In the most severe recession since World War II, the global economy is projected to shrink by 1.3 percent in 2009, with a slow recovery expected to take hold in 2010, according to the IMF’s April World Economic Outlook (WEO).
While the rate of contraction should moderate from the second quarter of 2009 onward, output per capita is projected to decline in countries representing three-quarters of the global economy. Growth is projected to reemerge in 2010, but at 1.9 percent it would be sluggish relative to past recoveries.
IMF Chief Economist Olivier Blanchard told reporters that the world economy was being battered by competing crosscurrents, with the collapse in confidence and demand continuing to pull the economy down and government stimulus measures and natural stabilization mechanisms pulling the economy up.
“This is not the time for complacency, and the need for strong policies, both on the macro and especially on the financial fronts, is as acute as ever. But, with such policies in place, there is light at the end of this long tunnel. World growth can turn positive by the end of this year, and unemployment can start decreasing by the end of next year.”
Shift toward recovery
Although Blanchard said that today “the first current strongly dominates the second,” he could see the balance shifting towards the end of the year, with growth in advanced countries becoming positive again in 2010, and returning to its normal level around the end of 2010.” Unemployment will crest only toward the end of 2010, however, and should decrease after that. Historical evidence presented in the WEO suggests recovery may be slower than in other recessions.
Achieving the projected turnaround will depend on stepping up efforts to heal the financial sector, while continuing to support demand through monetary and fiscal easing. “The immediate imperative is to move boldly with credible plans to deal with the financial crisis that has been at the core of the global recession over the past six months,” the report said. At the same time, macroeconomic policies should be geared to supporting demand to minimize the corrosive feedback from weakening real economic activity on the financial sector.
The WEO said that while there have been some encouraging signs of improving sentiment since the Group of 20 (G-20) meeting in early April, confidence in financial markets is still low, weighing against the prospects for an early economic recovery. Overall, the advanced economies are forecast to contract by 3.8 percent in 2009, with the U.S. economy shrinking by 2.8 percent. Emerging and developing economies will seen positive growth of 1.6 percent, bouncing back to 4.0 percent next year. Sub-Saharan Africa will remain in positive territory at 1.7 percent in 2009, recovering to 3.9 percent next year (see table).
“These projections are based on an assessment that financial market stabilization will take longer than previously envisaged, even with strong efforts by policymakers,” said Blanchard and José Viñals, head of the IMF’s Monetary and Capital Markets Department, in a joint statement.“Thus, financial conditions in the mature markets are projected to improve only slowly, as insolvency concerns are diminished by greater clarity over losses on bad assets and injections of public capital, and counterparty risks and market volatility are reduced.”
Two quarters of bad news
The WEO, presented ahead of the IMF-World Bank Spring Meetings in Washington, said the advanced economies experienced an unprecedented 7½ percent decline in real GDP during the fourth quarter of 2008, and output is estimated to have continued to fall almost as fast during the first quarter of 2009.
Although the U.S. economy may have suffered most from intensified financial strains and the continued fall in the housing sector, western Europe and advanced Asia have been hit hard by the collapse in global trade, as well as by rising financial problems of their own and housing corrections in some national markets, the report, released on April 22, said.
Emerging economies too are suffering badly and contracted 4 percent in the fourth quarter of 2008 in the aggregate. The damage is being inflicted through both financial and trade channels, particularly to east Asian countries that rely heavily on manufacturing exports and the emerging European and Commonwealth of Independent States (CIS) economies, which have depended on strong capital inflows to fuel growth.
In parallel with the rapid cooling of global activity, inflation pressures have subsided quickly. Commodity prices fell sharply from midyear highs, causing an especially large loss of income for the Middle Eastern and CIS economies but also for many other commodity exporters in Latin America and Africa.
Continued funding strains
Across the world, the IMF says banks are limiting access to credit (and will continue to do so) as the overhang of bad assets and uncertainty about which institutions will remain solvent keep private capital on the sidelines. Funding strains have spread well beyond short-term bank funding markets in advanced economies. Many nonfinancial corporations are unable to obtain working capital, and some are having difficulty raising longer-term debt.
“The broad retrenchment of foreign investors and banks from emerging economies and the resulting buildup in funding pressures are particularly worrisome. New securities issues have come to a virtual stop, bank-related flows have been curtailed, bond spreads have soared, equity prices have dropped, and exchange markets have come under heavy pressure.
“Beyond a general rise in risk aversion, this reflects a range of adverse factors, including the damage done to advanced economy banks and hedge funds, the desire to move funds under the ‘umbrella’ provided by the increasing provision of guarantees in mature markets, and rising concerns about the economic prospects and vulnerabilities of emerging economies,”the report said.
On the upside, however, bold policy implementation that is able to convince markets that financial strains are being dealt with decisively could revive confidence and spending commitments. But even when the crisis is past, there will be a difficult transition period, with output growth appreciably below rates seen in the recent past, the WEO said.
Need for forceful action
The IMF said this difficult and uncertain outlook argues for forceful action on both the financial and macroeconomic policy fronts. Past episodes of financial crisis have shown that delays in tackling the underlying problem mean an even more protracted economic downturn and even greater costs, both in terms of taxpayer money and economic activity, the report said.
Policymakers must be mindful of the cross-border ramifications of policy choices. Initiatives that support trade and financial partners—including fiscal stimulus flows—will help support global demand, with shared benefits. Conversely, a slide toward trade and financial protectionism would be hugely damaging to all, a clear warning from the experience of 1930s beggar-thy-neighbor policies.
The greatest policy priority at this juncture is financial sector restructuring. Convincing progress on this front is crucial for an economic recovery to take hold and would significantly enhance the effectiveness of monetary and fiscal stimulus.
The critical underpinning of an enduring solution must be credible loss recognition on impaired assets. To that effect, governments need to establish common basic methodologies for the realistic valuation of securitized credit instruments, which should be based on expected economic conditions and an attempt to estimate the value of future income streams.
Recapitalization methods must be rooted in a careful evaluation of the long-term viability of institutions, taking into account both losses to date and a realistic assessment of the prospects of further writedowns.
Avoiding cross-border strains
The IMF said greater international cooperation is needed to avoid exacerbating cross-border strains. Coordination and collaboration is particularly important with respect to financial policies to avoid adverse international spillovers from national actions.
At the same time, international support, including from the IMF, can help countries buffer the impact of the financial crisis on real activity and, particularly in the developing countries, limit its effects on poverty. Recent reforms to increase the flexibility of lending instruments for good performers caught in bad weather, together with plans advanced by the G-20 summit to increase the resources available to the IMF, are enhancing the capacity of the international financial community to address risks related to sudden stops of private capital flows, the Fund said.
