The International Monetary Fund has a creditable record of spotting, and tracking, world economic recovery more accurately than most other global institutions. As such its prognosis has always been keenly watched. Hence its warning, first issued while launching the latest edition of the World Economic Outlook on Tuesday and repeated on at least three different occasions, that the global economy was in “the danger zone” ought not to be treated as a hyperbole. The onus of taking corrective measures is squarely on politicians round the globe, and not just on those in the United States who have displayed an amazing disharmony in sorting out key economic issues. As Indian experience too demonstrates, a fiscal policy that is dictated by political considerations cannot complement the monetary policy adequately to achieve key objectives, such as reining in inflation. The global growth forecast for 2011 has been marked down to 4 per cent from 4.3 per cent. That small decrease in percentage terms, however, does not fully reflect the fears and forebodings of the IMF, which stand reinforced by its Global Financial Stability Report (GFSR), released almost simultaneously with the WEO. The report serves as an early warning system and recommends policy action to stave off a crisis.
There are ample reasons for policymakers of both the developed and the developing countries to worry, as risks of financial instability have increased significantly in the past few months. The global financial crisis that began with the U.S. sub-prime loans and then morphed into a systemic banking problem with international implications is far from being resolved. The sovereign debt crisis in the euro zone countries represented the next stage. Now, there is a political phase where a consensus on fiscal consolidation and adjustment has been eluding the politicians on both sides of the Atlantic. As part of a three-pronged action plan for the developed countries, the IMF has called for a credible, medium-term fiscal adjustment plan. The U.S. should take steps to resolve the problem of overstretched household balance sheets through an aggressive restructuring programme. Thirdly, the banking sector in Europe should be fixed immediately, if necessary through infusion of capital. Developing countries need to avoid a further build-up of financial imbalances. In words that seem prophetic, the IMF has cautioned that countries such as India will face a sudden reversal of capital flows if foreign investors see their growth prospects petering out. In the post-crisis period, country risk assessments have become more important than interest differentials.