Investors should brace for the most severe global economic downturn since the youthful days of the their grandparents. The International Monetary Fund now expects the 2009 global economy to contract 1.3 percent, the organization announced Wednesday, in its latest economic forecast, the World Economic Outlook (WEO).

Earlier this year, the IMF had forecast that the global economy would contract 0.5 percent. Further, because the global economy has a greater capacity for growth, any global growth rate below the 1.5 to 1.8 percent range is tantamount to a recession.

If the contraction turns out to be as pronounced as now forecast, it would be by far the global economy's worst performance since the end of World War II, when production in developed nations declined as nations demobilized.

Further, the synchronized nature of the contraction, combined with damage done to credit markets by the financial crisis, is expected to weigh on the recovery when it starts, with the IMF projecting only a sluggish recovery relative to past recoveries of 1.9 percent in 2010.

2010: No GDP growth for US, euro-zone

What's more, the IMF does not project GDP to turn positive in the U.S. or in the euro-zone in 2010, forecasting 0.0 percent GDP for the U.S. and -0.4 percent GDP growth for the euro-zone. However, it should be noted the these rates would still represent an economic recovery, given that they would represent an increase in economic activity from an earlier, larger GDP contraction period.

Light at end of tunnel

The IMF has reiterated its call for a sustained, international policy response to tackle financial problems and support demand.

"This is not the time for complacency, and the need for strong policies, both on the macro and especially on the financial fronts, is as acute as ever. But, with such policies in place, there is light at the end of this long tunnel," IMF Chief Economist Olivier Blanchard said in a statement. "World growth can turn positive by the end of this year, and unemployment can start decreasing by the end of next year."

Further, IMF added that unemployment will crest toward the end of 2010 and decrease after that, if the correct policies are implemented to heal credit markets and boost demand.

"The immediate imperative is to move boldly with credible plans to deal with the financial crisis that has been at the core of the global recession over the past six months," the report said. Simultaneously, macroeconomic policies should be geared to support demand to minimize the corrosive feedback from weakening real economic activity on the financial sector, the IMF said.

The above is aimed at eliminating the 'negative feedback loop' that threatens to both prolong and deepen the economic slump. The financial crisis has hurt commercial activity by making it harder for companies to access credit, but the recession has also increased financial system stress, by reducing the value of assets and leading to an increase in toxic assets via home mortgage defaults.

Developed world: Huge contraction

The IMF now expects G-20 GDP to contract 3.8 percent in 2009, with the U.S. economy declining 2.8 percent. Emerging market economies are expected to register 1.6 percent GDP growth in 2009 – tantamount to a recession in this segment, due to both developing economies' higher growth rate capacity and their need for larger growth.

The IMF's 2009 / 2010 forecast growth rates for developed economies are as follows: U.S., -2.8 percent / 0.0 percent; Euro-zone, -4.2 percent / -0.4 percent; Germany, -5.6 percent / 0.4 percent; France, -3.0 percent / 0.4 percent; Italy, -4.4 percent / -0.4 percent; Spain, -3.0 percent / -0.7 percent; United Kingdom, -4.1 percent / -0.4 percent; Japan, -6.2 percent / 0.5 percent; Canada, -2.5 percent / 1.2 percent;

Emerging market region and individual nation 2009 / 2010 forecast growth rates are: emerging markets, 1.6 percent / 4.0 percent; China, 6.5 percent / 7.5 percent; India, 4.5 percent / 5.6 percent; Russia, -6.0 percent / 0.5 percent; Brazil, -1.3 percent / 2.2 percent; Mexico, -3.7 percent; 1.0 percent; Sub-Saharan Africa, 1.7 percent / 3.8 percent.

Economic Analysis: To be sure, a sobering global economic forecast. The IMF's research indicates that, assuming normalized credit markets, current fiscal stimulus to date will barely be enough to push the global GDP needle positive – and with no GDP growth in the United States and euro-zone. That points to a need to increase demand and find new engines of growth in these regions. If the private sector can create that demand, that would be preferred. However, in the absence of that, the public sector must create that demand, or, according to the IMF, the U.S. and Europe are looking at another year of well-below-adequate economic activity.

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