Little appears rosy in the global economy as Group of 20 leaders gather in London on Thursday. While normally there are exceptions to the general rule, bright spots are almost impossible to find. The financial crisis has morphed into a severe global recession and it is poised to become the worst downturn since the second world war.

Lehman Brothers’ collapse in September sparked a spectacular slump in confidence, leaving economic forecasters struggling to keep up with the unfolding disaster. The International Monetary Fund has produced three forecasts since the beginning of October, each much more negative than the last.

In its latest version, the Fund expects the global economy to contract by 0.5 to 1 per cent in 2009 with a modest recovery to 1.5 to 2.5 per cent in 2010. Long gone are the four consecutive years of 4 per cent plus growth of earlier this decade.

The main reason for the Fund’s latest forecast downgrade has been the worse-than-expected figures for the fourth quarter of last year, which set 2009 off to a very bad start.

Advanced economies will bear most of the brunt of the contraction, declining by 3 to 3.5 per cent this year, with Japan’s economy expected to shrink by a jaw-dropping 5.8 per cent.

While many officials from advanced countries in the US and Europe believe their economies will start to recover at the end of this year, the Fund is not so sure. “The prospects for recovery before mid-2010 are receding,” it said in a paper delivered to G20 finance ministers in mid-March.

With industrial output falling sharply, as investment has dived and consumers delay big ticket purchases, world trade has also declined for the first time in 80 years. It all adds up to make 2009 “a very dangerous year”, according to Robert Zoellick, the World Bank president.

Advanced economies were already weak by the time of the autumn financial crisis last year. A combination of falling asset prices and the boom in commodity prices had hit household and corporate incomes and reduced wealth. But its effect on emerging markets was as surprising as it has been alarming.

From a position of rude health, the emerging world has suddenly shown its dependence on advanced economies and its vulnerability to a sudden reduction in trade and capital inflows. Central and eastern Europe have been hit particularly hard, with full-blown crises hitting Hungary, Ukraine and the Baltic states. But no region is immune.

The economies of Latin America were booming on the back of commodity exports and better governance for most of 2008, but have suddenly come unstuck. Brazil’s economy has decelerated and Mexico is expecting a fall in output.

In emerging Asia, dependence on exports now appears a curse, as South Korea, Indonesia, Malaysia and even China are watching exports fall off a cliff and finding they cannot simply switch demand to domestic consumption.

The rare gains in African per capita incomes over the past decade have also disappeared, even if the continent’s output is not yet forecast to decline.

In response to the gloom, economic policy has eased faster than any time in history.

Effective interest rates have been cut across developed economies and are close to zero in the US, Japan, the UK, Switzerland, and even the eurozone. In the US, Japan and the UK, central banks are creating money to buy private sector assets and government bonds, in a policy known in most of the world as quantitative easing. The idea is to reduce further the interest rates paid by companies and households, making borrowing cheaper.

Banking rescue plans are far advanced in most countries, with guarantees for funding, almost unlimited liquidity and huge taxpayer-funded capital injections.

Stability and a return to more normal lending are seen as a prerequisite for economic recovery.

Although the speed of the global downturn is almost certain to moderate as companies stop selling out of accumulated stocks, the big unknown remains how the world can restore confidence so that more normal transactions can restart.

One G20 senior official muses that confidence can disappear in a minute but to restore it is a “multi-dimensional problem”.

Binit Patel and Alex Kelston of Goldman Sachs say that what disappeared so spectacularly in late 2008 could return if a few indicators start going in the right direction soon.

“So far each of these indicators suggests that it is still too early to sound the all-clear,” they say. But they believe that if consumption stabilises in the US and strengthens in the UK and Germany, a rapid recovery is not an impossible dream.

And if these signs of hope materialise soon, or are fostered by a successful G20 summit, the world could seem a lot less dangerous in a year’s time than it does now.

The problem is that a vicious circle remains in operation, with the financial sector dragging the advanced economies down and economic weakness still threatening advanced and emerging market financial sectors alike.

Until this dangerous spiral is broken, no one will be confident of recovery.

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