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IMF Hedging on Global Recovery

Posted by Larry Doyle on July 9, 2010 7:08 AM |

Do we truly need to focus on developments within the emerging economies of Asia or sub-Sahara Africa? I mean, you are probably thinking that we have enough on our plates right here at home to spend anytime thinking about economic developments half a world away. Why do we need to care, and why do we need to be aware of global economic developments? For the very simple reason that in a global economy overwhelmed by massive debts and limited pools of private and sovereign credit, what happens over there very clearly impacts us right here at home.

On this note, let’s review an International Monetary Fund report released yesterday. The IMF writes, World Recovery Continues, But Risks Increase:

…despite the stronger than expected first half recovery, the IMF warned that uncertainties surrounding sovereign and financial sector risks in parts of the euro area could spread more widely, posing difficulties for both financial stability and the economic outlook.

“While we predict the recovery will continue, it is clear that downside risks have risen sharply,” Olivier Blanchard, the IMF’s chief economist, told reporters.

The IMF highlights the fact that there are significant growth disparities across regions, but let’s focus on what the IMF perceives as the increased risks:

Both the WEO (World Economic Outlook) and GFSR (Global Financial Stability Report) updates said that risks have risen markedly. In the near term, the main risk is an escalation of financial stress and contagion, prompted by rising concern over sovereign risk. “This could lead to additional increases in funding costs and weaker bank balance sheets, and hence to tighter lending conditions, declining business and consumer confidence, and abrupt changes in exchange rates,” according to the WEO update.

Because of this uncertain backdrop, the overarching policy challenge is to restore financial market confidence without choking the recovery.

Making the new European Stabilization Mechanism fully operational, resolving uncertainty about bank exposures (including to sovereign debt), ensuring that European banks have adequate capital buffers, and continuing liquidity support are identified in the Global Financial Stability Report market update as immediate priorities in the financial sphere.

Regarding the European banks, please recall the other day I highlighted that highly renowned Harvard economist Kenneth Rogoff believes there are A Lot of Insolvent European Banks.

The update also calls for greater clarity on the details and timing of intended regulatory reforms, as uncertainty surrounding a final set of reforms is making it difficult for banks to take business decisions and constraining their willingness to lend.

Policies should be determined by country circumstances, the IMF said. Most advanced economies do not need to tighten before 2011 because tightening sooner could undermine the fledgling recovery, but they should not stimulate their economies more. Current fiscal consolidation plans for 2011 in large advanced economies that envisage a fiscal retrenchment corresponding to an average change in the structural balance of the economy of 1¼ percentage points of GDP are broadly appropriate.

What does this mean? That statement is economic-speak for the realities embedded in fiscal austerity programs. In other words, many governments, including ours, will be compelled by existing excessive debt burdens to take their foot off the economic pedal.

At a global level, the IMF said policies should focus on implementing credible plans to lower fiscal deficits over the medium term while maintaining supportive monetary conditions, accelerating financial sector reform, and rebalancing global demand.

What does this mean or how might it be viewed? Picture the clowns in the circus furiously running back and forth while trying to keep all the plates spinning.

In terms of global growth projections, the following IMF produced chart is comprehensive in highlighting the fact that the global economic power is shifting dramatically to the emerging economies. What happens in the process? Capital flows shift accordingly.

Navigate accordingly.

LD

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  • Jeffers

    How does the IMF actually make its projections?

  • Jeffers

    Or could the capital outflows be much more substantial and the IMF is low balling its estimates?

    • LD

      Jeffers,

      There has been a shift in the overall balance of power within the IMF itself from the U.S. to nations with emerging economies. I am sure there are plenty of politics going on within the IMF but I have never witnessed blatant distortions in economic projections from the IMF relative to other analysts.

      In regard to the capital flows into emerging economies from developed economies, here is a fabulous Bloomberg commentary on that topic, Emerging Market Growth Gap to Widen, El-Erian Says,

      Growth in emerging markets will accelerate faster than in developed nations as economies mature and leaders are quicker to make structural changes, according to Pacific Investment Management Co.’s Mohamed El-Erian.

      “The structural vision is going on outside of industrialized countries,” El-Erian, Pimco’s chief executive and co-chief investment officer, said in a radio interview today on Bloomberg Surveillance with Tom Keene. “You go to Brazil, you go to Russia, you go to China: they are thinking structurally whereas industrial countries are thinking cyclically.”

      I have tried to highlight the fact that our economy is very much going through major structural changes. Many in Washington and on Wall Street do not care to acknowledge that. They would maintain, and El-Erian highlights this fact, that we are going through cyclical developments.






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