IMF warns deeper financial turmoil would slam global growth

Highlights:

• IMF's Georgieva says 44 countries, including Rwanda, Barbados, Costa Rica, Bangladesh, and Jamaica, interested in new resilience trust loans and have reached agreements for loan programmes from the facility
• Interest rates likely to fall to pre-Covid levels, IMF predicts

The International Monetary Fund on Tuesday trimmed its 2023 global growth outlook slightly as higher interest rates cool activity but warned that a severe flare-up of financial system turmoil could slash output to near recessionary levels.

The IMF said in its latest World Economic Outlook report that banking system contagion risks were contained by strong policy actions after the failures of two US regional banks and the forced merger of Credit Suisse, reports Reuters. But the turmoil added another layer of uncertainty on top of stubbornly high inflation and spillovers from Russia's war in Ukraine.

"With the recent increase in financial market volatility, the fog around the world economic outlook has thickened," the IMF said as it and the World Bank launch spring meetings this week in Washington.

"Uncertainty is high and the balance of risks has shifted firmly to the downside so long as the financial sector remains unsettled," the Fund added.

The IMF is now forecasting global real GDP growth at 2.8% for 2023 and 3.0% for 2024, marking a sharp slowdown from 3.4% growth in 2022 due to tighter monetary policy.

Both the 2023 and 2024 forecasts were marked down by 0.1 percentage point from estimates issued in January, partly due to weaker performances in some larger economies as well as expectations of further monetary tightening to battle persistent inflation.

The IMF's US outlook improved slightly, with growth in 2023 forecast at 1.6% versus 1.4% forecast in January as labor markets remain strong. But the Fund cut forecasts for some major economies including Germany, now forecast to contract 0.1% in 2023 and Japan, now forecast to grow 1.3% this year instead of 1.8% forecast in January.

The IMF raised its 2023 core inflation forecast to 5.1%, from a 4.5% prediction in January, saying it had yet to peak in many countries despite lower energy and food prices.

"Our advice is for monetary policy to remain focused on bringing down inflation," IMF chief economist Pierre-Olivier Gourinchas told reporters.

In a Reuters interview, Gourinchas said central banks should not halt their fight against inflation because of financial stability risks, which look "very much contained."

Banking turmoil scenarios

While a major banking crisis was not in the IMF's baseline, Gourinchas said a significant worsening of financial conditions "could result in a sharper and more elevated downturn."

The report included two analyses showing financial turmoil causing moderate and severe impacts on global growth.

In a "plausible" scenario, stress on vulnerable banks - some like failed Silicon Valley Bank and Signature Bank burdened by unrealised losses due to monetary policy tightening and reliant on uninsured deposits - creates a situation where "funding conditions for all banks tighten, due to greater concern for bank solvency and potential exposures across the financial system," the IMF said.

This "moderate tightening" of financial conditions could slice 0.3 percentage point off of global growth for 2023, cutting it to 2.5%.

The Fund also included a severe downside scenario with much broader impacts from bank balance sheet risks, leading to sharp cuts in lending in the US and other advanced economies, a major pullback in household spending and a "risk-off" flight of investment funds to safe-haven dollar-denominated assets.

Emerging market economies would be hit hard by lower demand for exports, currency depreciation and a flare-up of inflation.

This scenario could slash 2023 growth by as much as 1.8 percentage points, reducing it to 1.0% - a level that implies near-zero GDP growth per capita. The negative impact could be about one-quarter of the recessionary impact of the 2008-2009 financial crisis.

Other downside risks highlighted by the IMF include persistently high inflation that requires more aggressive central bank rate hikes, escalation of Russia's war in Ukraine, and setbacks in China's recovery from Covid-19, including worsened difficulties in its real estate sector.

Oil price risk

The IMF forecasts do not include the impact of a recent oil output cut by OPEC+ countries that has caused oil prices to spike. It assumes an average 2023 global oil price of $73 per barrel - well below Monday's $84 Brent crude futures price, but Gourinchas said it was unclear if this level could be sustained.

For every 10% rise in the price of oil, IMF models show a 0.1 percentage point reduction in growth and a 0.3 percentage point increase in inflation, Gourinchas added.

The IMF also now pegs global growth at 3% in 2028, its lowest five-year growth outlook since the WEO was first published in 1990, reflecting naturally slowing growth as some emerging economies mature, but also slower growth in workforce populations and fragmentation of the global economy along geopolitical lines, marked by US-China tensions and Russia's war in Ukraine.

IMF's Georgieva says 44 countries interested in new resilience trust loans

IMF Managing Director Kristalina Georgieva said on Monday that 44 countries have expressed interest in borrowing from its $40 billion Resilience and Sustainability Trust after an initial five had arranged loans.

The facility was created last year to help channel excess IMF Special Drawing Rights reserves from wealthier countries to poor and vulnerable middle-income countries to provide long-term concessional financing for needs such as climate change adaptation and transitioning to cleaner energy sources, reports Reuters.

Georgieva told a Bretton Woods Committee event at the start of IMF and World Bank spring meeting week that the "healthy queue" of countries was a sign that the resilience facility resources needed to be scaled up to much higher levels.

Georgieva said the facility's current resources of around $40 billion were "modest in size." Rwanda, Barbados, Costa Rica, Bangladesh, and Jamaica have reached agreements for loan programmes from the facility, which come with certain economic policy requirements such as meeting fiscal targets.

Her comments come as IMF and World Bank member countries will discuss this week ways to dramatically scale up climate-related lending and private sector investment to meet needs estimated in the trillions of dollars a year to meet emissions reduction targets.

"So $40 billion is not a solution on its own, but it is a contribution to a solution, if it helps remove barriers for massively scaling investment, especially private investment, in emerging markets and developing economies," Georgieva said.

Interest rates likely to fall to pre-Covid levels, IMF predicts

Interest rates in major economies are expected to fall to pre-pandemic levels because of low productivity and ageing populations, according to a forecast.

IMF said increases in borrowing costs are likely to be "temporary" once high inflation is brought under control, reports BBC.

The Bank of England has been raising interest rates since December 2021, taking them from 0.1% to 4.25%.

This has raised mortgage payments for many homeowners.

Central banks in the UK, the US, Europe and other nations have been lifting interest rates to combat the rate of price rises, otherwise known as inflation.

In the UK, inflation is at its highest for nearly 40 years because of rising energy prices and soaring food costs. A number of factors are fuelling inflation, including Russia's invasion of Ukraine which has helped drive up energy costs.

However, in a blog the IMF said that "recent increases in real interest rates are likely to be temporary."

It added "When inflation is brought back under control, advanced economies' central banks are likely to ease monetary policy and bring real interest rates back towards pre-pandemic levels."

The IMF did not say, however, exactly when interest rates were set to fall back to lower levels.

The Washington-based financial institution said ageing populations would be one factor likely to lower inflation.

Explaining why older people affect inflation, George Godber, fund manager at Polar Capital, said that they tend to spend less.

"The amount that you spend relative to your income is highest when you're in your 20s, 30s and 40s - often that's maybe young families, when you've got households forming, you've got couples coming together, they tend to spend the most when they decorate and buy a car or whatever, and you as you get older in life you slow down your consumption," he told the BBC's Today programme.

"There's less heading to Glastonbury and nights out on the town, there's more sitting at home and watching the Antiques Roadshow, so therefore, your spending patterns sort of reduce and you save more and so an ageing population tends to be disinflationary."

Andrew Bailey, governor of the Bank of England, said recently that in the UK, the share of adults aged between 20 and 59 years-old has fallen to below 65% in the past decade "and it is set to decline further in the coming years".

He said that this has been driven by a decline in birth rates as well as people living for longer.

The IMF also said low productivity - the measure of how many goods and services are produced - would bring inflation down.

In a speech last month, Bailey said that prior to the financial crisis in 2008, UK productivity had been boosted by the country's manufacturing sector.

"But following the financial crisis, manufacturing productivity growth fell back sharply. This fall in manufacturing productivity is the main cause of the slowdown," he said.

Just prior to the Covid pandemic, the UK's interest rate was 0.75% but the Bank of England cut it twice in March 2020 to 0.1% as the country entered lockdown.

The rate of inflation has risen steadily over the past couple of years and hit 10.4% in February – more than five times higher than the Bank of England's 2% target.

Following the decision to raise UK interest rates again in March, the Bank of England said that it expected inflation "to fall sharply over the rest of the year."

This is due to the government's continuing help with household heating bills through the Energy Price Guarantee scheme as well as falling wholesale gas prices.

However, Bailey declined to say whether he believed that interest rates had reached a peak.