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IMF’s ‘hazardous’ economic outlook ‘too optimistic’

By Charbel Kadib
5 minute read

The global economic outlook has been downgraded amid a swathe of persistent headwinds, but revised growth projections are not dovish enough, according to Oxford Economics.

The International Monetary Fund (IMF) has revised its global economic growth projections, now anticipating world output of 2.8 per cent in 2023 before picking up to 3 per cent in 2024.

The fund’s January projections had forecast global output of 2.9 per cent in 2023 and 3.1 per cent in 2024.

According to the IMF, the revision reflects slimmer hopes of a “soft landing”, with inflationary pressures persisting despite aggressive monetary policy tightening across advanced economies.

“Although inflation has declined as central banks have raised interest rates and food and energy prices have come down, underlying price pressures are proving sticky, with labour markets tight in a number of economies,” the IMF observed.

Adding to expectations of a harder landing is financial system vulnerability exposed by sharp interest rate rises, with the IMF pointing to “turmoil” across the global banking sector.

“Side effects from the fast rise in policy rates are becoming apparent, as banking sector vulnerabilities have come into focus and fears of contagion have risen across the broader financial sector, including non-bank financial institutions,” the fund added.

Last month, three US banks — Silicon Valley Bank (SVB), Silvergate Capital, and Signature Bank — collapsed under the pressure of higher debt servicing costs, which drained liquidity stocks that were already depleted by overexposure to long-term bonds.

Swiss banking giant Credit Suisse faced similar challenges, rescued by an “emergency” takeover from its rival, UBS.

“We are therefore entering a perilous phase during which economic growth remains low by historical standards and financial risks have risen, yet inflation has not yet decisively turned the corner,” the IMF continued.

“More than ever, policymakers will need a steady hand and clear communication. The appropriate course of action is contingent on the state of the financial system.”

If the return to relative stability in the banking sector persists, policymakers should “stay firmly focused on bringing inflation down”.

“A silver lining is that the banking turmoil will help slow aggregate activity as banks curtail lending in the face of rising funding costs and of the need to act more prudently,” the IMF added.

“In and of itself, this should partially mitigate the need for further monetary policy tightening.

“But any expectation that central banks will abandon the fight against inflation would have the opposite effect: lowering yields, supporting activity beyond what is warranted, and complicating the task of central banks.”

The fund said “tighter fiscal policy” could also support monetary policy by “cooling off” economic activity, allowing real interest rates to “return faster to their low natural level”.

IMF’s ‘hazardous assumptions’ are ‘too optimistic’

But despite the IMF’s dimmer outlook, Oxford Economics’ chief global economist, Innes McFee, has claimed the projections are “too sanguine”.

Oxford Economics’ latest global economic forecasts, set to be released later this week, reportedly reflect a “marked decline” in the pace of growth, particularly in the second half of 2023.

“This is largely due to the delayed impact that monetary tightening will have on the advanced economies but, our latest forecast, also makes some allowance for a tightening in credit conditions due to the recent bank funding turmoil,” Mr McFee said.

The chief economist said the looming credit crunch would suppress aggregate economic activity, pointing to recent lending data from Oxford Economics and Haver Analytics.

“Tighter credit conditions have become an increasingly important factor in the outlook, as the most recent balance sheet data for the US banking system makes clear,” he continued.

“That data shows an ongoing outflow of deposits (amounting to $620 billion since the start of the year) and the largest two-week decline in bank lending since the 1970s.

“Lending data is highly volatile making it too early to draw any conclusions, but it does serve as a timely reminder of the risks from tightening credit conditions.”

He said the IMF’s focus on market interest rates clouds its expectations, with modelling pricing in monetary policy easing later this year.

“We think that stubbornly high inflation will keep policy rates high for the rest of this year,” Mr McFee added.

“This could explain why the IMF expect a more muted impact from tighter financial conditions in advanced economies.”

Oxford Economics has now forecast a “flatter profile” for global growth over the course of 2023 and the first half of 2024.

“Tight financial conditions due to bank funding concerns and the delayed impact of interest rate rises will continue to weigh on the world economy and pose substantial further downside risks,” Mr McFee noted.

“We will soon publish a research briefing fully quantifying these risks but we see them as more severe than the IMF’s risk scenarios which estimate tighter credit conditions could knock 0.25 per cent off the level of GDP in 2023 and 2024.

“But while we wait to see whether these risks will crystallise, taking an optimistic view on how quickly credit conditions will normalise in the baseline feels like a hazardous assumption.”

The IMF report has been released ahead of the latest inflation figures from a host of countries, including the United States.

The US Federal Reserve actioned a dovish hike in late March, largely off the back of banking instability.

However, markets are expecting further hikes to the funds rate over the coming months, and a terminal rate of at least 5–5.25 per cent.

The IMF is expecting US economic growth to slow to 1.6 per cent in 2023 and 1 per cent in 2024 — outpacing the Euro region in 2023 (0.8 per cent) but recording weaker growth in 2024 (1.4 per cent).

As in the IMF’s previous global economic outlook report, China and India are tipped to drive global growth in the coming years.

The Chinese economy is projected to grow 5.2 per cent in 2023 and 4.5 per cent in 2024, while the Indian economy is expected to expand 5.9 per cent and 6.3 per cent, respectively.

Overall, emerging markets are expected to outperform advanced economies, with growth of 3.9 per cent in 2023 and 4.2 per cent in 2024, compared to 1.3 per cent and 1.4 per cent over the same period.