Outlook bleak as US tots up Katrina cost

By Stewart Fleming

Date: 22/09/05

AMID deepening concern about the outlook for the world economy, European Union finance ministers and central bankers are heading for Washington this weekend for a series of tense high-level discussions during the annual meeting of the leading international financing institutions, the International Monetary Fund (IMF) and the World Bank.

Late last week, leaked internal forecasts indicated that the IMF had sharply downgraded its predictions for the growth of most of the major eurozone economies for 2005 and 2006 but was leaving virtually unchanged its forecasts for the United States, at 3.5% for this year and 3.3% next year. But these forecasts are assumed to have been drawn up before the devastation caused by Hurricane Katrina which has shut down major oil refineries, sent US petrol prices soaring and, according to the latest surveys, dealt a significant blow to consumer confidence.

Indicative of the growing unease about the global economic outlook, Stephen Roach, chief economist at US investment bank Morgan Stanley in New York, said this week that he "would now assign about a 40% probability to a hard landing [for the world economy] at some point in the next 12 to 18 months".

Continuing concern about the stability of the US economy prompted the Federal Reserve to raise interest rates on Tuesday (20 September), in the aftermath of Hurricane Katrina.

The Fed is clearly worried about the risks of inflation and it cannot risk foreign investors not wanting to buy dollar assets.

The IMF too, in its latest World Economic Outlook, says that the rapid growth of America's foreign- owned debt involves "significant risk of a low-probability but high- cost, abrupt adjustment" of the world's economic imbalances, notably the massive US current account deficit. The Organisation for Economic Development and Co-operation (OECD) expects it to hit EUR 658 billion this year.

There are growing worries that the cumulative impact of high oil prices, rising inflation and eroding business and consumer confidence in several G7 countries could, cumulatively, produce a 'tipping point' for the global economy, triggering the sudden downswing that has long been feared.

Ahead of the IMF meetings, US Treasury Secretary John Snow has again been ratcheting up the pressure on China to agree to a bigger currency revaluation to make Chinese imports more expensive and US exports cheaper. He has also invited his Chinese counterpart to participate again in some of this weekend's meetings of the Group of Seven (G7) finance ministers from the leading industrial countries including France, Germany, Italy and the UK.

How to incorporate countries like China, India and Brazil more formally into international meetings and institutions is becoming a hotter issue. A paper to be released in Washington tomorrow (23 September) by Edwin Truman, a senior fellow at the Institute for International Economics and a former top official at the Federal Reserve Board, says that the IMF, described as "the pre-eminent institution for international financial co-operation", now "faces an identity crisis".

This is reflected in "a total lack of consensus about the fund's role in the world today," he says. "The central issue," Truman argues, "is that many countries think that the industrial countries are over-represented" at the IMF.

Brussels too is agonising over the EU's role at the IMF. Some eurozone countries, in particular, are unhappy at what they see as the unsatisfactory co-ordination which takes place within the EU on international economic policy issues - the British push for debt relief for the poorest countries, which culminated at the G8 Gleneagles summit in the summer, was cited as an example by a senior official from one eurozone country. They also feel that the EU's voice would be stronger if its representation at the IMF was unified. At present there are ten executive board seats at the IMF representing one or more EU member countries.

But, as Truman's paper makes clear, reallocating national representations on the board of the IMF, which he sees as a first step towards increasing "the sense among IMF members of the Fund's legitimacy", is a diplomatic minefield. Even more difficult, but ultimately unavoidable, will be resolving the problem of reallocating national shares, and therefore voting power, at the IMF. Eurozone countries hoping to see the single currency backed by a single voice at the IMF can be under no illusion about just how difficult it will be to achieve this goal, not least because even some eurozone members are less enthusiastic about reaching this objective than others.

• Stewart Fleming is a freelance journalist based in Brussels.

Preview of the annual meeting of the leading international financing institutions, the International Monetary Fund (IMF) and the World Bank, Washington, 24-25 September 2005, to be attended by European Union Finance Ministers and central bankers. Author says that there was deepening concern about the outlook for the world economy, including the eurozone countries, and the stability of the US economy in the aftermath of the Hurricane Katrina disaster.

IMF: Annual and Spring Meetings: 2005 Annual Meetings of the World Bank Group and International Monetary Fund http://www.imf.org/external/am/2005/index.htm

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