World economy fragile, faces 'uneasy calm': IMF

Global growth is slowly improving as the US recovery gains traction and dangers from Europe recede, but risks remain elevated and the situation is very fragile, the International Monetary Fund said on Tuesday.

Another flare-up of the euro-zone sovereign debt crisis or sharp escalation in oil prices on geopolitical uncertainty could disrupt the world economy finding its feet now tensions in the euro zone have subsided, the IMF said.

"An uneasy calm remains. One has the feeling that at any moment things could well get very bad again," IMF chief economist Olivier Blanchard told reporters as he detailed the Fund's World Economic Outlook.

"Our baseline forecast is for low growth in advanced countries, especially in Europe, but with downside risks being extremely present," he said.

The global economy is on track to expand this year by 3.5% and by 4.1% in 2013, up slightly from 3.3% and 3.9% GDP output respectively that the IMF had forecast in January, when market concern was rampant that Greece could default and Italy and Spain were facing budget crises.

Since then, Greece has restructured its debt, Italy and Spain are adopting tough fiscal measures and euro-zone leaders have agreed to enlarge their bailout fund, causing financial market tensions to ease.

The United States, meanwhile, is gradually gaining momentum while China and other emerging economies appear on track for gradual slowdowns without crashing, the IMF said.

But the gains are precarious. Should the euro zone crisis erupt once more, it could trigger a widespread dumping of risky assets and rob 2% from global growth over two years and 3.5% from the euro zone, the Fund warned.

Additionally, a 50% increase in the price of oil would lower global output by 1.25%, it said. To secure the global recovery, the IMF urged central banks in the United States, euro zone and Japan to stand ready to deliver further monetary easing; governments to exercise caution over the pace of budget cutbacks wherever feasible; and Europe to consider using public funds to recapitalize banks.

Euro zone shaky, US improves

While European leaders have made "major progress" in building firewalls against financial contagion, the region faces a tricky balance of cutting government debt and restoring competitiveness without excessively stifling growth, it warned.

European banks also are deleveraging, which will reduce their balance sheets by $2.6 trillion over the next two years and slice about 1%age point from growth this year alone.

"Bad news on the macroeconomic or political front still carries the risk of triggering the type of dynamics we saw last fall," the IMF said. The euro zone is likely to endure a mild recession this year, shrinking by 0.3% and then posting 0.9% growth in 2013, the IMF said.

That is a minor improvement from the 0.5% 2011 contraction followed by 0.8% growth that it forecast in January. The United States, meanwhile, is "pulling itself up by its bootstraps" as domestic conditions improve, the IMF said, though the pace of growth remains constrained by an indebted consumer, high unemployment and a weak housing market.

The IMF lifted its forecast for the U.S. to 2.1% this year, up from 1.8% in January. For 2013, it nudged up the forecast to 2.4% from 2.2%. It sees unemployment this year holding at its current level of 8.2% and inching down in 2013 to 7.9%.

Despite the improvement, the fate of the United States remains deeply intertwined with that of the euro zone, where renewed problems could rob 1.5%age point from the outlook.

"A flare-up in the euro area from increased sovereign and bank stress could easily undermine confidence in the US corporate sector and thereby squeeze investment and demand, undermining growth," the IMF said.

The United States faces its own fiscal challenges, made worse by political fights that have delayed work on crafting a medium-term plan to reduce its budget deficit. If tax cuts expire at the end of this year and planned budget cuts kick in, the United States will face an abrupt fiscal tightening.

"Such massive adjustment could significantly undermine the economic recovery," the IMF said.

Emerging economies resilient

The IMF is sanguine on the outlook for China, leaving its growth forecasts unchanged at 8.2% this year and 8.8% in 2013. Strong domestic investment and growing consumption as the middle class expands are supporting growth offsetting a slowing exports.

IMF's deputy director of research Joerg Decressin, speaking at a news conference, welcomed Beijing's decision last weekend to allow China's currency to fluctuate within a narrow band and said more flexibility would help in rebalancing its economy toward internal consumption.

He said it was unclear whether the Chinese yuan was fairly valued, since the IMF is reviewing its methodology for evaluating currencies.

Emerging and developing economies overall are seen growing by 5.7% this year and by 6% next year, upwardly revised from 5.4% and 5.9% from January. Their challenge is to prevent overheating while retaining room for fiscal and monetary stimulus should dangers from the euro zone or high oil prices spill over, the IMF said.