World Economic Developments and Outlook

International Monetary Fund. Middle East and Central Asia Dept.
Published Date:
October 2008
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The global economy is cooling rapidly

The slowdown in global growth, which started last summer in the wake of the financial turmoil emanating from the subprime market in the United States, has deepened further in 2008. Global growth softened from 5 percent in 2007 to 3¾ percent in the second quarter (annualized) of 2008, and many advanced economies are now close to—or in—recession. While remaining on a faster track, growth in emerging and developing countries has also eased in the first half of 2008 due to slowing external demand and moderating domestic demand. However, commodity exporters have benefited from high food and fuel prices.

The credit crunch has deepened

Financial market conditions have worsened considerably, and entered a tumultuous new phase in September. Authorities in developed economies have taken extraordinary measures aimed at stabilizing markets, although these have not entirely reassured markets, and the situation remains highly uncertain. Banks have been gradually repairing their balance sheets but face additional losses from weakening credit performance in the context of slowing economies. Moreover, inflation risks—while receding globally—remain present in some countries, reducing the flexibility for policymakers to ease financial stress. Financial conditions are likely to remain very difficult, and with slowing economies and a deleveraging process that is likely to be long and arduous, the pace of credit creation is expected to be slow.

Soaring commodity and food prices have boosted inflationary pressure

High oil and food prices, together with financial factors, have created inflationary pressure. Oil prices reached a record high of US$147 a barrel in July 2008, although they have since retreated sharply. Food prices were boosted by poor weather conditions, by continued strong growth in demand, including from the use of biofuels, and by restrictive trade policies. Financial factors, notably U.S. dollar depreciation (through July 2008) and low real interest rates, have also played a role in short-term price dynamics. Accordingly, inflationary pressures have continued to build up. This has particularly been the case for emerging and developing economies, with headline inflation in these countries reaching 8½ percent in August 2008 and core inflation also rising amidst signs of increasing inflation expectations and wage increases. Although commodity prices are softening, and the dollar has recovered from earlier lows, inflation is not expected to fall significantly in the short term because of the continuing pass-through of past commodity price increases—even at current levels, oil prices remain above their 2007 average of US$71 a barrel. In advanced economies, inflation rose to 4¼ percent through August 2008, while core inflation remained contained.

Oil and commodity prices will likely remain high

Looking forward, commodity prices are expected to stay relatively high. Although world oil prices have recently fallen below US$100 a barrel, the price of oil is nevertheless projected to average US$107¼ a barrel in 2008 and US$102½ in 2009–13. In the food markets, rising biofuels production and sustained strong demand from emerging and developing markets are expected to continue to exert upward pressure on some prices in 2008. In the medium term, however, food prices should ease substantially, as supply responds to current world prices and policies aimed at boosting production.

Global growth will slow significantly in the second half of 2008

Economic activity in the world is expected to continue slowing through end-2008, before very gradually recovering during the course of 2009. Global growth is projected to moderate to 3.9 percent in 2008 and 3 percent in 2009 (Figure 18). This outlook is based on the assumption that credit conditions and financial markets will remain under substantial stress through 2008 and much of 2009, with growth slowly turning up in 2009 due to stabilized commodity prices and rising confidence that the financial problems of financial institutions are being resolved. Advanced economies are expected to expand by 1½ percent and ½ percent in 2008 and 2009, respectively. Growth in emerging markets and developing countries is projected to continue to slow to 7 percent in 2008 and 6 percent in 2009, reflecting slower global demand as well as efforts to prevent overheating in some countries.

Figure 18.Global Outlook

(In percent; unless otherwise indicated)

Source: IMF, World Economic Outlook.

Inflation is expected to fall gradually, as commodity prices stabilize and food prices start to ease. With economic growth slowing across the world, including in China, and demand for raw materials easing, oil and food prices are expected to stabilize from the second half of 2008, following the downward corrections from the very high levels in the summer. Accordingly, inflation in advanced economies is expected to decline below 2 percent by end-2009. In emerging and developing economies, inflation is projected to continue to rise in 2008 as earlier commodity price increases feed through the pipeline, before easing somewhat in 2009.

Risks to the outlook are to the downside

In this exceptionally uncertain situation, there are substantial downside risks to the baseline outlook. The principal downside risk is tied to two related concerns: that financial stress could continue at very high levels, and that credit constraints from deleveraging could be deeper and more protracted than envisaged, implying a full-blown “credit crunch.” In addition, the U.S. housing market deterioration could be deeper and more prolonged than forecast, while European housing markets could weaken more broadly. Inflation risks to growth are, however, now more balanced because commodity prices have retreated in response to slowing global growth. At the same time, potential disruptions to capital flows and the risks of rising protectionism represent additional risks to the recovery.

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