Credit crisis to shape IMF forecast

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.

Banks

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.