Altogether a depressing scenario emerges with newer challenges ahead for the world economy, even five years after the worst financial crisis and recession, from the International Monetary Fund’s World Economic Outlook (WEO), ahead of the Fund-Bank annual meetings (Oct.11-13). There is a downward revision of growth projections across the world, with significant scaling down in the case of emerging market and developing economies by some three percentage points from 2010 levels.

Among BRIC nations, India gets the sharpest downward revision to 3.8 per cent in fiscal 2013 and 5 per cent in 2014. It, however, ranks high in consumer price inflation over these two years (10.9 and 8.9 per cent) besides current account deficits of -4.4 and -.3.8 per cent of GDP respectively. China, although also slowing, is projected to grow at 7 .6 and 7.3 per cent for the two years 2013-14.

Russia goes down to 1.5 per cent this year before recovering to 3 per cent in 2014 while Brazil’s growth is set at 2.5 per cent for both years. China and other BRIC nations have also been performing well below potential and the output gap worked out by IMF is larger for India. Against a projection of 4.3 per cent growth in 2013 on a calendar year basis, under a Global Projection Model of IMF (different from the official WEO forecast), India’s potential growth is estimated at 5.7 per cent.

The ongoing slowdown in emerging markets, according to IMF analysis, reflects both cyclical factors (Russia and South Africa) and growth below potential in other major emerging economies from structural factors. The output gap was the largest for India and Brazil. Reasons for weaker growth differ across emerging market and developing economies and include tightening capacity constraints, stabilizing or falling commodity prices, less policy support, and slowing credit after a period of rapid financial deepening.

Infrastructural and regulatory bottlenecks and weak investment climate are among other factors cited in WEO. Many of these economies have also experienced capital outflows and currency depreciations, and although the Federal Reserve recently decided not to taper yet, “there is a distinct risk of financial conditions tightening further form their current, still supportive levels.”

Normalization of interest rates in advanced economies is likely to lead to a partial reversal of previous capital flows, and countries with weaker fiscal positions or higher inflation are particularly exposed. IMF report suggests, first, where needed, countries must put their macro houses in order by clarifying their monetary policy framework and maintaining fiscal sustainability. Second, they must let the exchange rate depreciate in response to outflows but may need to guard against risks of disorderly adjustment.

On monetary policy, it says while cyclical weakening of activity, in principle, calls for easing in economies, the responses would need to consider inflationary pressures and policy credibility. In Brazil and India, “more tightening may well be needed to address continued inflationary pressures from capacity constraints, which will likely be reinforced by recent currency depreciation”, WEO says.

IMF’s revised estimate for the world economy is 2.9 per cent - down 0.32 points from 2012, with a projected recovery to 3.6 per cent in 2014. US growth is still tepid but economic activity has been picking up with strong private demand and housing market recovery despite higher mortgage rates. Terming sequester a “bad” approach to consolidation which proved excessive hurting recovery while ongoing fiscal standoff is creating more uncertainty, IMF cautioned a longer shutdown could be “quite harmful” and, even more, failure to promptly raise the debt ceiling would seriously damage the global economy.

WEO has projected US growth at a more modest 1.6 per cent in 2013 and 2.6 per cent in 2014. The impulse to global growth is expected to come from advanced economies, mainly the United States where activity will move into higher gear as fiscal consolidation eases and monetary conditions stay supportive. But there was still risk with the Republicans not willing to vote a stop-gap budget for the fiscal year, which has begun or to increasing debt ceiling without “spending concessions” by the Obama Administration.

WEO growth estimates assume a budget settlement without deeper cuts and raising of the debt ceiling .Also, that the Fed’s accommodative policy would remain and asset purchases would be scaled back only gradually starting later his year, and policy rates will remain near zero until early 2016. On this basis, growth is projected to accelerate in late 2013 and in 2014, as the pace of fiscal consolidation slows, growth continues to benefit from monetary accommodation, and the housing market recovery remains.

Growth in the euro area will be held back by weak economies in the periphery, Germany being the only major economy expected to grow by 0.5 per cent in 2013. The euro-zone is expected to turn positive with one per cent growth in 2014. Likewise, for the European Union as a whole, growth which is expected to be nil this year may rise to 1.3 per cent next year.

IMF has cautioned that any unwinding in monetary policy accommodation in USA should be guided by the strength of recovery, while considering other potential issues such as inflation and financial stability challenges. Along with careful calibration of the timing of exit, effective communication about the strategy would be critical to ensure a smooth normalization process and to minimize risks of negative global spillovers for other economies.

According to WEO, the changing global growth dynamics raises new policy challenges. Two recent developments will likely shape the path of global economy in the near term - the perception of US monetary policy reaching a turning point - tapering talk having already resulted in large increase in long-term yields in US and other economies. Change in the policy could pose risks for emerging economies where “activity is slowing and asset quality is weakening”.

Second, a conviction that China would grow more slowly over the medium term. The expectations of Chinese authorities providing strong stimulus if the economy was declining toward 7.5 per cent, the official target, have had to be revised. Lower growth in China would no doubt affect other countries, mainly exporters of commodities and industrial goods from among emerging market and developing economies.

WEO suggests that for emerging economies to overcome slowdown, there should be an appropriate policy mix taking into account the difference in output gaps, inflationary pressures, fiscal space availability and external and other vulnerabilities. Many emerging economies have also been urged to focus on enhancing productivity growth through structural reforms and strengthening productivity in domestic services and other non-tradable sectors is also important, it said. (IPA Service)