The International Monetary Fund this week cut its forecast for global growth this year as it warned of a possible chain reaction from the six-month-old credit crunch rippling through the global economy.
Predicting the weakest expansion since 2003, the IMF said tougher lending standards imposed as a result of the sub-prime meltdown in the United States threatened to curb consumer spending in the West, leading to a knock-on effect on the export-dependent economies of Asia.
“The financial market strains originating in the US sub-prime sector have intensified, while the recent steep sell-off in global equity markets was symptomatic of rising uncertainty,” it said. The IMF forecasts came as the Federal Reserve, the US’s central bank, prepared to announce whether it would follow last week’s emergency cut in interest rates of 0,75 percentage points with a further reduction in the cost of borrowing.
Despite news on Tuesday that higher military spending and aircraft orders led to a 5,2% annual increase in durable goods orders in December, Wall Street was convinced that the Fed would cut by 0,5 points to 3%. Figures released earlier this week from the 10 biggest metropolitan districts in the US showed house prices falling by a record 8,4% in the year to November.
The IMF has now cut its forecast of global growth in 2008 twice in three months. Back in October it was predicting expansion of 4,8% this year to continue the longest period of sustained strong growth since the late 1960s and early 1970s, but that was trimmed to 4,4% after it was found that higher inflation in the past decade in emerging economies such as China and India meant growth had not been quite as fast as originally believed. It has now further cut its growth estimate to 4,1%.
All three of the West’s big economic blocs — the US, the eurozone and Japan — saw their growth projections reduced. The IMF said it now expected the US GDP to increase 1,5% in 2008, down 0,4 points on October, while the eurozone is predicted to grow 1,6%, a 0,5 point cut. The Japanese economy is predicted to grow 1,5%, compared with 1,7% last autumn.
Advance warning of the new growth forecasts had been trailed by Dominique Strauss-Kahn, the IMF’s managing director at the annual meeting of the World Economic Forum in Davos last week.
Strauss-Kahn backed the Fed’s decision to reduce interest rates four times since the financial markets froze up last year and also supports the $150-billion package of tax cuts planned by the G eorge Bush administration to boost growth.
Despite more aggressive use of monetary and fiscal policy in the US, the IMF said it was possible that 2008 could still turn out to be worse than it was forecasting. “The overall balance of risks to the global outlook is still tilted to the downside,” the IMF said. It added that the principal risk was that consumers cut back their spending in response to the financial turmoil of the past six months.
Its concern is that the big losses suffered by banks and hedge funds from the still declining US real estate market will lead to a tightening of credit worldwide, with lenders making borrowing more expensive and harder to come by.
Strauss-Kahn believes that the IMF needs to improve its surveillance of the global economy as policy-makers seek to learn the lessons from what world economist George Soros described last week as the most serious crisis to hit the financial system since World War II.
“Supervisors and auditors have a key role to play to promote early, consistent and clear disclosure of exposures and values of sub-prime and related securities, both on and off the balance sheet,” the IMF said.
It expected China to grow by 10% this year but added that there were warning signals from slowing export growth. “No one is going to be exempt from some slowdown,” chief economist Simon Johnson said.
The IMF said that rising inflationary pressures made life more complicated for policy-makers. “Monetary policy faces the difficult challenge of balancing the risks of higher inflation and slower economic activity.”
Johnson backed the cautious approach adopted by the European Central Bank towards cuts in interest rates. “The eurozone finds itself in a difficult position. The economy is slowing, but inflation remains a concern.” — Â