Rebound faces fresh risks, IMF cautions

The global economy has staged a faster rebound than expected, the International Monetary Fund said yesterday, but prospects are uneven and emerging markets face the destabilising prospect of a flood of capital inflows.

The Fund’s updated forecasts came as the Institute of International Finance, representing the world’s largest banks, predicted that capital flows to China, Brazil and other emerging markets would stage a remarkable bounce-back from the gloom of last year.

Hot money flooding into emerging markets required sober management, both organisations warned, with the risk of new asset price bubbles developing and unbalanced world economic growth if poorer countries attempted to maintain weak currencies.

The IMF said it believed the world economy would grow by 3.9 per cent in 2010, an upward revision of 0.8 percentage points, and the recovery would accelerate in 2011 to 4.3 per cent. But emerging markets would significantly outperform more mature economies.

Advanced economies, led by unexpected strength in US consumption, are expected to grow by 2.1 per cent in 2010. Emerging markets, with China in the vanguard, are forecast to grow by 6 per cent. The Fund’s upward revisions for both groups was similar at just under one percentage point.

The Fund attributed the surprising strength of the world economy to a rebound in confidence that helped people around the world be more confident about taking risks and boosting economic activity. But officials warned that temporary policy had been vital in securing growth.

Olivier Blanchard, IMF chief economist, said: “For the moment, the recovery is very much based on policy decisions and policy actions. The question is ‘When does private demand come and take over?’ Right now it’s OK, but a year down the line, it will be a big question.”

The arena where the private sector has been most willing to take new risks with its own money has been in emerging markets, where growth prospects are the strongest. Philip Suttle, chief economist of the IIF, said this was because for the first time ever, “emerging market assets offer every prospect of higher returns but not higher risk than mature economy assets”.

The IIF predicted that net private sector capital flows to emerging economies would jump to $722bn this year from $435bn in 2009. “Such a rapid move from famine to feast raises the obvious question of whether another global financial bubble is in the making, this time in key emerging economies, especially Brazil, China and India,” Mr Suttle added.

The IMF warned of the same danger, noting that capital inflows alongside more buoyant economies might lead to inflation. “Various emerging economies are grappling with the challenges posed by surging capital inflows, in some cases resisting exchange rate appreciation that could support stronger domestic demand and a reduction in excessive current account surpluses,” the IMF said in its update of the World Economic Outlook.

It urged emerging countries to allow exchange rates to rise to boost domestic demand and cut trade surpluses, but acknowledged that capital inflows could be destabilising. It called for tighter fiscal policies to ease pressure on exchange rates but added that because the money might leave as quickly as it arrived, “policies aimed at limiting the emergence of new asset price bubbles, some build-up of reserves, and some capital controls on inflows can be part of the appropriate response”.

This caveat is likely to be seized on by countries such as China and Brazil at the World Economic Forum in Davos as a way of continuing export-led growth strategies at the same time as international efforts are trying to limit the re-emergence of trade imbalances. –Chris Giles in Zurich, Financial Times