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Wed 21 Sep 2011 03:57 PM

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IMF warns of fresh crisis over Europe debt woes

Fund cuts global growth forecast on fears Eurozone crisis will spread

IMF warns of fresh crisis over Europe debt woes

The International Monetary Fund cut its forecast for global growth and predicted “severe” repercussions if Europe fails to contain its debt crisis or US policy makers deadlock over a fiscal plan.

The world economy will expand 4 percent this year and next, the IMF said Tuesday, compared with June forecasts of 4.3 percent in 2011 and of 4.5 percent in 2012. The US growth projection for 2011 was lowered to 1.5 percent this year from 2.5 percent in June.

“Global activity has weakened and become more uneven, confidence has fallen sharply recently, and downside risks are growing,” the IMF said in its World Economic Outlook report.

In Europe “leaders must stand by their commitments to do whatever it takes to preserve trust in national policies and the euro” while in the US “deep political divisions leave the course of US policy highly uncertain.”

IMF chief Christine Lagarde last week urged global policy makers to find “collective resolve” as investors worry Greece may default and European banks will be forced to take losses on bonds sold by the region’s most indebted countries. Under an alternative to its growth scenario, the institution predicts the US and Europe could fall back into recession, with global output next year 3 percentage points less than now forecast.

“When could things go wrong? Anytime,” IMF chief economist Olivier Blanchard told reporters today at a press conference in Washington. “Policymakers don’t have the luxury of time,” he said, urging Europe to “get its act together.”

The Washington-based IMF said it based its forecasts of a “modest pickup of activity” in advanced economies and of “robust growth” in emerging counterparts on the premise that European policy makers implement the measures to reinforce their bailout mechanism agreed on in July.

It also assumed that volatility in financial markets doesn’t worsen and that US authorities agree on a fiscal plan that both supports the economy and outlines fiscal consolidation over the medium term.

“Key drivers of stronger activity over the near term include the rebound of activity in Japan, the drop in oil and food prices, and solid demand growth in key emerging market economies,” the IMF said.

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The IMF predicts growth of 6.4 percent in developing economies this year and 6.1 percent next year, down from 6.6 percent and 6.4 percent forecast in June.

Richer nations will grow 1.6 percent this year instead of the 2.2 percent expected in June, and 1.9 percent next year instead of 2.6 percent, the IMF said.

Japan was the only Group of Seven economy to have its forecast raised for this year, with the IMF now predicting a 0.5 percent contraction, compared with a 0.7 percent decline in June. Growth in 2012 should reach 2.3 percent, 0.6 percentage point less than in June.

In the euro area, where the IMF cut its prediction to 1.6 percent from 2 percent this year and to 1.1 percent from 1.7 percent next year, injecting capital into banks and restructuring or closing down others is “essential,” the IMF said.

The IMF is “very worried” that banks will seek to increase their capital buffers “by decreasing the assets that they hold, by deleveraging, which would lead to a decrease in bank lending and a credit crunch,” Blanchard said.

The European Central Bank should lower interest rates if risks to growth persist from the current benchmark of 1.5 percent.

Asked about the ECB’s sovereign bond purchases, Blanchard said the bank is playing a “very important role” in making sure Italy’s borrowing rates remain low and its debt sustainable.

In its downside scenario, the IMF assumes that banks need to absorb losses resulting in a 10 percent decrease of their capital as a result of “major financial turbulence in the euro area, combined with a downscaling of expectations for US medium-term growth prospects and real-estate-related financial stress in emerging Asia.”

In the US, where the IMF now sees expansion of 1.8 percent next year as the housing market also weighs on the recovery, the fiscal plan is a priority, the IMF said. The Federal Reserve should also stand ready to “deploy new unconventional support for the economy.”

The IMF urged emerging economies to roll back fiscal deficits and to continue raising interest rates, though situations vary across countries. It said that China’s currency remains “substantially undervalued.”

The IMF now assumes oil at $103.20 a barrel in 2011, based on the average prices of U.K. Brent, Dubai and West Texas Intermediate crudes, compared with $106.30 in June.