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IMF says world will grow faster than expected this year
July 16, 2010

IMF has released their World Economic Outlook for July 2010. In their latest projection, they believe the world will grow at a higher rate of 4.6% this year, 0.4% higher than April's forecast. We take a closer look into IMF's report and share our findings.

Author : iFAST Research Team

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The pace of the recent equity market correction has slowed down with most equity markets already bottomed out. However, equity prices were not able to pick up strongly as investors are still jittery over the outlook for the rest of the year. The sovereign debt crisis in Europe and cuts in government spending, coupled with slowing growth momentum in China and aggressive measures to curb property bubble formation, as well as discouraging economic data from the US recently exerts downward pressure on global growth and hence equity markets.

However, IMF’s latest World Economic Outlook (WEO) report which was released on 8 July 2010 (11.30am, GMT+8) took the market by surprise. While consensus were expecting IMF to revise growth projections downwards amidst signs suggesting slower growth, the international lender of last resort projected a stronger rate of growth for 2010 at 4.6% instead, 0.4% higher than their previous projection in April.

World to grow at an even faster rate

Table 1: IMF GDP Forecast (July revision)
2010 Forecast (%) 2011 Forecast (%)
World 4.6 (+0.4) 4.3 (0.0)
US 3.3 (+0.2) 2.9 (+0.3)
Eurozone 1.0 (0.0) 1.3 (-0.2)
Japan 2.4 (+0.5) 1.8 (-0.2)
Emerging Markets 6.8 (+0.5) 6.4 (-0.1)
Developing Asia 9.2 (+0.5) 8.5 (-0.2)
Source: IMF World Economic Outlook, July 2010

Asia’s recovery came in stronger than initially expected at the time IMF released April 2010 WEO. In a broader perspective, there are encouraging signs from global indicators that indicate strong economic activity leading into 2Q 2010 while confidence is on the mend. As such, IMF is now projecting global growth to reach 4.6% in 2010, an upward revision of 0.4%. Table 1 shows a quick summary of the respective regional GDP projections for 2010 and 2011.

However, IMF explained that the upward revision for 2010 GDP forecast is retrospective of the stronger than expected growth in 1H 2010. While signs of global growth have been encouraging, they also seem to have peaked in 2Q 2010. Doubts over the sustainability of the strength of recovery surfaced. It is accelerated by worries that should the European financial system fail, it may potentially derail the global economy, offsetting the concerted efforts made to lift the world from the recent recession. Together, these have led to lowered expectations of future growth, evident in IMF’s revision of 2011 GDP projections.

China still the fastest growing country

China has recorded better than expected exports growth and resilient domestic demand so far this year. Although the pace of growth seems to have peaked and growth momentum is slowing, the strong 1H 2010 performance warranted an upward revision of 0.5% for 2010 projected growth by IMF, to 10.5%. This makes China the fastest growing economy. However, IMF is expecting growth to moderate, slowing to 9.5% in 2011. The growth projection for emerging economies is revised to 6.8% in 2010, a 0.5% increment from April’s forecast. ASEAN’s growth saw one of the largest upward revisions. It is projected to grow at 6.4% in 2010, 1.0% higher than the previous projection.

Eurozone growth not revised lower for 2010

There is thus far little evidence that the sovereign debt crisis Europe has had a negative spillover effect on real activity at a global level. In addition, it is challenging to ascertain the potential dampening effect Europe’s debt problems may have on global growth. IMF has incorporated a modest negative effect on the growth in Eurozone under the assumption that the European Stabilization Mechanism (750 billion euro aid mechanism) can preserve financial stability and coordinated policies are capable of rebuilding investor confidence in Europe’s banking system. This negative effect is however assumed to be mitigated by the boost in net exports due to the depreciation of euro. As such, the projection for Eurozone’s growth remains unchanged at 1.0% for 2010.

The effect of austerity measures, which are now adopted Europe-wide, is likely to drag on Europe’s economic growth over the next few years. European economies are bracing themselves for pro-longed anemic growth as they focus on fiscal rebalancing as their key priority. Global growth has probably peaked already, and the slowing growth momentum will also see exports out of Europe moderate accordingly. IMF therefore revised both Eurozone’s and European Union’s growth for 2011 lower by 0.2% each, to 1.3% and 1.6% respectively.

IMF acknowledges downside risk has risen sharply

While growth is expected to be stronger than April’s projection, IMF acknowledges that the downside risk is sharply higher than before. The latest projections hinges on the assumption that the negative impact from Europe’s problem is minimal. Should this assumption not stand, we may see an escalation of financial stress and contagion which will weaken confidence level.

To illustrate the likely impact should the key risk highlighted materialize, IMF presented an alternative scenario using their Global Projection Model. In their simulation, they assumed that the magnitude of shocks to financial conditions and domestic demand in the Eurozone are as large as those experienced in 2008. The simulation model also incorporates significant contagion to financial markets, particularly in US. Given negative financial and trade spillovers, the model simulates suppressed growth in other regions as well. The simulation result shows a 1.5% reduction of 2011 world growth which is not sufficient in dragging the world back into a recession.

In order to avoid the worst case scenario, IMF stresses that “the overarching policy challenge is to restore financial market confidence without choking the recovery”. They believe that it is important for European leaders to restore confidence to the market through well-coordinated policies by ensuring that the aid mechanism proposed is fully operational and also to ensure European banks are adequately capitalized.

IMF also urged for financial system reforms to be accelerated so as to restore the health of banking systems. The reforms should prioritize the improvement of banking transparency aimed at resolving uncertainty about bank exposures as this can help alleviate pressure in the European interbank market as well as help improve overall market sentiments. In addition, advanced economies should engage in structural reforms that will enhance growth and competiveness while emerging economies should aim at rebalancing global demand as well as adopt greater exchange rate flexibility.

What should investors do?

The first half of the year is already behind us. The global recovery has been progressing healthily but is asynchronous, led by strong growth in Asia and emerging markets while economic growth in advanced economies remained modest but inline with expectations. However, the uncertainty brought by the debt crisis in Europe has negatively impacted confidence levels worldwide, resulting in global equities trading at valuations lower than historical averages.

With cheap valuation as a buffer for downside risk and economic fundamentals at better than expected levels, we view the current landscape as an attractive opportunity for investor to accumulate. However, we do remain cautious of the downside risk involved and the lack of market catalysts to drive prices higher in the near term.

At this juncture, we remain overweight in equities. Investors who have a strong appetite for risk may look to increase their holdings and/or shift to an overweight exposure in Asia ex Japan. For investors who do not wish to increase their holdings, they are advised to review their portfolio (if they have not done so this year) and decide if there is a need to rebalance. Lastly, for investors who have stayed on the sidelines throughout or have no idea how to get started, we recommend that they take guidance from our  Recommended Portfolios.

iFAST and/or its content and research team’s licensed representatives may own or have positions in the mutual funds of any of the Asset Management Company mentioned or referred to in the article, and may from time to time add or dispose of, or be materially interested in any such. This article is not to be construed as an offer or solicitation for the subscription, purchase or sale of any mutual fund. No investment decision should be taken without first viewing a mutual fund's offer document/scheme additional information/scheme information document. Any advice herein is made on a general basis and does not take into account the specific investment objectives of the specific person or group of persons. Investors should seek for professional investment, tax, and legal advice before making an investment or any other decision. Past performance and any forecast is not necessarily indicative of the future or likely performance of the mutual fund. The value of mutual funds and the income from them may fall as well as rise. Opinions expressed herein are subject to change without notice. Please read our disclaimer in the website.

© 2010 iFAST Financial India Private Limited All Rights Reserved.

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