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Gloomier by the day or can it get worse?

— PHOTO: AFP

Guessing game: Jaime Caruana (left), Director, Capital Markets, with Olivier Blanchard, Economic Counsellor, IMF, addressing the joint World Economic Outlook (WEO) and Global Financial Stability Report (GFSR) press conference in Washington DC recently.

A recent (January 28) IMF (International Monetary Fund) report paints a grim picture of the global economy in 2009. It forecasts economic growth around the world to fall to 0.5 per cent, its lowest level in 60 years. This pessimistic view permeates IMF’s latest update to its World Economic Outlook (WEO) 2008.

The IMF’s chief economist expects the world economy to come to “a virtual halt” if the growth prognosis comes true. In November last year, the WEO had predicted the world economy to grow by 2.2 per cent this year.

So the most recent forecast is 1.7 percentage points lower than what the IMF had estimated as recently as four months ago.

In fact economic news from every corner of the globe has been one never ending story of successive downward revisions of anticipated growth rates.

The persistent pessimism is rooted in the fact that the financial sector crisis and the resultant global economic problems defy known, conventional solutions even if their manifestations are seen across all sectors in practically every country.

More recent developments point to an intensification of the economic crisis and therefore reinforce the pessimism.

The IMF records the fact that global output and trade fell sharply in the final months of 2008.

Government policies have been unable to dispel the great uncertainty caused by the financial crisis.

As a consequence asset prices have plummeted in both advanced and developing countries, decreasing household wealth and thereby curtailing demand. Households and businesses are postponing expenditures and reducing demand for consumer and capital goods.

Simultaneously widespread disruptions in credit are constraining household expenditure and slowing production and trade.

News from individual countries reinforces the pessimism. During the last quarter of 2008 (October-December), the U.S. economy was down by 3.8 per cent from its previous quarter.

China’s GDP growth at 6.8 per cent was sharply lower than the double digit growth in preceding quarters. Japan which, along with the U.S. and Euro Zone countries, is in recession, reported a sharp fall in factory output in November and December.

How will the world economy fare during 2009? According to the IMF, while all countries have been affected by the crisis, the economies of advanced countries will shrink, while those of developing countries will continue to grow albeit at a much slower pace.

The IMF estimates that in 2009 advanced countries will witness their sharpest ever contraction since the Second World War: the U.S. economy will decline by 1.5 per cent, the Euro area countries by 2 per cent and Japan by 2.5 per cent. India, China and other developing countries, though continuing to be resilient, will suffer setbacks. The IMF expects China to grow by 6.75 per cent and India by just 5 per cent in 2009.

In India, all recent official forecasts are far less upbeat than they were just months ago. In late January, the Prime Minister’s Economic Advisory Council (EAC) and the RBI had placed growth for the current fiscal around 7.1 per cent and 7 per cent, respectively.

These are sharply lower than their earlier forecasts of 7.7 per cent and 7.5-8 per cent, respectively. The RBI has not announced its forecast for 2009-10 but the EAC somewhat optimistically predicts a 7.5 per cent growth next year.

Recent and current experience rules out optimism on the growth front even next year. However, the IMF expects world economic growth to rebound in 2010 to 3 per cent, sharply above the 0.5 per cent rate for this year. The problem is that policy makers everywhere are still groping in the dark for the right measures to counter the crisis.

The IMF’s prescriptions (in its recent report) are full of generalities. On measures to restore financial sector health, it urges stronger policy actions. Many countries have implemented several policy measures “but a comprehensive framework for restoring financial health and dealing with bad assets remains to be built and the crisis has lingered. More aggressive and concerted actions are now needed — through a unified approach involving liquidity provision, capital injection and disposal of problem assets.”

On monetary policy, the IMF makes the point that as long financial conditions remain disrupted, the effectiveness of low interest rates to support activity will be limited.

It therefore urges central banks to rely increasingly on unconventional measures to unlock credit markets.

Fiscal policy is constrained as deficits are widening sharply because of the cyclical downturn and the impact of asset price declines on revenues as well as stimulus measures and the cost of financial sector rescues.

To prevent an adverse market reaction, the IMF urges policy makers “to strengthen fiscal frameworks and commit to credible longer term policies that reverse the deficit buildup as economies recover.”

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