16 July 2012

IMF: Weak global recovery depends on progress in Europe and United States

The global recovery shows signs of further weakness, mainly because of continuing financial problems in Europe and slower-than-expected growth in emerging economies, the IMF said in a regular update to its World Economic Outlook (WEO).

The update to the Global Financial Stability Report (GFSR) said that risks to financial stability increased in the second quarter of 2012 because of the continued slow global recovery and fears about the quality of bank assets in Europe. An update to the IMF’s Fiscal Monitor said that fiscal adjustment in both advanced and emerging economies is proceeding as expected.

“More worrisome than these revisions to the baseline forecast is the increase in downside risks”, said Olivier Blanchard, the IMF chief economist and director of the IMF’s Research Department, which prepares the WEO.

The IMF emphasised that the relatively minor setback to the global outlook under its baseline projections is based on three important assumptions:

• that there will be enough policy action for financial conditions in the so-called euro area periphery, which includes Greece and Spain, to ease gradually through 2013;
• that US fiscal policy does not tighten sharply in 2013; and
• that steps by some major emerging markets to stimulate growth gain traction.

The IMF said the most immediate risk to the global recovery is that delayed or insufficient policy action will further escalate the euro area crisis. “Simply put, the euro periphery countries have to succeed”, said Blanchard. The report cited agreements at the June 28 eurozone summit as a step in the right direction. It said the summit actions should help break the “adverse links between sovereigns and banks and create a banking union”. But the recent deterioration in sovereign debt markets demonstrates that timely implementation of these measures, together with further progress on banking and fiscal unions, must be a priority.

Meanwhile, the IMF’s Fiscal Monitor update said that fiscal adjustment is proceeding generally as expected in advanced and emerging economies. Advanced economy budget deficits are forecast to decline by about 0.75 per cent of GDP this year and about 1 per cent of GDP in 2012, a rate that strikes a compromise between restoring fiscal sustainability and supporting growth. In most emerging economies, deficits are projected to remain broadly unchanged over 2012–13, implying a slightly slower rate of adjustment than previously expected, something the report sees as appropriate given these countries’ generally stronger fiscal positions and the downside risks to the global economy.

However, the IMF does see some issues. “A focus on nominal deficit targets could lead to excessive tightening if growth weakens in advanced economies”, said Carlo Cottarelli, Director of the IMF’s Fiscal Affairs Department, which prepares the Fiscal Monitor. “For countries that have space to do so, focusing instead on the measures to be implemented to improve the public finances would be preferable.”

Both Spain and Italy are implementing sizeable deficit reductions in the next two years to regain market confidence, the IMF said. In the three euro area countries with programmes supported by lending from the European Union and the IMF—Greece, Ireland, and Portugal—adjustment is proceeding, but the recent deterioration in the political and economic climate in Greece serves as a warning about the potential onset of “adjustment fatigue”, which remains a threat to continued reforms, the Fiscal Monitor said.

Press release

World Economic Outlook

Fiscal Monitor

© International Monetary Fund