The International Monetary Fund has trimmed its 2023 global growth outlook slightly as higher interest rates cool activity but warns that a severe flare-up of financial system turmoil could slash output to near recessionary levels.
The IMF said in its latest World Economic Outlook report on Wednesday 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 spill-overs from Russia’s war in Ukraine.
“With the recent increase in financial market volatility, the fog around the world economic outlook has thickened,” the IMF said as it and the World Bank launch spring meetings this week in Washington DC.
“Uncertainty is high and the balance of risks has shifted firmly to the downside so long as the financial sector remains unsettled,” the IMF added.
The IMF is forecasting global real GDP growth at 2.8 per cent for 2023 and 3.0 per cent for 2024, marking a sharp slowdown from 3.4 per cent 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 US outlook improved slightly, with growth in 2023 forecast at 1.6 per cent versus 1.4 per cent forecast in January as labour markets remain strong.
But the IMF cut forecasts for some major economies, including Germany, now forecast to contract 0.1 per cent in 2023, and Japan, now forecast to grow 1.3 per cent this year instead of 1.8 per cent forecast in January.
The IMF raised its 2023 core inflation forecast to 5.1 per cent from a 4.5 per cent 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 said.
In a Reuters interview, Mr Gourinchas said central banks should not halt their fight against inflation because of financial stability risks, which look “very much contained”.
While a major banking crisis was not in the IMF’s baseline, Mr 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 unrealised 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 per cent.
The IMF also included a severe downside scenario with much broader effects from bank balance sheet risks, leading to sharp cuts in lending in the US and other advanced economies, a major pullback in household spending and a “risk-off” flight of investment funds to safe-haven US-dollar-denominated assets.
Emerging market economies would be hit hard by lower demand for exports, currency depreciation and a flare-up of inflation.
This scenario, which Mr Gourinchas put at a 15 per cent probability, could slash 2023 growth by as much as 1.8 percentage points, reducing it to 1.0 per cent – a level that implies near-zero GDP growth per capita.
