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6 The IMF, in its World Economic Outlook, has lowered its forecast for world growth and cited significant risks to the economic outlook Beyond Market 10th Oct ’11 The global economic uncertainty is getting murkier and murkier with each passing day. Recently the US Fed talked about significant risks to the US economic growth in the back drop of the global environment and its internal issues. Few days back Washington-based international financial institution, the International Monetary Fund (IMF) in its report on the world economic outlook started with the theme of “slowing growth, rising risk”. In its opening remarks, it says relative to the previous world economic outlook presented in April, the economic recovery has become more uncertain. The world economy suffers from the confluence of two adverse developments. The first is the slower recovery in advanced economies since the beginning of the year, a development largely failed to be perceived as it was happening. The second is the large increase in fiscal and financial uncertainty, which has been particularly pronounced since August. And each of these developments is worrisome. It’s simplified...
It says with accumulating signs of weaknesses in key advanced economies, including the bad news about the US economy over the past couple of months, equity markets have fallen sharply and equity price volatility has jumped up too and prices for strong sovereign bonds and gold have risen - all signs that investors have become more cautious about the prospects for the major advanced economies. The US economy has been in the news over the past couple of months. The US government passed the debt ceiling bill raising the debt limit to $14.3 trillion or (equal to its size of GDP) in July ’11. The move allowed the US government to borrow more and thus accommodate monetary easing. This came along with the downgrade of the US sovereign debt rating from AAA to AA+. GROWTH & DOWNSIDE RISKS The IMF has cut the world economic growth forecast by 30 basis points for the current calendar year to 4% and 50 basis points for the next year to 4% as compared to its estimates in June this year. However, more than economic growth, which is more or less coming down, the IMF draws attention towards the uncertainty and the downside risk to the global economy. The IMF said that the global economy is in a dangerous new phase. Global activity has weakened and become more uneven, confidence has fallen sharply recently and downside risks are also growing. It projects that the real GDP growth in the advanced economies, which includes the US, Europe, Japan and others could expand at an anaemic pace of about 1.6% in calendar year 2011. This is almost 150 basis point lower than the GDP growth of 3.1% in the year 2010. More importantly, this is the base case scenario that there are downside risk to these estimates, which means if some of the concerns or risks mentioned in the report come true, growth could even be lower. Economic Growth (%) World US Euro Japan China India Source - IMF 2009 -0.7 –3.5 –4.3 –6.3 9.2 6.8 2010 5.1 3 1.8 4 10.3 10.1 2011 4 1.5 1.6 –0.5 9.5 7.8 2012 4 1.8 1.1 2.3 9 7.5 It said that risks to the outlook remain large and downside risks dominate upside risks. The probability of global economic growth-now pegged at 4%- below 2% is appreciably higher than April ’11 when the world economic outlook was presented. FEAR OF THE UNKNOWN The report highlights that the markets have clearly become more sceptical about the ability of many countries to stabilize their public debt. The worries, which were till some time lilted towards the few small countries on the periphery of Europe, have spilled over to other regions like Japan and the US, among others in the developing world on the back of fresh concerns over economic growth. Further, the evolving sovereign crisis in the developing world has translated into worries about the impact on the banks, which holds these sovereign bonds, mainly in Europe. With the uncertainty about the debt, the concerns over the flow of liquidity and tight lending have surfaced. The IMF in its report has prepared a downside scenario where different factors have been analyzed to present the magnitude of the impact. Broadly, the scenario includes the kinds of shocks that could arise mainly in three regions including the European countries, the US as well as emerging Asian economies. First is the ongoing crisis in the Euro zone, which already seems to be running beyond the control of policymakers. The shock is to bank capital, reflecting primarily recognition of losses on holdings of public debt but also of other losses on loans arising from the macroeconomic fallout. The report also says that vulnerable sovereigns are prone to a sudden loss of investor confidence in their debt sustainability if fundamentals deteriorate sharply. European banks have a large exposure to the sovereign debts of countries, which are in the news for the wrong reasons, including the risk of default. With this background the chances of recapitalization is low considering that the investors will become risk-averse. Further, the IMF report says that these banks rely on wholesale funding, which is prone to freezing during financial turmoil. This is also the reason why trouble in a few sovereigns could quickly spread across Europe. And from there it could move to the United States by way of US institutional investors’ holdings of European assets – and to the rest of the world. In the US, according to the report, the shock scenario has two components. Of this, first is slower potential output growth, which could be lower than the expected growth in the economic activity. The economic activities in the US have already softened and pressure is seen in the housing markets and employment generation. Beyond Market 10th Oct ’11 It’s simplified... 7
Page 1: The IMF, in its World Economic Outl
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