Risks of prolonged market turmoil in emerging markets and of euro-zone deflation are threatening the world's improved economic prospects, the International Monetary Fund (IMF) says.
The IMF, in a staff report prepared for central bankers and finance ministers from the Group of 20 nations, said the recovery was still weak and "significant downside risks remain". A January global growth forecast of 3.7 per cent for this year, from 3 per cent last year, hinges on recent market volatility being short-lived, according to the report.
"Capital outflows, higher interest rates, and sharp currency depreciation in emerging economies remain a key concern," said the report, which was prepared for the G20 meeting starting in Sydney tomorrow. "A new risk stems from very low inflation in the euro area, where long-term inflation expectations might drift down, raising deflation risks in the event of a serious adverse shock to activity."
Rising political tensions from Ukraine to Thailand, China's slowdown and the US Federal Reserve's tapering of its stimulus have resulted in falling stocks and currencies in emerging markets. Less than two months into 2014, global investors pulled more money out of emerging-market stock and bond funds than the total amount they retracted last year.
To weather the turbulence, the IMF urged developing economies to further increase interest rates when inflation remains high and cut spending when fiscal credibility is lacking.
"Exchange-rate flexibility should continue to facilitate external adjustment, particularly where currencies are overvalued," IMF staff wrote. Currency intervention "where reserves are adequate, can be used to smooth excessive volatility or prevent financial disruption".
Advanced economies must maintain accommodative monetary policy, with the Fed needing to pay particular attention to its communication over the gradual adjustment of its asset purchases, according to the note. Fed policymakers plan to soon change their guidance for the path of interest rates as unemployment declines towards a threshold for considering an increase in borrowing costs, minutes of their January meeting showed yesterday.
In the euro zone, which is "turning the corner from recession to a weak recovery", the fund urged authorities to make it clearer that public backstops will be available for banks that may need funds after stress-test results.
The IMF also suggested the G20 adopt co-operative monetary and economic policies in order to raise worldwide growth.