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IMF's revised economic forecast warns of 'elevated downside risks'

The global economy is back in a buckle-your-seatbelts phase, as weaker growth in the United States and Europe's debt crisis heighten the threat of turbulence in the months ahead, the International Monetary Fund said in a revised economic forecast.

"Global activity is projected to slow in the second quarter of 2011, and then reaccelerate in the second half of the year," the IMF said in an update to its April World Economic Outlook. "But activity will remain unbalanced amid elevated downside risks."

Over all, the fund's forecast for global economic growth this year is little changed at 4.3 per cent, compared with 5.1 per cent in 2010. The world's gross domestic product will expand 4.5 per cent in 2012, the IMF says.

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The IMF cut its outlook for the United States this year to 2.5 per cent from 2.8 per cent. Japan's economy is projected to contract 0.7 per cent as the result of the earthquake, tsunami and nuclear meltdown, compared with the previous forecast for growth of 1.4 per cent.

Stronger-than-expected growth in Germany, France and Italy will offset the weakness in the U.S. and Japan. The GDP of Central and Eastern Europe will expand 1.6 percentage points more than was forecast in April, led by Turkey, the IMF says. The estimate for Canada was revised to 2.9 per cent from 2.8 per cent.

The IMF is clinging to the belief that the global economy can withstand the current crisis of confidence, reflected in sliding stock markets, the chaos in Greece and a critical mass of data that shows the U.S. economy hit a soft patch in May and June.

"The fundamental drivers of growth remain in place: overall still-accommodative macroeconomic conditions, pent-up demand for consumer durables and investment, and strong potential growth in emerging and developing economies," the IMF says.

Emerging and developing economies are projected to grow 6.6 per cent in 2011, little changed from April. China is forecast to lead the way at 9.6 per cent.

The IMF said there is a greater chance now, than there was in April, that its estimates could turn out to be too optimistic. The fund said there is "heightened potential" the situation in Europe could spread through the financial system, and it noted there is greater concern that the U.S. recovery has been knocked off course.

"If these risks materialize, they will reverberate across the rest of the world - possibly seriously impairing funding conditions for banks and corporations in advanced economies and undercutting capital flows to emerging economies," the IMF says in its economic update.

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The fund calls on the United States and Japan to implement "credible and well-placed" fiscal consolidation plans. However, consolidation should be "gradual and sustained," rather than deep and immediate, the IMF says. That's because the IMF considers their economies to be too fragile to withstand a heavy dose of austerity. In Washington, politicians should immediately resolve to raise the debt ceiling and launch a budget plan that both reduces entitlement liabilities and includes "revenue-raising tax reform."

Monetary policy should remain accommodative in the U.S., Japan and the euro zone, although policy makers must watch closely for increases in core inflation rates, the IMF said.

In emerging markets, where economic output has returned to precrisis levels, "the priority is to expeditiously tighten macroeconomic policies, and use exchange rate flexibility and macroprudential tools, possibly including capital controls, to help contain risks of boom-bust cycles." The IMF singled out Asian countries running wide current-account surpluses, saying they should allow their currencies to rise.

"The global economy has turned the corner from the Great Recession," the IMF report says. "However, securing the transition from recovery to expansion will require a concerted effort at addressing diverse challenges."

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