In its biannual outlook the IMF says a fragile economic recovery could be jeopardised by failed efforts to cut debt around the globe.
“The recovery has weakened considerably. Strong policies are needed to improve the outlook and reduce the risks,” Olivier Blanchard, the IMF’s chief economist, said.
“Markets have clearly become more sceptical about the ability of many countries to stabilise their public debt. Fear of the unknown is high.”
“Europe must get its act together,” Mr Blanchard said, adding that there was “widespread perception policymakers are one step behind the action”. Urging a speedy implementation of the July 21 agreement to bolster the single currency area’s €440bn bail-out fund, he said: “The eurozone is a major source of worry. This is a call to arms.”
“In the euro area, the adverse feedback loop between weak sovereign and financial institutions needs to be broken. Fragile financial institutions must be asked to raise more capital, preferably through private solutions. If these are not available, they will have to accept injections of public capital or support from the EFSF, or be restructured or closed.”
“Global activity has weakened and become more uneven, confidence has fallen sharply recently, and downside risks are growing,” the IMF said as it cut its global growth forecast for both 2011 and 2012.
The IMF’s World Economic Outlook called the Japanese tsunami and the rise in oil prices caused by the unrest in north Africa and the Middle East as two of a “barrage” of shocks to hit the international economy in 2011.
It said it now expected the global economy to expand by 4% in both 2011 and 2012, cuts of 0.3 points and 0.5 points since it last published forecasts three months ago.
“The structural problems facing the crisis-hit advanced economies have proven even more intractable than expected, and the process of devising and implementing reforms even more complicated. The outlook for these economies is thus for a continuing, but weak and bumpy, expansion,” the IMF said.
The UK was downgraded sharply, from June’s 1.5pc prediction to just 1.1pc for this year and from 2.3pc to 1.6pc for 2012. Canada and much of Europe saw even bigger downgrades.
According to the IMF’s “downside scenario” – a “shock” to European banks’ capital, higher bad debts in the US and Asia, and slower US growth – “the US and the euro area would fall back into recession, with output in 2012 more than 3pc below projections”.
“Markets have become more sceptical about the ability of governments to stabilise their public debt. Worries have spread from countries on the periphery of Europe to countries in the core, and to others, including Japan and the US,” Blanchard said. He added that there was a risk of low growth, fiscal, and financial weaknesses could easily feed on each other.
“Lower growth makes fiscal consolidation harder. And fiscal consolidation may lead to even lower growth. Lower growth weakens banks. And weaker banks lead to tighter bank lending and lower growth.” As a result, there were “clear downside risks” to the fund’s new forecasts.
In the US if income tax relief and unemployment benefit are not extended and if Capitol Hill cannot agree a longer-term strategy for dealing with the $14.3 trillion public debt, “the result could be a lost decade for growth,” the IMF warned,
The IMF urged Republicans and Democrats in Washington to settle their differences: “Deep political differences leave the course of US policy highly uncertain. There is a serious risk that hasty fiscal cutbacks will further weaken the outlook without providing the long-term reforms required to reduce debt to more sustainable levels.”
In its report, the IMF said it expected the strong performance of the leading emerging nations to be the main driving force behind growth in the world economy. China’s growth rate is forecast to ease back slightly, from 9.5% in 2011 to 9% in 2012, while India is predicted to expand by 7.5% in 2012 after 7.8% growth in 2011.