IMF Managing Director Dominique Strauss-Kahn.BENOIT TESSIER
The International Monetary Fund told Group of 20 finance ministers and central bank governors earlier this month that Europe's debt crisis may cause it to lower its outlook for world economic growth this year.
That warning sums up IMF Managing Director Dominique Strauss-Kahn's rather sombre assessment of the state of the world economy at the June 4-5 meeting in Busan, Korea, which the fund released Wednesday on its website.
Ignoring indicators that suggest the economy was actually performing better than expected, the IMF focused on the risk that contagion would cause the financial system to tighten, making the cost of borrowing more expensive and slowing trade.
"The repercussions of financial stress in the third quarter of 2008 illustrate that developments in financial markets can have strong effects on economic activity," the IMF said in the assessment. "Persistent financial stress would likely have negative effects through higher private and sovereign funding rates, reduced lending and tighter credit conditions, reduced capital flows and reallocations of portfolios to safe assets, reduced incomes for commodity producers, and lower confidence. In such a case, economies with fiscal and/or external balances would be worst affected."
In all, the report makes for disconcerting reading. The IMF, which has emerged as the unofficial research arm for the G20, punctuates its text with phrases such as "urgent action is needed" and "the risk of a loss in fiscal credibility." The fund was criticized widely for failing to see the financial crisis coming. If the world slumps into another recession, Mr. Strauss-Kahn won't be accused of being asleep at the switch this time.
The IMF's focus in on Europe, where it sees no easy routes out of the continent's fiscal plight. At other times, the euro's slump might be expected to give exporters the sort of trade advantage that would generate sales and increased industrial production - but not when the reason for a weaker currency is a lack of confidence in the region. How, the IMF asks, will you increase production widely without capital?
"The depreciation of the euro would tend to encourage net exports for the euro area," the report says. "However, to the extent that the depreciation is driven by increased risk aversion, the net effect on growth could be negative."
Here's the fund's message to Prime Minister Stephen Harper: "it is of overarching importance that G-20 countries commit now to credible medium term fiscal adjustment plans, which could include legislation creating multi-year targets."
As galling as it is to be supplicants to bond traders, such is the relationship between is the relationship between debtor and creditor. Individually, countries are introducing measures aimed at convincing investors that they are serious about containing deficits and reducing debt. The IMF suggests that a collective commitment to credible austerity plans on the part of the G20 would ease investors' concerns.
The IMF stressed that, for the most part, this need not be done until 2011, saying the recovery remains fragile and stimulus programs should be left to run their course. However, the fund said those countries that are facing extreme funding pressure must begin cutting their deficits immediately, just as the fastest growing emerging markets must take steps to curb inflation.
No one should be contemplating new stimulus programs, the IMF said.