Risks of prolonged market turmoil in emerging markets and of deflation in the eurozone are threatening the world’s improved economic prospects, the IMF says.
The IMF, in a report prepared for central bankers and finance ministers from the G20, said the recovery is still weak and “significant downside risks remain.”
Last month’s global growth forecast of 3.7 percent for this year, from 3 percent last year, hinges on recent market volatility from Turkey to Brazil being short-lived, the report said.
“Capital outflows, higher interest rates and sharp currency depreciation in emerging economies remain a key concern,” the report said. “A new risk stems from very low inflation in the euro area, where long-term inflation expectations might drift down, raising deflation risks in the event of a serious adverse shock to activity.”
Rising political tensions from Ukraine to Thailand, China’s slowdown and the US Federal Reserve’s tapering of its stimulus have resulted in falling stocks and currencies in emerging markets.
To weather the current turbulence, the Washington-based IMF urged developing economies to further increase interest rates when inflation remains high and cut spending when fiscal credibility is lacking.
“Exchange-rate flexibility should continue to facilitate external adjustment, particularly where currencies are overvalued,” the report said.
Currency intervention “where reserves are adequate, can be used to smooth excessive volatility or prevent financial disruption,” it said.
Advanced economies must maintain accommodative monetary policy, with the Fed needing to pay particular attention to its communication over the gradual adjustment of its asset purchases, the report said.
In the 18-country eurozone, which is “turning the corner from recession to a weak recovery,” the fund urged authorities to make it clearer that public backstops would be available for banks that may need funds after stress-test results. That would help the credibility of the test and make it easier for them to raise private capital, it said.
Very low inflation, “if below target for an extended period, could de-anchor longer-term inflation expectations,” IMF economists wrote.
It “also complicates the task in the periphery where the real burden of both public and private debt would rise as real interest rates increased,” they said.
Better coordination between central banks over their exit of unconventional monetary stimulus, combined with measures such as infrastructure investment, changes to labor markets and policies to boost domestic demand in export countries could raise the world’s output by 0.5 percentage points a year, or US$2.25 trillion, by 2018, the fund said in a separate note.