World Economic Outlook Update: World growth is projected at about 4.5 per cent in 2010 and 4.25 per cent in 2011. Relative to the IMF's (International Monetary Fund) April 2010 World Economic Outlook (WEO), this represents an upward revision of about ½ percentage point in 2010, reflecting stronger activity during the first half of the year.

The forecast for 2011 is unchanged. The IMF says at the same time, downside risks have risen sharply amid renewed financial turbulence. In this context, the new forecasts hinge on implementation of policies to rebuild confidence and stability, particularly in the Eurozone. More generally, policy efforts in advanced economies should focus on credible fiscal consolidation, notably measures that enhance medium-run growth prospects, such as reforms to entitlement and tax systems. Supported by accommodative monetary conditions, fiscal actions should be complemented by financial sector reform and structural reforms to enhance growth and competitiveness. Policies in emerging economies should also help rebalance global demand, including through structural reforms and, in some cases, greater exchange rate flexibility.

The IMF says the world economy expanded at an annualized rate of over 5 per cent during the first quarter of 2010. This was better than expected in the April 2010 WEO, mostly due to robust growth in Asia. More broadly, there were encouraging signs of growth in private demand. Global indicators of real economic activity were strong through April and stabilized at a high level in May. Industrial production and trade posted double-digit growth, consumer confidence continued to improve, and employment growth resumed in advanced economies. Overall, macroeconomic developments during much of the spring confirmed expectations of a modest but steady recovery in most advanced economies and strong growth in many emerging and developing economies.

Nevertheless, the Fund says recent turbulence in financial markets - - reflecting a drop in confidence about fiscal sustainability, policy responses, and future growth prospects - - has cast a cloud over the outlook. Crucially, fiscal sustainability issues in advanced economies came to the fore during May, fuelled by initial concerns over fiscal positions and competitiveness in Greece and other vulnerable Eurozone economies.

Overall, output in advanced economies is now expected to expand by 2.5 per cent in 2010, a small upward revision of ¼ percentage point, due mostly to stronger-than-expected growth during the first quarter, especially in advanced economies in Asia. On a Q4-over-Q4 basis, the forecast is broadly unchanged at 2.25 per cent, implying lower growth during the second half of 2010 on account of the financial turbulence

For 2011, growth in advanced economies remains broadly unchanged from the April 2010 WEO, at 2.5 per cent. Somewhat stronger projected growth in the United States (owing to gathering momentum in private demand) is offset by slightly weaker projected growth in the Eurozone (due to the turbulence). Overall, the WEO forecast continues to be consistent with a modest recovery in advanced economies, albeit with substantial differentiation among them. Challenging the recovery in these economies are high levels of public debt, unemployment, and in some cases, constrained bank lending.

The Eurozone is forecast to grow by 1.0 per cent in 2010 and 1.3 per cent in 2011. 0.2% was shaved off 2011 growth because of the debt crisis.

The US economy is forecast to grow by 3.3 per cent and 2.9 per cent in 2010 and 2010, up 0.2 and 0.3 per cent respectively.

The Update says of utmost importance are firm commitments to ambitious and credible strategies to lower fiscal deficits over the medium and long term. Such plans could include legislation creating binding multiyear targets and should emphasize policy measures that reform pension entitlements and public health care systems, make permanent reductions in non-entitlement spending, improve tax structures, and strengthen fiscal institutions. Such steps should mitigate the type of adverse short-term effects on domestic demand that fiscal consolidation has commonly caused in the past by reducing the fiscal burden for the future and boosting the economy’s supply potential.

The Fund says most advanced economies do not need to tighten before 2011, because tightening sooner could undermine the fledgling recovery, but they should not add further stimulus. Current fiscal consolidation plans for 2011, which envisage a fiscal retrenchment corresponding to an average change in the structural balance of 1.25 per centage points of GDP, are broadly appropriate (see Figure 6 below)

The IMF says economies facing sovereign funding pressures have already had to embark on immediate fiscal consolidation; in these economies, strong signals of commitment through politically-difficult, upfront measures are necessary. More generally, countries that are unable to credibly commit to medium-term consolidation may find themselves compelled by adverse market reactions to undertake more frontloaded adjustments.

Meanwhile, fast-growing advanced and emerging economies can start to tighten now. For some, it may be preferable to use fiscal policy rather than monetary policy to contain demand pressures if tighter monetary conditions could exacerbate pressure from capital inflows. In contrast, in economies with excessive external surpluses and relatively low public debt, fiscal tightening should take a backseat to monetary tightening and exchange rate adjustment, in order to facilitate the necessary rebalancing toward domestic demand, the IMF says.

World Economic Outlook Update