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IMF forecasts cast gloom over Davos – and carry a message for Osborne

The IMF forecasts put numbers on the gloom felt in Davos – and once again suggest Osborne’s budget cuts in the UK are dangerously deep

The forecasts from the International Monetary Fund captured the air of gloom perfectly as members of the World Economic Forum gathered before the start of their annual meeting in Davos. This is the fifth meeting of the global policy elite since the start of the financial crisis in 2007 and each has had its own mood: concern in early 2008, total panic in the dark winter of 2009, tentative optimism in 2010 that the worst was over, confidence in 2011 that better times were just around the corner, and now the sense that recovery will be longer and tougher than most of the Davos crowd ever envisaged.

Stripped of the buoyant growth in some of the big emerging markets – China and India in particular – the Fund’s new forecasts suggest that the global economy will be quite close to sinking back into recession in 2012. The advanced economies are expected to expand by just 1.2% this year, with a mild recession in the eurozone, a negligible expansion in the UK and unspectacular growth in the United States. Every part of the developed world apart from America has had its growth forecast cut by the IMF since its last set of predictions in September 2011.

It is not just the IMF that has become more downbeat about the prospects for 2012. The Economist Intelligence Unit said the world was “perilously” close to another recession and estimated that there was a 40% chance of a break-up of the single currency.

So what’s gone wrong? Why the big mood swing in the past two years? The pat answer is that it is all down to the weakness in the eurozone, which has hit confidence and led to lower exports from other parts of the global economy. No question, the intensification of the sovereign debt crisis since the middle of 2011 has been the immediate trigger for the IMF growth downgrades, but Europe’s problems are symptomatic of a deeper malaise.

The sequence of events goes like this. Consumers in some countries – such as the US, Britain and Spain – lived beyond their means. They funded their spending habits by borrowing money, normally against the rising (paper) value of their homes. Banks willingly provided the finance, leveraging up massive loan books against precious little capital.

It wasn’t just individual consumers that lived beyond their means: countries did so too, which was why they ran big current account deficits. The other half of the world did the saving and ran current account surpluses. The whole thing was a house of cards: indebted consumers were not as rich as they thought they were; banks were not as secure as they thought they were; and both creditor and debtor nations lived in a fool’s paradise in which they believed sorting out the global imbalances was somebody else’s problem.

There came a point where asset prices stopped going up, banks were left sitting on toxic debts, the global financial system froze up and deep recession resulted. Deep structural problems in globalisation were revealed, and these were only papered over by ultra-low interest rates, budget deficits and quantitative easing. Governments acted as the consumer of last resort, so private debt became public debt.

All this was deeply traumatic to the global economy, and it was always a fantasy to imagine that there would be a miracle cure. Despite its reputation for a slash and burn approach, the IMF has actually taken a pragmatic and sensible approach to resolving these problems, urging caution and patience. Countries with low interest rates that have the ability to borrow should “reconsider the pace of near-term fiscal adjustment”, it says. In the eurozone that means Germany. But it also applies to Britain, where the IMF has previously warned about the need to delay the pace of deficit reduction should growth undershoot expectations. Which, as Wednesday’s GDP figures will show, it certainly has. © 2012 Guardian News and Media Limited or its affiliated companies. All rights reserved. | Use of this content is subject to our Terms & Conditions | More Feeds