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IMF, World Bank say recovery process still fragile

The IMF and World Bank said the path to global economic recovery is rife with risks and the onus is on policymakers to avoid runaway inflation and other pitfalls that could derail the process.

At a forum in Montreal, International Monetary Fund chief Dominique Strauss-Kahn and World Bank President Robert Zoellick turned their focus to life after the crisis, issuing a list of “do's and don'ts” for governments as they try to nurse their economies back to health.

Strauss-Kahn maintained his forecast for a global economic recovery in early 2010, with the turnaround starting in September and October of this year.

“We still believe, as we've said for months, that the most credible scenario is that the recovery will take place in the first half of 2010 with the turning point in September, October, beginning of growth at the end of this year, and then really the first positive quarter as Q1 or Q2 in 2010,” he said.

But he warned that the biggest risk to his outlook is countries taking too long to cleanse toxic assets from their banking systems.

“You never recover until the cleansing of the balance sheet of the financial sector has been completed,” Strauss-Kahn said.

For confidence to return, banks should disclose not only losses related to US subprime mortgages but other losses linked to the economic slowdown.

“What we are noticing is that there still is a system of credits, or of losses, that are not made public,” he said. “These are not things that are linked today to the original subprime crisis, but to the fact that the economic slowdown has rendered a certain number of assets of poor quality and that new losses were registered.”

“The loss of confidence comes from the fact that we do not know exactly where the losses are and what they are.”

Amid encouraging “green shoots” suggesting the worst of the global recession is over, Strauss-Kahn reminded policymakers that the same policies that helped them through the crisis will cost them dearly in years to come as fiscal and monetary stimulus is withdrawn.

The threat of spiraling inflation tops the list of concerns.

“The risk of very rapid inflation at the end of the crisis is a real risk. How are we going to dry up all the markets?” he said. “The world after the crisis is not that simple.”

The prospect of bulging government deficits for years to come is another reason to start acting with restraint now, Zoellick said.

He said to continue injecting stimulus, without fixing credit markets, amounted to a “sugar high.”

“I wouldn't, frankly, be trying to have additional sort of spending built in, in part because one of the challenges in this environment - and you see this in discussion with (German) Chancellor (Angela) Merkel and others - is getting the balance right between expenditures to get out of the hole with building a problem for the future,” Zoellick said in the session at an economic conference in Montreal.

Zoellick also warned that protectionism could stifle recovery.

“Right now there is a low-grade fever; it isn't full influenza, but we need to keep a close watch because as unemployment numbers go up politicians are under stress and some of them may turn to protectionism,” he said in a statement earlier on Monday.

He said it is not clear where demand would come from to fuel global recovery but suggested that the Chinese economy could make a surprisingly strong comeback.

Strauss-Kahn also warned that some emerging economies face huge financing gaps that, through no fault of their own, could put them at risk of defaults, which would ripple through the regional and global economies.

This is not due to incorrect policies in those countries, but rather a drying up of capital inflows due to the crisis.

“I do believe that these types of financing gaps in emerging countries are now under control, but you never know,” he said.

The economic crisis in the world's poorest nations could easily lead to social unrest, political instability and even war, which would also spill over into the global economy even though those countries normally have little influence on financial markets.

The IMF is in the process of crafting an early warning system to try to mitigate the impact of future financial crises. Strauss-Kahn said some governments were uncomfortable with the idea of publishing information about their banking systems, but he said the IMF would have a full-blown early warning exercise ready by its fall meetings in Istanbul.

“We are going to do it anyway,” he said. The emphasis would be on price movements, inflation and the need to avoid short-term reactions to crises, he said. (Reuters)