IMF Eyes Lower Growth Forecast

Come January 2012, the International Monetary Fund (IMF) will have to pare its growth forecast for the world. IMF’s September 2011 projections indicated a global growth of 4% for 2012 as opposed to over 5% in 2010. This announcement by the IMF does not come as a surprise. The financial turmoil and the deepening Eurozone crisis, largely responsible for sluggish global growth and weak investor confidence prompted the IMF to contemplate a recast. “The storm in the Euro area casts a long shadow over the entire global economy,” the IMF chief, Christine Lagarde said in one of her recent statements.

In Eurozone, factory activity contracted the fastest in two years and so did British manufacturing. In China too, manufacturing activity was lower in November for the first time in three years. The U.S. however, bucked the trend in November.

According to the IMF’s September 2011 outlook for the global economy, the countries need to rebalance their economies internally and externally. While internally, private demand needs to be pushed, it is clearly not happening because of tight credit and highly leveraged households.

Externally, countries with large current account deficits like the U.S. where local demand is low need to look at exports. However, countries like China, which have large current account surpluses, are riding the export-driven growth path. The contribution of domestic demand to growth in these countries is not happening at a significant pace. We are therefore, looking at radical transformations in country growth models, which will take time.

Weak consumer confidence and efforts to build savings are affecting growth. Low growth means industrial weakness, fiscal instability and market uncertainties. The banking system could also deteriorate because of escalating non-performing assets in such a scenario. The weakness all around is self-reinforcing as it spreads back and forth across industries leading to a vicious downward spiral.

The banking sector in particular looks vulnerable. Notable European banks, such as HSBC Holdings Plc (HBC - Analyst Report), Europe’s largest bank by market value and UBS AG (UBS - Analyst Report), Switzerland’s largest bank faced credit ratings downgrades. Major US banks – Bank of America (BAC), Citigroup (C - Analyst Report), J P Morgan (JPM - Analyst Report), Wells Fargo (WFC - Analyst Report), Goldman Sachs (GS - Analyst Report), Bank of New York Mellon () and Morgan Stanley (MS - Analyst Report) have also not been spared.

All these banks have globally diversified operations. However, the overall economic weakness and exposure to European sovereign debt appear to be weighing on them. According to the Bank of International Settlements, US banks have an exposure of $767 billion to the European debt market. Credit Default Swaps ($518 billion) and direct lending ($181 billion) are the major parts of this exposure.