Another Global Downturn

By Dr Arvind Kumar

Another global financial downturn is round the corner if forecasts of the IMF and World Bank are to be believed. Revising its forecast for global growth in 2012 to 3.3 percent—0.7 percentage points lower than its September 2011 forecast—and warning of outright recession in Europe, the IMF said world recovery was threatened by “intensifying strains in the euro area and fragilities elsewhere.” Growth began to decline in the fourth quarter of 2011 “as the euro crisis entered a perilous new phase.”

While there had been higher than expected growth in the advanced economies, these developments were not expected to sustain significant momentum. In view of the often repeated claim that “emerging markets” will provide the basis for a new expansion of the world economy, the IMF’s comments on these regions were particularly significant. Growth in these economies, the IMF report said, had “slowed more than forecast.” It put this down to the combined effects of tightening government spending and “weaker underlying growth.” Warning that “downside risks” had “risen sharply,” the report said the most significant risk came from “the intensification of adverse feedback loops between sovereign and banking pressures in the euro area.” This refers to rising interest rates on the bonds of highly indebted governments, leading to a fall in the value of those bonds held by major banks, weakening their financial position, and raising the need for further government bailouts. Summing up the present situation, the report said: “The current environment—characterised by fragile financial systems, high public deficits and debt, and interest rates close to the zero bound—provides fertile ground for self-perpetuating pessimism and the propagation of adverse shock, the most critical of which is the worsening of the crisis in the euro area.”