The International Monetary Fund raised its global growth forecast for the first time in nearly two years on Tuesday, saying fading economic headwinds should permit advanced countries to pick up the mantle of growth from emerging markets.
But the IMF warned that richer countries were still growing below full capacity, and it added the spectre of deflation to its long list of risks that could derail the nascent recovery.
In an update to its World Economic Outlook report, the Fund predicted the global economy would grow 3.7 per cent this year, 0.1 percentage point higher than its October projection. It said it sees growth of 3.9 per cent next year.
Olivier Blanchard, the IMF’s chief economist, said less government austerity and uncertainty and a healthier financial system were all allowing growth to speed ahead.
“The basic reason behind the stronger recovery is that the brakes to the recovery are progressively being loosened,” Blanchard said on a conference call.
The IMF forecast higher growth in advanced economies this year but kept its outlook unchanged for the developing world, where higher exports to rich countries were expected to be offset by weak demand at home.
The IMF expects China’s economy to grow 7.5 per cent this year and 7.3 per cent the next, which would be among the lowest rates in more than a decade.
The United States is likely to be one of the bright spots, after a budget deal in Congress reduced some of the government spending cuts that had weighed on domestic demand.
The IMF expects domestic demand to lift US growth to 2.8 per cent this year. In its previous forecast in October, it looked for growth of 2.6 per cent.
It also saw a rosier outlook for Britain amid cheap credit, a boost in consumption and greater confidence. It raised its growth forecast to 2.4 per cent this year from 1.9 per cent.
While the IMF said Japan is unlikely to slip back into deflation, it warned that other rich countries now risk the same problem of sluggish price growth, which can happen when economies linger well below their full potential.
Disinflation can turn to economically debilitating deflation if there is a negative shock to economic activity, the IMF warned.
A falling spiral of prices would weaken demand by making cash more valuable over time, discouraging consumption. It also increases the burden of debt, a big problem for highly indebted places like the United States and the euro zone.
The IMF urged central banks to avoid raising interest rates too soon and called on the European Central Bank in particular to help sluggish demand by boosting credit growth.
Central banks may not have much room to act in emerging markets, many of which are growing close to full capacity. For such countries, “the main policy approach for raising growth must be to push ahead with structural reform”, the IMF said.
It particularly singled out China, calling on the world’s second-largest economy to move more quickly towards consumption-led growth and away from investment.
“On the internal front, perhaps the main challenge is faced by China, which needs to contain the building of risks in the financial sector without excessively slowing growth, a delicate balancing act,” Blanchard said.