World Economic Update

The International Monetary Fund (IMF) has again cut its forecast for world economic growth and is bracing for more bad news in rich and poor countries, even as it stopped short of using the word "recession" on Tuesday (WASHINGTON).

This year, the global economy will post its weakest performance in five years, the global economic watchdog said in an update to its semi-annual World Economic Outlook report.

The warning comes days after IMF managing director Dominique Strauss-Kahn broke with tradition and asked governments to spend more - even at the cost of increasing budget deficits, which the agency normally considers a cardinal sin - to stimulate their economies. Strauss-Kahn cited the severity of the unfolding downturn.

Growth in 2008 likely will slow to 4.1%, from 4.9% in 2007. Last October, it predicted 4.4% growth for 2008. This would be the worst performance since 2003, when the world economy grew by 3.6%, according to the IMF.

"The overall balance of risks to the global growth outlook is still tilted to the downside," the fund said.
"Growth in emerging market countries that are heavily dependent on capital inflows could be particularly affected, while the strong momentum of domestic demand in some emerging market countries provides upside potential" according to the World Economic Outlook Update.

The report also points to other risks: "monetary policy faces the difficult challenge of balancing the risks of higher inflation and slower economic activity although a possible softening of oil prices could moderate inflation pressures".

U.S. growth is projected by the IMF to slow to 1.5% this year, down from 2.2% in 2007 but the update points out that the 2008 number reflects the carryover from 2007. Projections on a quarterly basis (Q4-Q4) give a better sense of the slowing growth momentum. On this basis, growth is projected at 0.8% in the fourth quarter of 2008, compared with 2.6% during the same period of 2007. IMF also describes the recent move by the U.S. Federal Reserve to cut rates by 75 basis points as “appropriate and helpful”.

For the Euro area growth on an annual basis is projected at 1.6% in 2008, down from 2.6% last year. On a Q4-Q4 basis, growth is projected at 1.3%, compared with 2.3% in 2007. IMF economist Simon Johnson said inflation remained a serious concern in Europe and the European Central Bank had done a good job of managing liquidity.

The world’s second largest economy Japan has been dampened by a tightening in building standards, while consumer and business sentiment have weakened. Japan's growth is forecast on an annual basis at 1.5% in 2008, down from 1.9% last year.

Regarding emerging markets and developing countries, led by China and India they have continued to expand strongly. These countries have benefited from the strong momentum of domestic demand, more disciplined macroeconomic policy frameworks, and in the case of commodity exporters, from high food and energy prices. But growth is also expected to ease moderating from 7.8% in 2007 to 6.9% in 2008. In China, growth is projected to decelerate from 11.4% to 10%.

Headline inflation has increased since mid-2007 in both advanced and emerging economies and has become a major challenge. Core inflation has also drifted upward. In the United States, the Federal Reserve has been cutting interest rates in response to increasing downside risks to activity, while policy has been on hold in the Euro area and Japan. Meanwhile, central banks have continued to tighten monetary policy in many emerging market economies, where food and energy represent a higher share of consumption baskets and overheating is more of a concern.

In a separate Global Financial Stability Report Markets Update IMF said that deteriorating economic conditions could exacerbate pressures on major financial institutions that have already suffered big losses from the subprime crisis.

A possibly deeper economic downturn in the United States or elsewhere could also serve to widen the crisis beyond the subprime sector, as credit deteriorates more broadly, it stated. Already delinquency rates in 2007 vintages of U.S. prime mortgages (those to the most credit worthy borrowers) are rising faster than in previous years, albeit from low levels, and other forms of consumer credit show signs of deterioration.

IMF warns that in Western Europe signs of a future slowdown in credit growth are just now emerging and there is some potential for worsening credit quality as lending has been very robust in some countries and several countries face housing markets considered overvalued.

Lending in some segments of the corporate sector also expanded rapidly in the first half of 2007 with the rise in leverage buyouts. Weaker quality corporates have already seen a substantial rise in the cost of credit although yields investment grade debt has remained relatively stable. Additionally, a slowing economy will likely exacerbate the tighter credit environment further as unemployment picks up and job growth slows.

Emerging markets have been resilient so far, but face challenges ahead. Emerging market equities have outperformed mature equity markets, but prices in some markets have declined steeply since the start of the year on expectations that the U.S. economy may slow more rapidly.