The Greek crisis highlights need for fiscal tightening
THE global economy, led by emerging markets, is still on track for a fairly strong overall recovery this year and in 2011. But the road ahead is strewn with an unusually large number of obstacles and dangers, the International Monetary Fund (IMF) warned yesterday with the publication of its latest World Economic Outlook (WEO) report.
Predicting that world GDP (gross domestic product) growth would be around 4.5 per cent this year (slightly ahead of the 4.25 per cent forecast in April) - slowing slightly to 4.3 per cent next year - the WEO identified the dangers of financial system shocks transmitted via banking systems and over-rapid fiscal consolidation as being among landmines ahead.
The Greek crisis and the market reaction to it have highlighted the need for fiscal tightening around the world, IMF officials said, while cautioning that this is going to require painful adjustments such as 'reduced social entitlements' in some countries and the raising of retirement age to take pressure off public pension systems.
'We are cautiously optimistic (about the global economic outlook) but there are clear dangers ahead,' said IMF economic counsellor and director of research Olivier Blanchard at a briefing in Hong Kong where the WEO launch was held for the first time outside of IMF headquarters in Washington.
Growth was stronger than expected in the first half of 2010 in economies such as the United States, Europe, Japan, Brazil and India, pushing overall world growth for that period to 5 per cent, Mr Blanchard noted. 'But most recent indicators point to some slowdown of demand,' he said, adding that 'it is too early to assess how significant this will be'.
The WEO expects advanced economies to grow by 2.6 per cent this year and by 2.4 per cent in 2011, while it forecasts 6.8 per cent growth in emerging and developing economies in 2009 falling to 6.4 per cent next year. But this assumes that countries make the right policy responses to global challenges, Mr Blanchard said.
He cautioned that all economies face slowing growth in the short term with fiscal spending cuts. They also face a slowdown in bank lending under the impact of a 'freeze' in inter-bank markets in the wake of the Greek crisis and a reallocation of capital flows between advanced and emerging markets.
Fiscal consolidation could 'derail' the global recovery if not handled properly, Mr Blanchard acknowledged. 'While fiscal stimulus was necessary to stem a potentially catastrophic collapse of output in 2008 and 2009, countries must return to a sustainable fiscal path,' he insisted.
'The adjustment should start soon, but too much front-loading, too sharp a cut in deficits this year or next year would be counter-productive,' he suggested. 'The recovery is still fragile and monetary policy (already very accommodative) cannot yet be used to significantly offset the adverse short run effects of fiscal consolidation.'
Calling Asia a 'fitting' place for the first launch of the WEO, and of the IMF's Global Financial Stability Report, outside the US, because the region is providing 'momentum for a robust global recovery', IMF financial counsellor and monetary and capital markets department director Jose Vinals said it would nevertheless be dangerous to assume that Asia is immune to aftershocks from the eurozone crisis.
'Global financial stability has experienced a setback,' he noted. 'Sovereign credit risks in part of the euro area have materialised and have spread to the financial sector there, threatening to spill over to other regions and re-establish the adverse feedback loop with the economy.'
Banks mainly (but not only) in the euro area 'remain cautious about lending to each other' in the aftermath of the Greek crisis, Mr Vinals noted. Along with their legacy of bad debts resulting from the global financial crisis, many banks now find that they have problematic assets in the shape of government bond holdings, he said.
Domestic liquidity conditions in Asia have remained calm but 'European banks are significant providers of liquidity in certain Asian markets', he noted, without specifying which. The authorities in these markets will need to act quickly to prevent financial contagion from spreading via such mechanisms, Mr Vinals suggested.
Apart from the danger of a liquidity crunch, there is also a danger of 'crowding out' of private borrowers as they compete with governments for funding, he said, citing the cases of Japan, Britain, the US and the euro area where around US$4.3 trillion of government debts will need to be rolled over during the second half of this year.
Mr Vinals also warned of disruptive capital flows into Asia, while praising Singapore, Hong Kong and China for taking measures to offset the impact of such flows by introducing 'prudential measures to dampen real estate price appreciation and (to limit)the share of real estate loans in new bank lending'.
Source: Business Times, 9 Jul 2010