IMF: European financial crisis, US budget crisis worsens global economic outlook

07/16/2012 10:47 EDT | Updated 09/15/2012 05:12 EDT
WASHINGTON - The global economy will grow more slowly over the next two years, according to the International Monetary Fund's latest forecast.

And Europe's financial crisis and a potential budget crisis in the United States could slow world growth even further, the international lending organization warned.

The world economy will likely expand 3.5 per cent this year, the IMF said in a quarterly update to its World Economic Outlook. That's down slightly from its previous estimate of 3.6 per cent in April.

The IMF also cut its forecast for global growth to 3.9 per cent in 2013, from 4.1 per cent three months ago.

And it shaved its U.S. growth forecast to 2 per cent this year from 2.1 per cent in April. For 2013, it expects U.S. growth of 2.3 per cent, down from 2.4 per cent.

The IMF warned that economic conditions could worsen if the United States doesn't deal with a pending budget crisis soon.

Several large tax cuts are set to expire at the end of the year and big spending cuts are scheduled to kick in at the same time. If Congress doesn't take action, the U.S. could suffer another recession and the global economy could slow sharply.

Olivier Blanchard, the IMF's chief economist, said failure to deal with these issues could cut up to 4 percentage points off U.S. growth in 2013. It would also reduce growth in other advanced economies — principally Europe, Canada and Japan — by 1.5 percentage points.

"We are talking about, potentially, an enormous shock," Blanchard said. "If it were to happen, it would be a major, major event."

The U.S. should also raise its borrowing limit, the report said. The level of debt the government can issue is capped by law. Last August, a battle between the Obama administration and Congress over raising the limit wasn't resolved until the U.S. almost defaulted on its debt.

Blanchard noted that Europe's leaders must follow through on the promises that were made at a leaders' summit at the end of last month.

At that time, the 17 nations that use the euro agreed to centralize the regulation of European banks and to expand the use of the region's bailout funds.

European leaders need to ensure that borrowing costs for Spain and Italy don't get so high that they are unable to borrow from private lenders, possibly necessitating another bailout.

"The implications of such an event could easily derail the world recovery," Blanchard said.

Even if the 17-nation eurozone follows through with its commitments, the region's economy will shrink 0.3 per cent this year and grow only 0.7 per cent in 2013, the IMF predicted.

Germany and France are expected to grow this year and in 2013, though at a slow pace. The IMF estimates Italy and Spain will contract this year and next.

IMF officials said that European leaders should do more to aid Spain and Italy. They should consider using the region's bailout to funds to provide aid to struggling banks. And the European Central Bank could purchase more government bonds, to hold down the two nations' borrowing costs.

The IMF also expects growth will slow in several large developing countries, mostly because they will export less to Europe and the United States.

China's economy will likely expand 8 per cent this year, down from April's 8.2 per cent forecast. India's economy will grow 6.1 per cent, down from 6.8 per cent. And Brazil's growth will be only 2.5 per cent, compared to 3.1 per cent.