IMF vindicates RBA October rate cut as it warns of one-in-six chance of recession in advanced economies

The International Monetary Fund (IMF) says there is a one in six chance (17%) of a recession in advanced economies, with Chinese economic growth slowing to around 7% in the first half of 2012.

The warning, contained in its October 2012 World Economic Outlook report, vindicates the decision by the Reserve Bank to reduce the cash rate in October primarily due to global risks and concerns expressed by RBA governor Glenn Stevens in his monetary policy decision statement that growth in Asia "is being dampened by the more moderate Chinese expansion".

“There is now a one in six chance of global growth falling below 2%, which would be consistent with a recession in advanced economies and low growth in emerging market and developing economies," says the IMF, which has cut its global GDP forecast by 0.2 percentage points to 3.3% for 2012 and by 0.3 percentage points to 3.5% in 2013.

The IMF reports that the global recovery has continued “but it has weakened”.

“In advanced economies, growth is now too low to make a substantial dent in unemployment. And in major emerging market economies, growth that had been strong earlier has also decreased.

“Relative to our April 2012 forecasts, our forecasts for 2013 growth have been revised from 2% down to 1.5% for advanced economies, and from 6% down to 5.6% for emerging market and developing economies.

Australia's outlook is better than most advanced economies, with the IMF expecting Australian economic growth of 3.3% this year and 3% growth in 2013.

The IMF notes monetary policy has been easing and will "remain very accommodative", with "various advanced economies recently cut policy rates (Australia, Czech Republic, Israel, Korea) or postponed rate hikes".

In line with the RBA concerns, the IMF warns that slowing growth in China “has affected activity in the rest of Asia, a consequence of the deepening of linkages throughout the region in the past decade”.

The IMF forecasts Chinese growth to slow to 7.8% in 2012 and then pick up to 8.2% in 2013. The Chinese economy grew by 9.2% in 2011.

“Growth is estimated to have weakened appreciably in developing Asia, to less than 7% in the first half of 2012, as activity in China slowed sharply, owing to a tightening in credit conditions (in response to threats of a real estate bubble), a return to a more sustainable pace of public investment, and weaker external demand,” says the IMF.

The main impact of a global recession on Australia would be a further sharp fall in commodity prices, a decline in real national income and an increase in unemployment with the IMF noting that “in Australia, continued strong mining activity and related investment have also supported growth”.

Olivier Blanchard, economic counsellor at the IMF, warns that the recovery has “suffered new setbacks, and uncertainty weighs heavily on the outlook”.

“A key reason is that policies in the major advanced economies have not rebuilt confidence in medium-term prospects."

The IMF notes that there has been a clear change in attitudes in the key eurozone area, "where new architecture is being put in place”.

“The lessons of the past few years are now clear. Euro area countries can be hit by strong, country-specific, adverse shocks.

“Weak banks can considerably amplify the adverse effects of such shocks. And, if it looks like the sovereign itself might be in trouble, sovereign-bank interactions can further worsen the outcome.”

The IMF says its lower forecast rest on “critical policy action in the euro area and the United States, and it is very difficult to estimate the probability that this action will materialise”.