IMF Trims Global Growth Outlook for 2023 Due to Higher Interest Rates and Financial Turmoil?

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IMF Trims Global Growth Outlook for 2023 Due to Higher Interest Rates and Financial Turmoil?
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The International Monetary Fund (IMF) has revised its global growth outlook for 2023, predicting a slight reduction in growth as higher interest rates cool activity. However, the IMF warned that a severe flare-up of financial system turmoil could slash output to near recessionary levels.

The latest World Economic Outlook report released by the IMF stated 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. But the turmoil added another layer of uncertainty on top of stubbornly high inflation and spillovers from Russia’s war in Ukraine.

IMF’s Forecast and Downward Trend

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 U.S. 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.

Economies and Inflation Resilient

U.S. Treasury Secretary Janet Yellen told a news conference that she was more optimistic about the outlook as a number of advanced and emerging market economies were showing resilience. “I wouldn’t overdo the negativism about the global economy,” Yellen said. “I think the outlook is reasonably bright.”

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. “Monetary policy needs to stay focused on price stability” to keep inflation expectations in check, IMF chief economist Pierre-Olivier Gourinchas told a news conference.

Banking Turmoil Scenarios

While a major banking crisis was not in the IMF’s baseline, Gourinchas said a significant worsening of financial conditions could recur as nervous investors try to test the “next weakest link” in the financial system as they did with Credit Suisse.

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 unrealized 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 U.S. 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.

IMF CHIEF’S RECOMMENDATIONS

IMF Managing Director Kristalina Georgieva emphasized the need for countries to prioritize investments in health, education, and green infrastructure to ensure a strong and inclusive recovery from the pandemic. She also urged countries to work together to address global challenges such as climate change and inequality.

“We must ensure that this recovery is sustainable and resilient, and that it leaves no one behind,” Georgieva said.

Georgieva also called for continued fiscal support in the near term, especially for vulnerable households and businesses, and for central banks to maintain accommodative monetary policies to support the recovery.

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  1. Shalal A. Yellen says vigilant to downside economic risks, but don’t “overdo the negativism.” Reuters. https://www.reuters.com/business/finance/yellen-says-vigilant-downside-risks-given-war-ukraine-banking-pressures-2023-04-11/. Published April 11, 2023. Accessed April 12, 2023.
  2. World Economic Outlook, April 2023: A Rocky Recovery. IMF. Published April 11, 2023. Accessed April 12, 2023. https://www.imf.org/en/Publications/WEO/Issues/2023/04/11/world-economic-outlook-april-2023