The global economy is experiencing “transitions on an epic scale”, the International Monetary Fund managing director said on Thursday, warning that turbulence in emerging markets could knock 0.5 to 1 percentage point off their growth.
Christine Lagarde’s remarks show the damage done to emerging markets by a recent round of “taper talk”, over the possibility of the US Federal Reserve slowing the pace of its asset purchases and their vulnerability to future changes in the pattern of global capital flows.
“The immediate priority is to ride out the turbulence as smoothly as possible,” said Ms Lagarde. “Currencies should be allowed to depreciate. Liquidity provision can help deal with dysfunctional market behaviour. Looser monetary policy can also help.”
But she warned that countries with inflationary pressures – such as Brazil, India, Indonesia and Russia – have less scope to use monetary policy and that high debt and deficits mean many developing countries have little space for fiscal stimulus either.
“Overall, the global outlook remains subdued,” said Ms Lagarde, in her traditional speech ahead of the annual World Bank and IMF meetings in Washington next week. “In many of the advanced economies, however, we are finally seeing signs of hope. Growth is looking up, financial stability is returning, and fiscal accounts are looking healthier.”
The impact of a slowdown on US Federal Reserve asset purchases had been expected to dominate this year’s annual meetings but the Fed’s decision to hold off on tapering has removed that focus.
Instead, the world’s economic policy makers will have a ringside seat as they assemble in a US capital where much of the federal government is shutdown and a potential default is just days away if Congress cannot resolve its differences. Ms Lagarde said that raising the debt ceiling is “mission critical” for the world economy.
“Because the normalisation of monetary policy affects so many markets and people across the globe, the US has a special responsibility: to implement it in an orderly way, linking it to the pace of recovery and employment; to communicate clearly; and to conduct a dialogue with others,” said Ms Lagarde.
The expectation of “tapering” by the Fed had prompted a flight of capital from emerging markets, causing currencies and asset markets to fall, only for a sharp flow back the other way when the US central bank unexpectedly kept its purchases at $85bn a month in September.
Ms Lagarde said the US showed the clearest signs of recovery among advanced countries. “We see it all around us. Households are in better shape, the housing sector is looking brighter and the private sector engine is humming again. And yet, growth this year will still be too low – below 2 per cent – due to too much fiscal adjustment.”
She also pointed to improved growth in the eurozone. “Now, after six quarters of recession, the region came up for air last spring, and growth should be back in positive territory next year – almost 1 per cent,” she said. “Yet unemployment – at 12 per cent – is still far too high.”
China should slow down its credit boom and try to expand its economy via higher productivity, she said. “This means liberalising interest rates, ramping up financial sector oversight, opening up protected sectors to private initiative and further strengthening of the social safety net.”
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