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G-20 facing economic risks: IMF

Euro-area deflation, emerging-markets turmoil threaten positive global economic prospects.

Risks of prolonged market turmoil in emerging markets and of deflation in the euro area are threatening the world’s improved economic prospects, according to the International Monetary Fund, or IMF.

The IMF, in a staff report prepared for central bankers and finance ministers from the Group of 20, said the recovery is still weak and “significant downside risks remain”. A January global growth forecast of 3.7 per cent for this year, from three per cent in 2013, hinges on recent market volatility from Turkey to Brazil being short-lived, according to the report.

“Capital outflows, higher interest rates, and sharp currency depreciation in emerging economies remain a key concern,” according to the report prepared ahead of the G-20 February 22 and 23 meeting in Sydney. “A new risk stems from very low inflation in the euro area, where long-term inflation expectations might drift down, raising deflation risks in the event of a serious adverse shock to activity.”

Rising political tensions from Ukraine to Thailand, China’s slowdown and the Fed’s tapering of its stimulus have resulted in falling stocks and currencies in emerging markets. Less than two months into 2014, global investors pulled more money out of emerging-market stock and bond funds than the total amount they retracted last year.

Stocks fell after the IMF report.

To weather the current turbulence, the Washington-based IMF urged developing economies to further increase interest rates when inflation remains high and cut spending when fiscal credibility is lacking.

“Exchange-rate flexibility should continue to facilitate external adjustment, particularly where currencies are overvalued,” IMF staff wrote. Currency intervention “where reserves are adequate, can be used to smooth excessive volatility or prevent financial disruption.”

Advanced economies must maintain accommodative monetary policy, with the Fed needing to pay particular attention to its communication over the gradual adjustment of its asset purchases, according to the note.

Fed makers plan to soon change their guidance for the path of interest rates as unemployment declines toward a threshold for considering an increase in borrowing costs, minutes of their January meeting showed on Wednesday. In the 18-country euro area, which is “turning the corner from recession to a weak recovery,” the fund urged authorities to make it clearer that public backstops will be available for banks that may need funds after stress-test results.