'Debt explosion' fears: IMF puts pressure on G20

By Chris Cermak Apr 22, 2010, 11:39 GMT

Washington - The International Monetary Fund made a sharp change of course this week, joining a growing chorus fearful that wealthy countries may be spending themselves into a second financial crisis.

What a difference a year makes. In 2009, the IMF urged governments around the world to inject billions of dollars into their economies to avoid the onset of a 1930s-style depression.

Those stimulus packages have done part of the job - a depression has been avoided. The IMF on Wednesday said the world was firmly out of recession and moving into a faster-than-expected recovery.

After shrinking 0.6 per cent in 2009, the IMF forecast world growth of 4.2 per cent this year and 4.3 per cent in 2011.

But in its two major reports on the global economy and financial industry, the IMF painted a sobering picture of what could happen if governments from the United States to Europe to Japan fail to bring their skyrocketing deficits under control.

A public debt crisis would have knock-on effects for private sectors, which in turn could usher in a 'new phase' in the financial turmoil that engulfed the global economy in late 2008. Banks would raise borrowing rates for governments and further limit loans to companies in order to protect their own balance sheets.

The IMF's warnings renew pressure on finance ministers from the world's leading economies to make more debt-reduction pledges. The ministers are set to gather later this week in Washington for a series of meetings.

The Group of 20 (G20) bloc of developing and industrial nations will come together on Friday, followed by the semi-annual meetings of the IMF and World Bank's decision-making committees.

Advanced economies are approaching debt burdens at around 100 per cent of gross domestic product, levels not seen since World War II. Many have used up the space to stimulate their economies, while sluggish demand over the last few years has sharply reduced tax revenue.

Greece's debt woes of recent months and the effects on the wider eurozone have served as a warning to other countries - and investors - about the pitfalls of unsustainable government debt.

This has prompted the IMF to change its tune.

While stimulus measures should continue through this year, the global lender urged governments to make deficit control their top priority, and to ease investor fears by mapping out clear plans for reining in spending in 2011 and beyond.

'The loss in fiscal revenues associated with the loss in output from the crisis is threatening to lead ... to a debt explosion,' IMF chief economist Olivier Blanchard said. 'In most countries, fiscal consolidation has increasingly become the priority.'

For finance ministers coming to Washington, this presents a conundrum.

Government stimulus has so far kept many of their economies afloat, and the IMF notes that private sectors are unlikely to pick up the slack once the public spending tap is turned off.

The global recovery is being driven mostly by emerging powerhouses like China and India, and masks ongoing weakness in wealthier countries like the United States, where the financial crisis originated.

The IMF predicted advanced economies as a whole will grow by just 2.3 per cent this year, while facing unemployment rates remain around 8 per cent through 2011. The US jobless rate will remain above 9 per cent this year, and the 16-country eurozone's unemployment will sit at 10.5 per cent.

The risk of a 'jobless' recovery is pushing many governments to consider extra spending that might encourage companies to renew hiring. G20 labour ministers meeting Wednesday in Washington promised to consider 'additional employment measures' to speed job growth.

Yet the IMF suggested tackling unemployment could not come at the expense of clear plans to reduce ballooning deficits. Blanchard acknowledged that cutting public debt would have 'an adverse effect' on private demand.

How might the private sector fill that gap? The answer, according to Blanchard, is a drastic rebalancing of the global economy. Wealthy countries should allow their currencies to depreciate in order to boost exports.

For this to happen, developing powers like China - criticized by many for keeping its renminbi too low - will have to do their part, allowing currencies to rise. Blanchard argued this would help the Chinese to tackle an over-reliance on exports that threatens their economies in future.

'It is in their global interest to do so,' Blanchard said, 'as this adjustment may be needed to sustain growth in advanced countries and, by implication, strong growth in the rest of the world.'