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OECD sees weak recovery, lasting damages

The slowdown in OECD economies is reaching the bottom following the deepest decline for more than 60 years, says the OECD’s latest Economic Outlook.

But recovery is likely to be weak and fragile, and the economic and social damage caused by the crisis will be long-lasting.

The latest edition of the Economic Outlook is the first in two years to see previous projections for economic growth revised upwards – most clearly for the large emerging economies and the United States – rather than downwards. But the prospects for the euro area this year have worsened and Japan’s have changed little since the OECD’s previous projections were published in March.

 “Thanks to firm action to stimulate our economies it appears that we have escaped the worst during this crisis,” said Angel Gurría, Secretary-General of the OECD. “But the next few months will be equally testing. There needs to be a clear and credible plan and timeline for phasing out the emergency measures as the recovery takes hold. It is critical to consider these exit strategies now in order to prevent new risks in the years ahead.”

US economic activity this year is expected to fall 2.8%, against the 4.0% decline projected in March. Growth in 2010 is now forecast at 0.9% compared with 0% previously. The trough in US activity is expected during the second half of this year but the Outlook warns that as the impact of the stimulus measures fades, increased savings by corporations and consumers to reduce their indebtedness will continue to hold back growth. The recovery will not be strong enough to stop unemployment rising to around 10% over the next two years.

A recovery already appears to be taking hold in China, helped by major stimulus measures. Chinese GDP growth is forecast to be 7.7% in 2009 and 9.3% in 2010, an upward revision from the OECD’s March forecasts of 6.3% this year and 8.5% next year. In Brazil, economic activity is forecast to fall by 0.8% in 2009 and rebound to 4.0% growth in 2010 (March forecast -0.3% and +3.8%); in Russia, economic activity is forecast to drop by 6.8% in 2009 and climb by 3.7% in 2010 (March forecast -5.6% and +0.7%); and in India, growth is predicted to slow to 5.9% in 2009 before accelerating to 7.2% in 2010 (March forecast 4.3% and 5.8%).

Japan’s GDP is forecast to fall 6.8% in 2009 and to rise 0.7% in 2010, compared with March projections of falls of 6.6% and 0.5% respectively. There are signs that the slowdown triggered by the collapse in trade is coming to an end but the recovery will be slow. With high unemployment and much unused productive capacity, deflation is likely to become further entrenched.

Signs of recovery are not yet clearly visible in the euro area. GDP is expected to contract 4.8% this year and to show 0% growth in 2010. The previous projections were for a 4.1% fall in 2009 and a 0.3% fall in 2010.  Each country has its own specific combination of weaknesses such as bursting housing bubbles, declining exports and damaged financial sectors. The eventual recovery is likely to be slow as rising unemployment will hit consumer spending.

The Outlook sees continued downward pressure on inflation over the next two years but little risk of sustained deflation outside Japan.

Because of the weakness of the expected recovery, the OECD argues that governments need to implement announced stimulus measures promptly and fully. These tax breaks or spending measures should not be withdrawn at a pace which jeopardizes the recovery. Similarly, better regulation of financial markets to guard against future crises is now urgent.

When the recovery is sufficiently strong, fiscal consolidation will be needed, says the Outlook. To avoid damaging long-term growth prospects, this will mean careful targeting of where spending can be cut and taxes raised. “The required consolidation is large in some cases but it is not without precedent” said Jorgen Elmeskov, Acting Chief Economist. “What is without precedent, though, is the simultaneity of fiscal consolidation across countries.” (press release)