IMF slightly lowers GDP Forecasts but Sees More Downside Risks

The IMF provided a regular update to its World Economic Outlook (WEO).

The latest World Economic Outlook projects that the global economy will grow 3.5 percent this year, down 0.1 percentage points from the April forecast, and 3.9 percent in 2013, 0.2 percentage points lower.

“More worrisome than these revisions to the baseline forecast is the increase in downside risks,” said Olivier Blanchard, the IMF chief economist and director of the IMF’s Research Department, which prepares the WEO.

The IMF emphasized that the relatively minor setback to the global outlook under its baseline projections is based on three important assumptions:

• that there will be enough policy action for financial conditions in the so-called euro area periphery, which includes Greece and Spain, to ease gradually through 2013;

• that U.S. fiscal policy does not tighten sharply in 2013; and

• that steps by some major emerging markets to stimulate growth gain traction.

The IMF said the most immediate risk to the global recovery is that delayed or insufficient policy action will further escalate the euro area crisis. “Simply put, the euro periphery countries have to succeed,” said Blanchard. The report cited agreements at the June 28 eurozone summit as a step in the right direction. It said the summit actions should help break the “adverse links between sovereigns and banks and create a banking union.” But the recent deterioration in sovereign debt markets demonstrates that timely implementation of these measures, together with further progress on banking and fiscal unions, must be a priority.

The WEO update also cited the possibility that growth in the United States would stall because of excessive fiscal tightening caused by political gridlock. “In the extreme, if policymakers fail to reach consensus on extending some temporary tax cuts and reversing deep automatic spending cuts,” the U.S. economy could face a steep decline of more than 4 percent of GDP in its fiscal deficit in 2013. That so-called fiscal cliff would cause a severe decline in U.S. growth, with “significant spillovers to the rest of the world.” Moreover, if the United States does not act promptly to raise its federal debt ceiling, there will be increased risk of financial market disruption and loss in consumer and business confidence.

Growth has slowed in a number of major emerging economies, especially Brazil, China, and India. This was due both to a weaker external environment and a sharp deceleration in domestic demand in response to capacity constraints and policy tightening. Overall, though, emerging markets have weathered the crisis well.

Both Spain and Italy are implementing sizeable deficit reductions in the next two years to regain market confidence, the IMF said. In the three euro area countries with programs supported by lending from the European Union and the IMF—Greece, Ireland, and Portugal—adjustment is proceeding, but the recent deterioration in the political and economic climate in Greece serves as a warning about the potential onset of “adjustment fatigue,” which remains a threat to continued reforms, the Fiscal Monitor said.

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