The US Federal Reserve needs to take special care as it contemplates reducing its colossal stimulus to the world's biggest economy, says the IMF. (AFP)
Badly handled budget cuts in the United States and a slowdown in activity in big developing countries mean the global economy will expand more slowly than expected this year, according to the International Monetary Fund (IMF).
Revising down its forecasts for growth in 2013 and 2014, the fund warned that the risks were that performance could be even more lacklustre and said the Federal Reserve – the US central bank – needed to take special care as it contemplated reducing its colossal stimulus to the world's biggest economy.
The IMF now expects the global economy to expand by 2.9% in 2013 and 3.6% in 2014 – down by 0.3 and 0.2 points respectively compared with its previous predictions made in July – despite signs of recovery in the euro region.
"Global growth is still weak, its underlying dynamics are changing, and the risks to the forecast remain to the downside," the IMF said in its latest World Economic Outlook.
The half-yearly analysis of global trends was critical of the way across-the-board budget cuts had been handled in Washington, noting that they had contributed to weaker US growth.
"The US economy remains at the centre of events. Private demand continues to be strong, although growth has been hobbled this year by excessive fiscal consolidation," said Olivier Blanchard, the IMF's economic counsellor.
"Politics is creating uncertainty about both the nature and the strength of the fiscal adjustment. The sequester is a bad way to consolidate, and conflicts around increasing the debt ceiling could lead to another bout of destabilising uncertainty and lower growth."
IMF forecasts now show the US growing by 1.6% this year and by 2.6% in 2014, down by 0.1 and 0.2 points from its previous estimates. Even so, it said it was time for the Fed to make plans for making an exit from ultra-low interest rates and quantitative easing, the bond-buying strategy that has sought to pump credit into the US economy.
Blanchard said: "While there are no major conceptual or technical issues involved, the communication problems facing the Federal Reserve are new and delicate. It is reasonable to expect some volatility in long rates as Fed policy shifts."
The fund says the Fed – which decided last month to wait longer before starting to scale back quantitative easing – will need to act with care and communicate its strategy clearly, given the slowdown in Chinese growth, the fragmented financial system in the euro area and worryingly high levels of public debt in the West. It warned that old problems could trigger new crises.
Blanchard said the major news in the World Economic Outlook came from emerging market economies, where the fund had been surprised by the declines in growth.
"The obvious question is whether this slowdown reflects cyclical factors or a decrease in potential output growth. Based on what we know today, the answer is that it reflects both, albeit to different degrees in various countries – more cyclical in Russia and South Africa, more decreased potential in China and India," Blanchard said.
He added that recovery from the global downturn was continuing, but at too slow a pace. "The focus at this time is on emerging-market economies – specifically, on the combination of slower growth and tighter financial conditions triggered by US monetary policy.
"But … other legacies of the crisis still linger, and may well come back to the fore. Public debt and, in some cases, private debt remain very high, and fiscal sustainability is not a given. The architecture of the financial system is evolving, and its future shape is still unclear."
The IMF said the impulse to stronger global growth in 2014 was expected to come mainly from the US, where activity is predicted to move into a higher gear as the impact of higher taxes and lower spending eases and the Fed slowly withdraws its stimulus.
"In the euro area, business confidence indicators suggest that activity is close to stabilising in the periphery and already recovering in the core economies," says the World Economic Outlook.
"Emerging market and developing economy growth rates are now down by about 3 percentage points from 2010, with Brazil, China and India accounting for two-thirds of the decline." – © Guardian News & Media 2013
Larry Elliott is the Guardian's economics editor