IMF tips global growth of 3.5 per cent

The International Monetary Fund expects global economic growth to slow to 3.5 per cent this year before returning to something close to last year's 4 per cent pace next year.

As well as, and largely because of, recession in Europe the IMF expects Asian growth to moderate, but only to a "soft landing" pace underpinned by growth in the locomotive Chinese economy of 8.2 per cent this year and 8.5 per cent next year.

The United States' recovery is forecast to gradually gather momentum, with growth rising to 2.1 per cent this year and 2.4 per cent next year, while Japan rebounds to growth rates of 2 and 1.7 per cent respectively, boosted as in New Zealand by rebuilding after seismic calamity.

In its World Economic Outlook released yesterday the IMF forecasts annual average growth of 2.3 per cent in New Zealand this year, rising to 3.2 per cent next year - underperforming Australia's 3 and 3.5 per cent respectively but outperforming the average for advanced economies of 1.1 per cent this year and 1.8 per cent next year.

These forecasts assume European policymakers "will prevent a Greek-style downward spiral from taking hold of another economy in the euro area periphery".

But the IMF also assumes additional support will only be forthcoming if market turmoil intensifies again.

It credits the European Central Bank's injection of a trillion euros ($1.59 trillion) of cheap three-year money into the banking system with easing near-term risks of another financial crisis.

But it says countries whose banks rely on foreign wholesale funding - including New Zealand and Australia - remain vulnerable to deleveraging in the global financial system.

In fact the whole global economy remains unusually vulnerable, it says.

"The two most immediate risks are renewed escalation of the euro area crisis and heightened geopolitical uncertainty which could trigger a sharp increase in the price of oil."

The IMF sketches a scenario in which Europe suffers a vicious circle in which banks tighten credit to rebuild their capital buffers, deepening the recession and putting further pressure on government finances and thereby banks' balance sheets.

The spillover could lower global output by 2 per cent, it estimates.

Remedying design flaws in European monetary union might mean EU institutions will need to be actively involved in national budgetary plans, it says. And the fiscal compact agreed late last year will need to be complemented by greater fiscal risk-sharing.

Structural reforms which would accelerate completion of a single European market for goods and services, and reforms to labour markets, could also help boost growth, it says.

The IMF also considers the possibility that a halt to Iranian exports drives up the price of oil by 50 per cent.

The effect in oil importing countries would cut global economic output by 1.25 per cent, it estimates, even without the adverse effects on confidence and financial markets.

The World Economic Outlook also discusses risks around the US fiscal position.

"Under current US laws many tax provisions, including the tax cuts enacted under President George W Bush, begin to expire in 2013, just as deep automatic spending cuts kick in. Such a massive adjustment could significantly undermine the economic recovery," it says.

"Should growth disappoint, the lack of a fiscal consolidation strategy may increase the US risk premium, which could have spillover effects for other major economies."