Journal Issue

IMF Sees World Growth Slowing

International Monetary Fund. External Relations Dept.
Published Date:
November 2007
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World economic growth is expected to slow next year, with recent turbulence in financial markets triggered by the fallout from the U.S. sub-prime mortgage market clouding prospects, the IMF said in the October 2007 World Economic Outlook (WEO) released on October 17.

Before the turbulence erupted in August, the global economy had been expanding vigorously, with growth running above 5 percent in the first half of 2007, according to the WEO. China’s economy gained further momentum, growing by 11½ percent. India also continued to grow very strongly at more than 9 percent, and Russia grew by almost 8 percent. In fact, these three countries alone have accounted for one-half of global growth over the past year. Robust expansions also continued in other emerging market and developing economies, including low-income countries in Africa.

Rapid growth in the emerging markets counterbalanced continued moderate growth of about 2¼ percent in the United States in the first half of 2007, as the housing sector continued to exert considerable drag. Among the advanced economies, growth in the euro area and Japan slowed in the second quarter of 2007 after two quarters of strong gains.

Subprime fallout clouding prospects

World growth is slowing but is expected to remain solid, supported by the strong momentum of major emerging markets.

(real GDP, annual percent change)
World output4.
United States3.
Euro area1.
Source: IMF, World Economic Outlook, October 2007.Note: Real effective exchange rates are assumed to remain constant at the levels prevailing during August 22–September 19, 2007.
Source: IMF, World Economic Outlook, October 2007.Note: Real effective exchange rates are assumed to remain constant at the levels prevailing during August 22–September 19, 2007.

Solid growth ahead despite turmoil

The IMF expects healthy growth to continue into 2008 (see table), with emerging market economies continuing to serve as the main growth engine of the world economy (see chart, next page). According to the latest forecast, global growth would slow from 5.2 percent in 2007 to 4.8 percent in 2008, down from the 5.4 percent rate registered in 2006. The largest downward revisions to growth are in the United States, and in countries where financial and trade spillovers from the United States are likely to be the largest.

In the United States, growth is now projected to remain at 1.9 percent in 2008, the same rate as in 2007 and a markdown of almost 1 percentage point compared with the IMF’s previous projections. The U.S. economy grew by 2.9 percent in 2006. Ongoing difficulties in the mortgage market are expected to extend the decline in residential investment, while higher energy prices and weaker house prices are likely to dampen consumption spending, the IMF said. In the euro area, growth has been marked down to 2.1 percent in 2008, and in Japan it is now expected to be 1.7 percent.

In the emerging markets, economies are expected to continue to expand strongly, although growth is expected to slow from the heady pace of the past two years. The Chinese economy will grow by about 10 percent in 2008, according to the IMF, and growth will also remain buoyant in other emerging markets.

Higher Food Prices Raise Questions About Biofuel

Commodity prices have risen sharply during 2007, with oil and a number of metal and food items setting new record highs. The rise in food prices raises questions about how to manage growing demand for biofuel.

Futures markets indicate that high prices are likely to continue over the medium term, providing incentives for a surge in biofuel production as a supplement to transportation fuels. This, together with droughts and animal disease, has pushed up food prices and inflation across the globe.

Using biofuel to supplement transportation fuels at modest blends—under current technology—has its pros and cons. Biofuel can supplement traditional fuels while contributing to rural development. However, until new technologies are developed, using food to produce biofuel might further strain already tight supplies of arable land and water all over the world, thereby pushing food prices up even more.

Realizing the potential benefits of biofuel requires better policies. Brazilian ethanol derived from sugarcane, for example, is less costly to produce than corn-based ethanol in the United States, and also yields greater environmental benefits. However, generous tax credits for blenders, tariffs on imported biofuel, and agricultural support for grain farmers in the United States and the European Union make it difficult for low-cost foreign biofuel producers to compete in these markets.

If tariffs and subsidies in the United States and EU were eliminated, biofuel would likely be produced largely by lower-cost producers such as Brazil and other Latin American countries. Similarly, under such a scenario, biodiesel would be produced mostly by Malaysia, Indonesia, India, and some African countries.

In sum, while we wait for more efficient fuel technologies to emerge, the first-best policy would be to allow free trade in biofuel. This would benefit the environment as well as make biofuel economically more viable.

Valerie Mercer-Blackman, Hossein Samiei, and Kevin Cheng

IMF Research Department

Risks tilted to downside

The IMF’s projections are based on the assumption that market liquidity is gradually restored in the coming months. But there is still a distinct possibility that recent turbulent conditions could have a deeper effect on credit availability than envisaged by the IMF in its baseline scenario, with considerably greater macroeconomic impact. Mortgage lenders are already tightening lending standards, and if financing becomes less readily available, a sharper downturn in housing markets, which look richly valued in some parts of the world, is a clear possibility. Not only would this affect consumption and residential investment spending, but as delinquencies rise it would also hurt the balance sheets of mortgage lenders themselves.

Other risks are linked more specifically to the emerging markets. On the upside, the slowing in growth envisaged in the baseline projections in emerging Asia, particularly in China and India, may not materialize given the underlying strength of domestic demand. The main downside risk to emerging markets is that turbulence in global financial markets could disrupt capital flows to emerging markets and trigger problems in domestic markets. Countries in emerging Europe and in the Commonwealth of Independent States are particularly exposed because of their large current account deficits and reliance on bank-related inflows.

The IMF is also still concerned about inflationary pressures. Although such concerns have taken a backseat in advanced economies since the recent bout of financial market turbulence, inflationary risks are more immediate in emerging market and developing countries. Here, rising food prices, dwindling spare capacity, continuing high oil prices, and still strong foreign exchange inflows may mean that monetary policy needs to tighten further to contain inflation pressures. Global oil markets also remain very tight, and with spare capacity still limited, supply shocks or heightened geopolitical concerns could lead to further oil price spikes that could quickly translate into higher inflation.

Large global imbalances

Global imbalances also remain a worrisome downside risk. The U.S. current account deficit is projected to decline only slightly to 5½ percent of GDP in 2008. And while the current account surpluses of oil-producing countries are expected to come down as these countries ramp up spending, China’s current account surplus remains very large.

Persistent large global imbalances raise two principal concerns:

• A disorderly depreciation of the U.S. dollar could have severe repercussions throughout global financial markets.

• Sustained large trade imbalances could prompt rising protectionist pressures.

In sum, the global economy has faced a significant test in recent months. Nonetheless, generally sound fundamentals should keep the global economy on course. So while growth in the coming months will be affected by the aftermath of the financial turbulence, at this stage it does not appear that the impact will be dramatic.

Tim Callen

IMF Research Department

Emerging Markets Now Main Engine of World Growth

China and India are now making the largest contributions to global growth, overtaking the United States as the world’s main growth engine. Growth in emerging markets is expected to remain very strong in the period ahead.

The Chinese economy continues to grow at breakneck speed, making China the single most important contributor to world growth for the first time (see chart). China’s economy is expected to grow by 10 percent in 2008.

Other emerging markets are also growing strongly. In 2007, India, China, and Russia accounted for more than one-half of global growth. Rapid growth in these and other emerging and developing countries is expected to counterbalance continued moderate growth in the United States.

Emerging market countries are reaping the benefits of careful macroeconomic management and are benefiting from favorable external conditions, including high commodity prices. But there are risks.

The main downside risk is that continued turbulence in global financial markets could disrupt financial flows to emerging markets. This is particularly a concern in countries with large current account deficits and substantial external financing needs. But despite these and other risks, the IMF expects emerging markets to remain strong in the foreseeable future.

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