Emerging nations urged to tighten fiscal policy

“Fear of the unknown at present is very high,” Andul Abiad, deputy division chief of the IMF’s research department, said recently.

Emerging economies with stubborn inflationary pressures should continue with monetary tightening while those with hazier signs of overheating could adopt a wait-and-see approach, he told a seminar on the “IMF World Economic Outlook” in Bangkok.

“Downside risks [to growth] are much larger than upside risks. Our feeling now is that even though we downgraded growth, it’s still a relatively strong, relatively optimistic World Economic Outlook forecast and many of the risks we can identify point to the downside.”

The IMF revised downward its estimate for global economic growth to about 4 per cent for both 2011 and 2012 on a downward revision to the advanced economies. Emerging market economies are estimated to expand by 6.4 per cent and advanced economies by 1.6 per cent this year. US growth is now at 1.5 per cent for this year, a full percentage point off April’s estimate.

The first downside scenario envisions the euro-zone crisis getting out of hand, where banks are required to absorb capital losses and de-leverage. That results in a credit crunch and falling economy activity.

Adding two more shocks, the second scenario lays out the potential for lower-than-expected growth in the United States and a rise in non-performing loans in emerging Asia.
Any of these factors could lower growth estimates below the IMF baseline, not just in Europe and the United States but relatively largely around the world.

However, “if things go badly wrong in the advanced economies, Asia will not be muted”, Abiad said.

The euro-zone crisis scenario alone could shed 1.75 percentage points off emerging Asia’s growth estimate.

“If all three factors are put in place, [emerging Asia’s] growth will be lowered by about 2.5 percentage points, relative to the baseline,” he said.

The IMF estimates developing Asia to grow by 8.2 per cent this year and 8 per cent next year. Thailand is forecast to grow 3.5 per cent, half a percentage point off from the previous estimate.
There remains a way out. However, it requires strong, serious responses especially in the advanced economies, in particular with the US and euro zone, which need to resolve the crises that have been dampening global consumer and investor sentiment.

The first step is to quickly adopt and implement the commitments that the European Union made in July, basically to strengthen the European Financial Stability Fund and others in the crisis resolution framework.

Recapitalisation is also needed at banks in those countries for more capital buffering.
“If no private capital is coming, it needs to come from public sources,” he said.

A shift away from fiscal stimulus and public demand – which supported growth in the aftermath of the global financial crisis in 2008 – toward private demand has already taken place in most advanced economies but has not sufficed. In the US and Europe, demand from households and firms remains weak.

Credible medium-term fiscal consolidation plans are particularly required for Japan and the US where more progress is needed.

“It [fiscal consolidation] can’t be too fast so it will kill growth. It can’t be too slow so that it will kill credibility,” he said.

Besides, to help support global growth, reform of the financial sectors is required and structural reform to boost domestic demand is needed.

Some of the current-account surplus countries like China have already announced structural reform to help rebalance away from foreign demand to domestic demand due particularly to the sharp fall in import demand from advanced economies, which have been running current-account deficits.

“It’s clear that these policies can’t be implemented overnight but they need to be implemented as fast as possible,” he said.