IMF lowers global growth forecast amid rising financial risk

IMF chief Rodrigo Rato

The International Monetary Fund last week slashed its 2008 global economic forecast, warning that turbulence stemming from a crisis in the US housing sector could crimp growth worldwide.

The world economy is expected to expand 4.8 percent next year after a 5.2 percent pace projected for 2007, the IMF said in its twice-yearly World Economic Outlook (WEO) report.

The downgrade comes in the wake of turmoil in global financial markets in August that prompted the IMF to reverse course after an unusual update in July in which it raised its 2008 global growth forecast to 5.2 percent.

The greatest threat to the world economy is the financial market unrest stemming from the high-risk US subprime mortgage sector, where loans were given home buyers with poor credit histories, the IMF said. This has affected banks and lenders worldwide and made credit conditions more difficult.

“Risks to the outlook lie firmly on the downside, centering around the concern that financial market strains could continue and trigger a more pronounced global slowdown,” the 185-nation institution in Washington said.

“Thus, the immediate task for policymakers is to restore more normal financial market conditions and safeguard the continued expansion of activity.”

Despite the heightened risks, the IMF said that overall the world economy is poised for “solid” 4.8 percent growth, underpinned by generally sound fundamentals and strong momentum in the emerging market economies, such as China.

“The expansion is projected to remain above the long-term trend, notwithstanding recent financial market turbulence, with emerging market and developing countries leading the way,” the IMF said, citing mainly low inflation levels and robust gains in trade volumes worldwide.
In a July update of the April WEO, the IMF had raised its global growth forecasts for both 2007 and 2008 by a 0.3 percentage point to 5.2 percent. The latest WEO holds this year’s forecast at 5.2 percent. But the IMF reversed course and downgraded its 2008 outlook following the financial market turmoil of August.

“Global credit market conditions have deteriorated sharply since late July as a repricing of credit risk sparked increased volatility and a broad loss of market liquidity,” said the Fund, whose mission is to promote global financial stability.

The IMF said it partly based its 2008 global forecast on the assumption that this year the US Federal Reserve would cut interest rates by a further half point and that the European Central Bank and the Bank of Japan would refrain from raising rates.

In September the Fed, in its first rate cut in four years, lowered its target for the federal funds rate by a half point to 4.75 percent to ease a credit crunch that had spread worldwide in August, pummeling stock markets.

The IMF said the world’s largest economy is facing a rising risk of recession due to a severe, two-year downturn in the housing sector that could crimp consumer spending.

The Fund shaved its US economic growth forecast by 0.1 point to 1.9 percent for this year and by a sharper 0.9 point to 1.9 percent for 2008.
Growth in Japan, the second-biggest economy, was marked down to 2.0 percent in 2007 and 1.7 percent in 2008, 0.6 percentage point and 0.3 percentage point lower, respectively, than the July estimates. The downgrade reflects the weaker-than-expected second-quarter economic output, slower global growth, and a slightly stronger yen.

In the 13-nation eurozone, growth was reduced to 2.1 percent in 2008, 0.4 percentage point lower than in July, as a result of the delayed effects of euro appreciation, trade spillovers from the US and more difficult financing conditions.

By contrast, “growth is expected to remain very strong” among emerging market and developing countries, the IMF said, with China continuing to set the pace, at 10 percent in 2008, about 0.5 percentage points lower than in the July update.

The IMF also noted risks to the global expansion that include potential inflation pressures, volatile oil markets, the impact on emerging markets of strong capital inflows, and continued large global imbalances.
It warned that an increasing global reliance on grain as a source of fuel could drive up food prices in poor countries.
The WEO report was released ahead of the annual meetings of the IMF and the World Bank that open Saturday in Washington.