Weaker emerging economies are exposed to sudden capital flight with the global economy staying on course to strengthen as expected this year, the International Monetary Fund said on Tuesday.
Although the fund said growth in most advanced and emerging economies was accelerating as expected, it warned that the world was “not out of the woods yet” with deflation fears increasing in Europe and the US and vulnerability in some emerging economies.
The warnings came as the IMF upgraded its 2014 global growth expectation by 0.1 percentage point. It now forecasts 3.7 per cent expansion in 2014, a figure that shows the world economy recovering from the 3.0 per cent rate last year.
Britain’s ability to surprise the fund with its resilient recovery continued with its growth forecast upgraded 0.6 percentage points, more than any other country, to 2.4 per cent in 2014.
In an interview with the Financial Times, Olivier Blanchard, the IMF’s chief economist said that the upgraded forecasts showed a strengthening global economy although with a number of caveats.
“The main brakes to the recovery – which were fiscal consolidation, weak banks and uncertainty – are slowly becoming less intense. So there is hope,” he said.
Expanding on concerns raised last week by Christine Lagarde, the IMF managing director, Mr Blanchard said the eurozone is the main region of the world threatened by deflation.
He added that the European Central Bank will need to do whatever it takes to prevent deflation, but its powers are limited. “They have many more legal and constitutional constraints than many central banks. We have to be realistic at this point. Monetary policy cannot work repeated miracles,” he said.
He said that the eurozone must try every means possible to bring down the high interest rates faced by firms and consumers in southern European economies. Sovereign debt yields have fallen but that has not passed through to the rest of the economy.
Mr Blanchard said he fears that, even if eurozone banks are recapitalised, the weak balance sheets of companies in southern Europe may still be a problem, with many lacking the profits to service their debts. “I think that, for the moment, we may have understated this aspect of things,” he said. “Even if you made the banks virginal again, there would still be this problem.”
The eurozone would emerge from contraction to post 1 per cent growth in 2014 and Japan’s growth rate would remain stable at 1.7 per cent, the IMF forecasts suggested.
Mr Blanchard said that Japan’s policy of raising consumption tax but offsetting it with some extra spending this year made sense.
“The main challenge on the fiscal front is this incredibly difficult juggling act. They need to do some fiscal consolidation because the level of debt is truly, truly high,” he said. “The minute the debt holders start having doubts – then Japan is in trouble. At the same time, Japan should not kill growth.”
For emerging economies, the fund forecast that growth would pick up a little to 5.1 per cent from 4.7 per cent in 2013 even with further slight slowing in China.
He said that, so far, China has managed well its efforts to slow down a credit boom.
“You can think of it going bad both ways: that somehow they are not able to slow it down and then it gets worse or they squeeze too fast and have a harder time maintaining growth,” he said.
“Our assumption is they largely know what they’re doing and have the fiscal means to avoid further effects on the economy – but there is some uncertainty, obviously.”