Economic resilience will be tested – IMF

The International Monetary Fund (IMF) say that there is resilience in the global economy but there are plenty of risks that threaten to impact its progress.

The IMF  released its latest World Economic Outlook which concluded that  despite gloomy predictions, the global economy remains remarkably resilient, with steady growth and inflation slowing almost as quickly as it rose.

Commenting on the outlook Pierre-Olivier Gourinchas, economic counsellor and the director of research of the IMF  said: “The journey has been eventful, starting with supply-chain disruptions in the aftermath of the pandemic, an energy and food crisis triggered by Russia’s war on Ukraine, a considerable surge in inflation, followed by a globally synchronized monetary policy tightening.

“Global growth bottomed out at the end of 2022, at 2.3 percent, shortly after median headline inflation peaked at 9.4 percent. According to our latest World Economic Outlook projections, growth this year and next will hold steady at 3.2 percent, with median headline inflation declining from 2.8 percent at the end of 2024 to 2.4 percent at the end of 2025. Most indicators continue to point to a soft landing.”

He added the IMF project less economic scarring from the crises of the past four years, although estimates vary across countries. The US economy has already surged past its pre-pandemic trend.

“But we now estimate that there will be more scarring for low-income developing countries, many of which are still struggling to turn the page from the pandemic and cost-of-living crises.”

Resilient growth and rapid disinflation point toward favourable supply developments, including the fading of energy price shocks, and a striking rebound in labour supply supported by strong immigration in many advanced economies. Monetary policy actions have helped anchor inflation expectations even if its transmission may have been more muted, as fixed-rate mortgages became more prevalent.

“Despite these welcome developments, numerous challenges remain, and decisive actions are needed,” Gourinchas, added.

The IMF says bringing inflation back to target should remain the priority. While inflation trends are encouraging, we are not there yet. Somewhat worryingly, progress toward inflation targets has somewhat stalled since the beginning of the year. This could be a temporary setback, but there are reasons to remain vigilant.

Most of the good news on inflation came from the decline in energy prices and in goods inflation. The latter has been helped by easing supply-chain frictions, as well as by the decline in Chinese export prices. But oil prices have been rising recently in part due to geopolitical tensions and services inflation remains stubbornly high. Further trade restrictions on Chinese exports could also push up goods inflation.

There are also clear divergence between national economies.

“The strong recent performance of the United States reflects robust productivity and employment growth, but also strong demand in an economy that remains overheated,” Gourinchas continued. “This calls for a cautious and gradual approach to easing by the Federal Reserve. The fiscal stance, out of line with long-term fiscal sustainability, is of particular concern. It raises short-term risks to the disinflation process, as well as longer-term fiscal and financial stability risks for the global economy. Something will have to give.”

China’s economy remains affected by the downturn in its property sector. Credit booms and busts never resolve themselves quickly, and this one is no exception the outlook warns. Domestic demand will remain lack lustre unless strong measures address the root cause. With depressed domestic demand, external surpluses could well rise. The risk is that this will further exacerbate trade tensions in an already fraught geopolitical environment.

Many other large emerging market economies are performing strongly, sometimes benefiting from a reconfiguration of global supply chains and rising trade tensions between China and the US. These countries’ footprint on the global economy is increasing.

“Going forward, policymakers should prioritise measures that help preserve or even enhance the resilience of the global economy,” said the IMF.

The first such priority is to rebuild fiscal buffers. Even as inflation recedes, real interest rates remain high and sovereign debt dynamics have become less favourable. Credible fiscal consolidations can help lower funding costs, improve fiscal headroom and financial stability. Unfortunately, fiscal plans so far are insufficient and could be derailed further given the record number of elections this year.

The second priority is to reverse the decline in medium term growth prospects. Some of that decline comes from increased misallocation of capital and labour within sectors and countries. Facilitating faster and more efficient resource allocation will boost growth. For low-income countries, structural reforms to promote domestic and foreign direct investment, and to strengthen domestic resource mobilization, will help lower borrowing costs and reduce funding needs. These countries also must improve the human capital of their large young populations, especially as the rest of the world is aging rapidly.

Gourinchas continued: “Artificial intelligence also gives hope for boosting productivity. It may do so, but the potential for serious disruptions in labour and financial markets is high. Harnessing the potential of AI for all will require that countries improve their digital infrastructure, invest in human capital, and coordinate on global rules of the road.

“Medium-term growth prospects are also harmed by rising geoeconomic fragmentation and the surge in trade restrictive and industrial policy measures. Trade linkages are already changing as a result, with potential losses in efficiency. The net effect could well be to make the global economy less, not more, resilient. But the broader damage is to global cooperation. It is still time to reverse course.”

Lastly, the green transition requires major investments. Cutting emissions is compatible with growth and activity has become much less emission-intensive in recent decades. But emissions are still rising. The IMF added much more needs to be done and done quickly. Green investment has expanded at a healthy pace in advanced economies and China. The greatest effort must now be made by other emerging market and developing economies, which must massively increase their green investment growth and reduce their fossil fuel investment. This will require technology transfer by other advanced economies and China, as well as substantial private and public financing.

“On these questions, as well as on so many others, multilateral frameworks and cooperation remain essential for progress,” concluded Gourinchas.

The IMF says bringing inflation back to target should remain the priority. While inflation trends are encouraging, we are not there yet. Somewhat worryingly, progress toward inflation targets has somewhat stalled since the beginning of the year. This could be a temporary setback, but there are reasons to remain vigilant.