IMF: East won't make up for West

The International Monetary Fund expects global growth to fall next year as the emerging economies which are leading the global recovery are unable to fully compensate for weaker demand in rich countries.

The IMF's World Economic Outlook forecasts global output to increase 4.8 per cent this year, after contracting 0.6 per cent in 2008.

But it expects growth to ease to 4.2 per cent next year, reflecting a temporary slowdown spanning the second half of this year and the first half of 2011 in both advanced and emerging economies.

That would still be in the range of annual global growth rates before the financial crisis.

It is the net effect of a two-speed world, with growth averaging 6.4 per cent among emerging and developing economies and just 2.2 per cent among advanced economies.

A sustained, healthy recovery requires two rebalancing acts, the IMF says.

One is an internal handover within the advanced economies from public to private sector-driven demand.

The other is an external rebalancing where deficit countries increase net exports and surplus countries, especially in emerging Asia, reduce net exports.

Advanced economies need to repair and reform their financial sectors and start reducing fiscal deficits in earnest next year, while emerging economies need to foster domestic sources of growth, supported by "greater exchange rate flexibility".

As these are formidable challenges, the IMF sees the risks to global growth as predominantly on the downside.

It expects continued but slow recovery in the United States as households struggle with a 25 to 30 per cent drop in house prices and unemployment near 10 per cent.

Europe looks even weaker, the IMF forecasting growth of 1.6 per cent next year as against 2.3 per cent in the US.

China's growth is also expected to slow next year, but only to 9.6 per cent. Asia as a whole is forecast to grow 6.7 per cent.

"Notwithstanding a relatively healthy growth outlook, emerging economies are unlikely to fully compensate for the lower demand from advanced economies over the medium term," the IMF says.

"In particular recent developments in economies with excessive surpluses do not point to a significant acceleration in domestic demand, relative to pre-crisis growth rates."

It points to the relatively small size of Chinese consumption overall and of its imports of consumer goods - which in 2008 accounted for just 3 per cent of global imports. A number of economies in emerging Asia have undervalued exchange rates, the IMF says.

"This ... presents a problem that might best be addressed by collective action taken in a co-ordinated manner."

It acknowledges concerns about destabilising currency appreciations and related loss of international competitiveness, which have led key emerging economies to accumulate foreign reserves rather than allow their exchange rates to rise in response to trade surpluses and capital inflows. But it points to the costs of that policy in terms of weaker domestic activity and rising inflation pressures.

The IMF warns that sovereign debt issues which flared up earlier in the year still pose risk to the global recovery.

Weaker members of the euro area have a large amount of debt maturing over the coming year and in refinancing it they will face stiff competition, given the large funding needs of other advanced economies, it says. Banks also face a "wall" of maturing debt to be refinanced - over US$4 trillion ($5.3 trillion) in the next two years.

"Funding problems could easily arise for specific institutions, prompted by renewed stress in sovereign debt markets, further weakness in real estate markets or downside surprises to economic activity," it says.

"Because of complex linkages within and across borders these problems could quickly become more widespread."