IMF Update from Tokyo

IMF

With concerns of European Union threaten global financial stability IMF has come strongly for measures to be taken in the recent Annual meeting. It urged European policymakers to deepen the financial and fiscal ties within the euro area with some urgency to restore sagging confidence in the global financial system. Despite many important steps already taken by policymakers, this agenda remains critically incomplete, exposing the euro area to a downward spiral of capital flight, breakup fears and economic decline. European banks are likely to offload $2.8tn in assets over two years to cut their risk exposure which could shrink growth in European Union. The more time that goes by without a complete solution, the more are the eventual costs for everybody of resolving the crisis.

Countries should not sacrifice growth for the sake of austerity. Balancing them is the puzzle faced by policymakers as the world economy slows further. Greece, Spain and other European countries laboring under massive debts have slashed spending and raised taxes, seeking to restore confidence in their public finances and qualify for emergency financing. The economies of financially healthier European countries, such as Germany and Finland, face a potential blow to growth if those troubled economies fail to get their financial houses in order. At the same time, the recovery of the euro nation could founder if tax increases and spending cuts bite too deeply.

US and Japan should also learn lessons from European Union, delaying the necessary policy adjustments until markets force their hands would result in harsh economic outcomes. ECB’s bond buying agreement had restored some market confidence and narrowed the spread between core and peripheral debt in the region. But private investors still lacked confidence in peripheral European markets and the difference between the yields on peripheral and core debt from banks and companies remained high, threatening any recovery. It is also important that US enact a balanced framework to bring down fiscal deficit at the same time focus on jobs and economic recovery in the medium term. If US economy does not take steps to come down from its fiscal cliff it can significantly impact the global economy.

For Asia as a whole, GDP growth fell to its lowest rate since the 2008 global financial crisis during the first half of 2012 averaging 5.50 percent. Weaker momentum in China and India also weighed on regional economies. In the case of India, weakening investor sentiment adding to supply constraints contributed to the slowdown however in the case of china they require deliberate efforts to execute a soft landing. The second half of 2012 is not encouraging for Asia. While relatively strong economic and policy fundamentals have helped buffer Asian economies against adverse financial market spillovers, aggressive deleveraging by euro area banks and flight of capital to traditional safe havens could also severely disrupt Asian financial systems. Policymakers need to support stable noninflationary growth, maintain financial stability, and lay the foundations for sustained and shared prosperity over the medium term.

Key policy steps have been announced to build growth, but effective and timely implementation is critical to rebuild confidence. Advanced economies should deliver the necessary structural reforms and implement credible fiscal plans. Emerging market economies should reserve or use policy flexibility as appropriate to facilitate a response to adverse shocks and support growth.