IMF sees rising recession risk from euro credit crisis

The global economy is slowing sharply and is at far greater risk of recession than was thought just months ago, with Europe’s debt crisis creating “fertile ground” for a rapid collapse, the International Monetary Fund warned Tuesday.

In a sobering trio of reports on growth, public debt and financial stability, the agency described global trade and investment as waning and depicted the world as perhaps one shock away from a serious downturn. The epicenter of the economic turmoil remains the euro zone, where political leaders have not committed the money needed to prop up weakened governments and banks, thereby threatening to create a cycle of “self-perpetuating pessimism” that could undermine the recovery, the IMF said.

Whether the trigger is a government default in Greece, a bank failure or some other traumatic event, “the world could be plunged into another recession,” said Olivier Blanchard, the IMF’s economic counselor. “The world recovery, which was weak in the first place, is in danger of stalling.”

The agency’s latest forecasts suggest that the process may be underway. Projected worldwide economic growth for 2012 was trimmed to 3.25 percent from the 4 percent rate projected in September. China and India, which have become major engines of global growth, are predicted to cool to around 8.2 percent and 7 percent, respectively. The IMF projects that the euro zone will fall into recession and contract by about 0.5 percent this year.

The U.S. economy’s projected growth rate has been holding steady at 1.8 percent since September, the IMF said.

The new reports suggest that the world economy is being undermined by some of the policies the IMF has recommended in recent months to address government debt and strengthen Europe’s banking system. Along with other recent reports issued by the World Bank and private organizations, the IMF studies underscore the major quandary facing policymakers in the United States, Europe and elsewhere as they confront high unemployment rates, slow growth and in some cases the threat of public unrest.

Growth is now so precarious, the agency said, that deficit reduction in the United States and stronger European nations such as Germany should take a back seat.

The IMF said the “accident prone” U.S. political system is at risk of pushing too hard on the brakes. If Congress does not renew the payroll tax cut and extend unemployment benefits that are set to expire in February, government spending this year would drop by more than 2 percent of the country’s annual output, “with negative repercussions for the still unsettled economic outlook,” the agency said.

The Obama administration and Republicans in Congress have been battling over whether and how to extend the payroll tax cut and jobless benefits. IMF officials say they worry that these political fights are distracting the U.S. government from developing a plan to address the chronic problems of long-term spending on health care and retirement.

The IMF has begun pushing countries in Europe and beyond to gird for the worst. The agency wants euro-zone nations to commit hundreds of billions of dollars to potential bailouts of Italy and Spain. Those countries are forecast to contract sharply, with a downturn of more than 2 percent in Italy making it that much harder for its government to meet its spending targets and retain the faith of investors on world bond markets. The IMF also wants to boost its own war chest and is pressing world economic powers to make an additional $500 billion available should it be needed.

The IMF is one of several organizations offering downbeat assessments. The World Bank last week projected even slower worldwide growth, of just 2.5 percent, and it forecast a euro-zone recession.

In a separate study released Tuesday, the Institute of International Finance said that the flow of capital into developing nations dropped by nearly 20 percent last year — a worrisome decline that also occurred during the 2008 financial crisis.

The IIF attributed much of that drop to European banks pulling out of investments and lending in Eastern Europe and Asia. This is one of the most direct ways in which Europe’s troubles are affecting the rest of the world. The decline poses particular problems for Eastern European nations such as Hungary and Ukraine that, unlike some countries in Asia, do not have access to local sources of money when French, Italian or German investors disappear.

The downturn in investment is partly a consequence of policies enacted in Europe to try to cope with its crisis. In this instance, European banks are retreating from other parts of the world to comply with stiffer regulations that the European Union imposed last year — partly at the urging of the IMF — that require the firms to maintain larger capital buffers against possible losses. The requirements are combining with government austerity measures to crimp growth.

The speed with which Europe demanded that its banks meet the new requirements “is having a drastic negative impact,” said IIF chief economist Philip Suttle. The IIF, which represents the world’s major financial institutions, has been fighting to soften the impact of financial industry regulations crafted after the 2008 crisis.

In its new reports, the IMF shared the concern that Europe’s move to recapitalize its banking system could be damaging. To limit the fallout, the agency said the euro zone should use taxpayer money from around the region to bolster banks that need help — just as euro-zone countries are pooling resources to back troubled governments.

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