Weak global recovery makes world economy vulnerable to adverse shocks, says IMF

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Photo courtesy: Asian Development Bank

The global recovery has weakened further amid increasing financial turbulence and falling asset prices, developments that point to higher risks of a derailed recovery at a time when the world economy is highly vulnerable to adverse shocks, the International Monetary Fund (IMF) has warned.

It said in a note ahead of the G20 meeting in Shanghai that economic activity softened towards the end of 2015 and the valuation of risky assets has dropped sharply, especially in advanced economies, increasing the likelihood of a further weakening of the outlook.

“Growth in advanced economies is modest already under the baseline, as low demand in some countries and a broad-based weakening of potential growth continue to hold back the recovery,” it said pointing to concerns about the global impact of China’s transition to more balanced growth, along with signs of distress in other large emerging markets, including from falling commodity prices.

Heightened risk aversion has triggered global equity market declines and brought a further tightening of external financial conditions for emerging economies. Strong policy responses both at national and multilateral levels are needed to contain risks and propel the global economy to a more prosperous path, the note said.

The IMF warned that financial market turbulence and asset price declines that have tightened financial conditions in advanced economies and could further weaken growth if they persist.

“Emerging market stress could rise more, also reflecting domestic vulnerabilities. At the same time, there is a risk that the decline in oil prices will further destabilize the outlook of oil exporters while the impact on importers generates less demand support than expected, lowering global growth and exacerbating the current low-inflation environment,” the note said.

Finally, shocks of a non-economic origin—related to geopolitical conflicts, terrorism, refugees, and global epidemics—loom over some countries and regions, and, if left unchecked, could have significant spillover impacts on global economic activity, it added.

IMF called for urgent broad-based policy response that would strengthen growth and manage vulnerabilities.

“In advanced economies, securing higher and sustainable growth requires a mix of mutually-reinforcing demand and supply policies. On the demand side, accommodative monetary policy remains essential where inflation is still well below central banks’ targets,” it said.

A comprehensive approach is needed to reduce over-reliance on monetary policy, the IMF said, adding near-term fiscal policy should be more supportive where appropriate and provided there is fiscal space, especially through investment that boosts both the demand and the supply potential of the economy.

In a number of countries, efforts to accelerate the repair of private sector balance sheets would help improve the transmission of monetary policy and support domestic demand. On the supply side, across advanced and emerging economies, credible and well-designed structural reforms remain critical to lift potential output, and can provide some near-term demand support directly and through increased confidence and expectations of higher future income, the note said.

In emerging economies, the note said, policymakers should reduce macroeconomic and financial vulnerabilities and rebuild resilience. In commodity exporters, fiscal buffers can help smooth the adjustment to lower commodity prices, but it will be important to plan for fiscal adjustment and new, more diverse growth models.

 

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