IMF more optimistic about global economy recovering

The International Monetary Fund has become more optimistic about the recovery in the global economy and expects to revise the growth projections modestly upward, mainly for 2010.

Speaking at Turkish Industrialists' and Businessmen's Association's conference in Turkey, IMF first deputy managing director John Lipsky, said, ''Financial conditions have improved, confidence is recovering gradually, and indicators of future production and demand have firmed. Reflecting these developments, I expect that in the coming weeks we will revise our growth projections modestly upward, mainly with regard to 2010.''

The last two quarters of an unprecedented global economic contraction, there were sign of  '' rate of output decline has moderated'' he said  ''While the latest data point to a slowing of the global contraction, the timing and pace of the global economic recovery remains uncertain.

He pointed to the "resolute policy actions" by governments in terms of ''sizeable fiscal stimulus injected into their economies, as the main reason for the global economy improving.

In April, the IMF had predicted the global economy was likely to contract 1.3 per cent this year and growth was set to re-emerge at a sluggish pace of 1.9 per cent in 2010. (See: IMF again slashes global growth forecasts)

Interestingly, World Bank President Robert Zoellick had said last week that the global economy will contract even more sharply than expected in 2009 and  the world economy would shrink by nearly 3 per cent which was more than the estimate of 1.75 per cent made in March.(See: WB president Zoellick projects bleaker than expected economic prospects for 2009)

Lipsky noted that the globally coordinated policies including through the G-20 process has magnified notably the positive impact of the measures taken at a national level.
The rising unemployment rates around the world showed that it is far too early to conclude that the'' goal of restoring global growth has been accomplished.'' he said. ''Moreover, financial conditions are still far from normal, despite recent improvements.''

 While the risk of new systemic financial system disruptions has been reduced sharply, credit growth in most markets remains subdued amid ongoing deleveraging, and many securitization markets remain dormant, he added.

Even the upbeat indicators widely cited as representing ''green shoots'' still point to a global recovery that would be sluggish by historic standards.

The IMF is of the view that activity in the advanced economies are likely to revive only gradually over the course of 2010, weighed down by financial deleveraging, limited credit growth, weak household income growth and declining household net worth.

Emerging economies as a group have weathered this crisis better due to strong policy frameworks put in place over the preceding decade and are unlikely to return to trend growth, while advanced economies are still underperforming, he noted. As a result, output gaps and unemployment rates in most economies likely will continue rising through 2010, he said

Policies must remain focused on recovery
He said continued strong policy actions will be needed during the remainder of this year and into 2010 in order to insure that economic activity begins a sustained improvement.

Lipsky added that three factors needed to be looked into and appropriates steps need to be taken for complete gradual recovery.

First and foremost, robust growth will not be achieved until continuing financial sector problems are addressed forcefully.

Recent bank stress tests in major advanced economies, notably the United States and the United Kingdom, have represented a significant step toward rebuilding market confidence and attracting new private capital.

However, progress overall in restoring banks to health has been slow and uneven, and limited progress has been made in dealing with problem assets on bank balance sheets, he said.

He pointed that in order to lay a foundation for revived bank credit growth, the near-term focus of policies should continue to be on restructuring weakened financial institutions by cleansing banks' balance sheets of impaired assets, assessing bank viability, and ensuring bank recapitalization where needed.

Policy responses should be coordinated internationally to avoid regulatory arbitrage and competitive distortions, and to ensure reasonable burden-sharing of crisis costs.

Second, macroeconomic policies in most countries should continue to support demand to insure that the risks of a deeper and more prolonged recession are capped.

Fiscal policy in advanced and many emerging market economies should remain expansionary, at least through 2010.

In line with their Leaders' Summit commitments, G-20 governments are providing discretionary stimulus of about 2 percent of GDP in 2009 and 1½ percent of GDP in 2010.

Lipsky added additional support still could be needed if downside risks to the outlook materialize and to be most effective, near-term stimulus measures should be anchored in a credible medium-term fiscal policy framework. If this is not in place, fears of future crowding-out pressures from sustained government debt growth could prove to be counter-productive.

Monetary policy should remain supportive until a sustained recovery takes place and major central banks should keep ''policy interest rates low''.

In emerging economies, monetary policy will need to balance the desire to support demand against the risk of exacerbating capital outflows or deteriorating credit quality, he said.

Moving beyond the crisis: the need for an exit strategy
Even as policy remains focused on ensuring an end to the global recession, it is not too early to begin planning to unwind the extraordinary policies that have been put in place during the past year, he said.

Lipsky said that while continuing to provide short-term support, ''credible and coherent exit strategies'' should be in place to ''unwind substantial public intervention in the financial sector'' in order to limit medium-term risks, to alleviate inflation concerns, and to minimize policy distortions.

 The importance of this issue was recognized by G-8 finance ministers at their meeting last week when they asked the IMF to take a leading role in helping countries to prepare exit strategies, he said.

He said that fiscal deficits in most economies will need to be consolidated after rising dramatically in 2009, in order to bring public finances back to a sustainable trajectory.

Pointing that fiscal deficits will remain wide in 2010 as fiscal support continues to sustain still-fragile economic conditions, Lipsky felt a more self-sustaining economic growth would provide the basis for'' a deliberate withdrawal of stimulus''.

He noted that longer-term fiscal prospects in many economies are of serious concern as  in many advanced economies the impending pressures will derive from population aging and rising healthcare costs.

Market confidence in the sustainability of budget positions would be helped by formulating medium-term fiscal frameworks and by announcing an outline of measures that will be used to tackle rising health care and retirement costs he said.

Second, the restoration of healthy and innovative financial systems will be central for returning to '' a new period of economic progress''.

For confidence and trust to be rebuilt '' private capital must be rebuilt, government guarantees rolled back, and the expansion of central bank balance sheets unwound,'' Lipsky noted.

He noted that simultaneously the regulation of financial markets and institutions must be overhauled by broadening the regulatory perimeter and establishing a more effective tracking of systemic leverage, and promote more robust risk management.

Further, he added that the traditional regulation should be supplemented by a '' macroprudential approach'' which would take account of systemic and cyclical factors and mitigate potential pro-cyclical effects of regulation.

Third, major central banks have brought interest rates close to their lower bounds and have dramatically expanded the size of their balance sheets.

He added that monetary authorities will need to devise plans to exit from unconventional measures to ensure ''a smooth return to private intermediation'' and to'' forestall concerns that inflation pressures could be allowed to rise rapidly.''

Finding new sources of growth
He said ''this is not the end of the policy challenges'' as policy-makers world over will face a daunting task in the coming months to ''maintain supportive policies'' while simultaneously ''planning for their well-timed reversal.''

For the global economy to return to solid and sustained growth, several longer-term structural issues will have to be addressed and the basic source of growth in many key economies will shift relative to the pre-crisis period, he said

He also pointed that ''it should not be assumed that growth in US consumer spending will provide the same degree of support for global growth as previously.''

IMF had concluded earlier that the pattern of global growth would have to change if the broad-based expansion experienced earlier this decade were to be sustained.

IMF had sponsored the innovative Multilateral Consultation on Global Imbalances, with the participation of the euro area, China, Saudi Arabia, Japan and the United States during 2006-07 with a aim  to develop a set of mutually consistent economic policy programs that would support growth while reducing imbalances.

The policy agenda included structural reforms to raise potential growth in Europe and Japan; steps to boost domestic demand growth in China, including increased social outlays and public investment plus increased currency flexibility; investment in new energy production and other support for domestic demand among oil producers; and higher public and private savings in the United States.

He noted that, if the policy agenda had been implemented adequately and expeditiously, it would have greatly reduced the depth and scope of the current Great Recession.

Lipsky pointed that in the wake of the crisis, the composition of global demand will have to adjust in order to restore and sustain growth. In particular, US growth will become relatively more dependent on expanding net exports and business investment while growth in emerging economies that have relied principally on export growth with large current surpluses in the future will have to depend relatively more on domestic demand growth.

After the crisis, the fiscal consolidation will be required and the inevitable rise in private saving in advanced economies, reflecting the steep decline in financial and housing wealth and tighter credit availability will need to be matched by an increase in emerging market domestic demand, he said.

This would be facilitated by stronger social safety nets that would reduce the need for precautionary savings, by developing more effective financial systems, and by more flexible currency management that would support more fluid rebalancing of global supply and demand, he said.

Earlier this week, the World Bank recently raised China's GDP forecast by 0.7 percentage point to 7.2 per cent in 2009 from its earlier forecast of 6.5 per cent.(See: World Bank raises China's GDP growth to 7.2 per cent in 2009)