World growth slows, credit crunch clouds outlook

The world economy is solid but will lose a step next year as growth slows in the US and Europe, the International Monetary Fund said, warning that disarray in global credit markets had clouded near-term economic prospects.

The IMF maintained its previous forecast, made in July, for 2007 global economic growth of 5.2 per cent, but lowered the forecast for 2008 by 0.4 percentage point to 4.8 per cent.

"While underlying fundamentals supporting growth are sound and the strong momentum in increasingly important emerging markets is intact, downside risks from the financial markets and domestic demand in the US and western Europe have increased," the IMF said in its semi-annual World Economic Outlook.

The IMF said the global expansion was now firmly led by China, whose economy is expected to grow by 11.5 per cent this year and slow slightly to 10 per cent next year.

The IMF's largest downward revisions in its growth forecasts were in the US and in countries affected by the troubles in the US subprime mortgage market, especially Canada, Mexico and some Asian economies. It said the US economy was set to grow just 1.9 per cent next year, a sharp downward revision from the 2.8 per cent forecast in July.

The problems in the US subprime mortgage market, which has seen a wave of foreclosures, spread quickly worldwide because the loans were packaged into complex financial securities and resold to investors.

The turmoil triggered a tightening of credit conditions in August, prompting central banks around the world to respond with massive injections of liquidity to ensure the global financial system did not feeze up. The US Federal Reserve cut interest rates sharply in an attempt to limit economic damage from the credit crunch and market turbulence.

The IMF said signs that US growth was likely to continue below trend would justify further interest rate cuts, provided inflation was contained. Meanwhile, rates should be held on hold in the eurozone rates and in Japan, where authorities should wait for clear signs of rising inflation, it added.

The IMF said its baseline forecast for global growth was based on the assumption that market liquidity would be gradually restored in the next few months and that interbank lending would revert to more normal conditions.

Still, the IMF said there was a distinct possibility that market turbulence may continue for some time, further dampening growth, particularly through the effect on housing markets in the US and some European countries.

Countries in eastern Europe and former Soviet states with large current account deficits could be affected should capital inflows weaken, it added.

The immediate task for policy-makers was to restore market conditions and to safeguard the global expansion, the fund said, citing uncertainties over the scale of losses that investment banks were suffering because of the credit turmoil.