverse feedback loop between weak sovereign and financial institutions needs to be broken. Fragile financial institutions must be asked to raise more capital, preferably through private solutions. If these are not available, they will have to accept injections of public capital or support from the EFSF, or be restructured or closed.”
The IMF urged Republicans and Democrats in Washington to settle their differences: “Deep political differences leave the course of US policy highly uncertain. There is a serious risk that hasty fiscal cutbacks will further weaken the outlook without providing the long-term reforms required to reduce debt to more sustainable levels.”