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Last Updated: Wednesday, 17 October 2007, 14:05 GMT 15:05 UK
Credit crisis to shape IMF forecast
By Andrew Walker
Economics correspondent, BBC News, Washington

Containers about to be shipped
The global economy's outlook is uncertain
It all looked so rosy the last time the IMF and World Bank ministerial committees met back in April.

Then the IMF was looking at four years of robust global economic growth, with another one coming next year.

The fund's chief economist Simon Johnson declared "we haven't seen a four-year span like this since the early 1970s".

Now despite the sub-prime mortgage and credit market problems that blew up in the US in the past couple of months, the IMF still sees a reasonably rosy year ahead as the most likely outcome.

The new forecast for global growth is 4.8% in 2008. The IMF calls that figure "solid growth" and it would be the fifth consecutive year of reasonably robust performance.

Nonetheless, the mark of the recent financial market turbulence is clearly visible. For one thing, the growth forecast for next year has been revised downwards by almost half a per cent.

And that forecast is just the IMF economists' judgement about what is the most likely growth figure for next year.

They always throw in some comments about how things might turn out different to that central forecast. This time, they say the risks have increased.

There are several channels through which the US mortgage crisis could do wider economic damage, which the IMF is likely to be watching warily in the coming months: banks and others sustaining losses; business credit drying up; American consumers; and the currency markets.


We already know that banks and other financial institutions have lost money as Americans with sub-prime mortgages couldn't maintain the payments.

Some lenders have gone out of business in the US and a sub-prime specialist has exited the UK mortgage market.

But the pain is not confined to the original lender. Mortgages were in effect bundled up together and resold in the financial markets, to a wide range of financial institutions. They too lost money when the defaults started to mount.

Those losses have been spread around the international financial system: Bank of China (a commercial bank), Citigroup, Credit Swiss to name just three.

The betting in the financial markets seems to be that the worst news in this area is over. That is what is behind the continued strength of share prices - with many markets hitting new highs - despite the sub-prime fall-out.

Business credit

This is another issue where the markets seem to think things won't get much worse. The sub-prime fiasco illustrated very starkly that borrowers do default, so many lenders have become more wary.

That was the root of the problem for the British mortgage bank Northern Rock.

There has been evidence that some other businesses are paying higher interest rates to borrow money, to fund investment or just to pay workers and suppliers while they wait for customers to pay.

American consumers

Spending by consumers accounts for about 70% of the US economy. The housing market problems may well make Americans more reluctant to continue to increase their outgoings.

Falling house prices make people feel less well off and more hesitant about spending sprees.

A lot of spending has been financed by borrowing. If prices fall, houses are also less useful as collateral - something the lender can seize if the borrower defaults.

A decline in US consumer spending could very well spell recession, if it were to happen.

Trade deficit and currency markets

Many economists think a slow down in US consumer spending would be a very welcome development.

The reason: the massive deficit in US international trade, about $800bn, or 6% of GDP.

The big worry is that it might lead to a rapid and disruptive decline in the value of the dollar because Americans need more foreign currency to pay for imports than foreigners need dollars to buy American goods.

The US currency has already weakened. A gentle decline would make American goods more competitive and would help reduce the trade deficit.

Too rapid a decline could cause more turmoil in financial markets and would be inflationary, by making imports more expensive.

That might make it harder for the central bank, the Federal Reserve, to cut interest rates if it were needed to ward off a recession.

The IMF warns if some of these factors get worse rather than better and if they interact with one another, the global economy could slow sharply.

So when ministers from the IMF member countries arrive later this week these warnings will be very much in their minds. But the mood is likely to be one of uneasy watchfulness, not panic.

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