Global Recovery Gaining Momentum, but Obstacles Remain

The Organization for Economic Cooperation and Development (OECD) announced yesterday (Wednesday) that it has lifted its economic growth outlook, but warned that governments must enforce strict fiscal policies to sustain the global recovery and balance global expansion.  

The OECD reported that the combined economy of its 31 members would grow 2.7% this year and 2.8% in 2011. Troubles of debt-plagued developed economies will be offset by the rapid economic growth of emerging markets. The numbers have been revised upward from November predictions of 1.9% growth in 2010 and 2.5% growth in 2011.

The OECD estimated global gross domestic product (GDP) would rise 4.6% this year and 4.5% in 2011, up from the previous expectation of 3.4% and 3.7%, respectively.

Behind the numbers is a global economy that's lacking balance: Emerging economies face the risk of overheating, while developed nations need to cut deficits and raise interest rates to support a true recovery. Both groups must develop stricter fiscal policies.

"As activity gathers momentum, global imbalances are beginning to widen again," said OECD Chief Economist Pier Carlo Padoan. "Strong, sustainable and more balanced growth can be achieved through a combination of macro-economic, exchange-rate and structural policies."

U.S. GDP growth was predicted to rise 3.2% in both 2010 and 2011. To sustain this growth level, the United States and other developed countries must reduce budget deficits but not reverse the effects of stimulus packages.

"Exit from exceptional fiscal support must start now, or by 2011 at the latest," Padoan said.

The OECD called for interest rates in the United States, United Kingdom and Canada to start rising by the end of 2010 at the latest, with U.S. rates hitting 3.5% by the end of 2011. Current budget policies should be further adjusted to stabilize debt-to-GDP ratios. Governments also should cut spending and subject budgetary guidelines to independent monitoring to increase fiscal policy credibility. Taxes should be increased, but not by so much that they stifle growth.

Countries should plan to cut borrowing to prevent an increase in government bond yields. The OECD estimated that for every one percentage point increase in yields, economic growth would contract by half a percentage point in both the current and subsequent years.  

The OECD also believes unemployment in the 31 member countries peaked at 8.5% and will be less severe than previously estimated.

Asia Fuels Growth, Nears Overheating

The rapid growth of emerging economies has increased trade flows and helped pull developed economies out of a recession, giving the recovery a self-sustaining momentum.

China - not an OECD member - is predicted to grow at 11.1% this year and 9.7% in 2011.

"The spillover from growth in non-OECD Asia could be stronger than expected, especially in the United States and Japan," reported the OECD. "From this point of view the overall environment is relatively auspicious."

Japan is forecast to grow 3% in 2010 and 2% in 2011.

But countries like China and India need to tighten fiscal policy to prevent a boom-bust scenario.

"Overheating in emerging-market economies also poses a serious risk," the OECD report said. "A boom-bust scenario cannot be ruled out, requiring a much stronger tightening of monetary policy in some non-O.E.C.D. countries, including China and India, to counter inflationary pressures and reduce the risk of asset-price bubbles."

The OECD said China's growth would slow as China tightens fiscal policy to curb inflation - which could be done by revaluing the yuan.

U.S. representatives met with China this week for the second Strategic and Economic Dialogue (S&ED) where the long-debated topic of currency valuation was addressed.  

"China will continue to steadily advance reform of the renminbi exchange rate formation mechanism following the principles of being independent, controllable, and gradual," Chinese President Hu Jintao said in his opening remarks.

Eurozone Debt Crisis Dangerous

Eurozone GDP is predicted to rise 1.2% this year and 1.8% in 2011, provided it can clamp down on spiraling debt. The OECD encouraged the European Central Bank to keep interest rates low this year as the euro area keeps working on calming its markets.  

"The fact that the second set of actions has taken 18 months after the first is a reminder that the period of significant financial instability that began in August 2007 is not yet over," said Padoan

Europe's sovereign debt crisis has threatened global growth. The OECD emphasized the importance of exercising "fiscal discipline" through external auditing of budget plans and stricter enforcement of Eurozone financial policies to prevent problems spilling over from Greece.

"This turbulence has highlighted the need for the euro area to strengthen significantly its institutional and operational architecture to dissipate doubts about the long-term viability of the monetary union," OECD Secretary-General Angel Gurría said in a speech. "Surveillance of domestic policies needs to be strengthened, taking on board broader competitiveness considerations."

The OECD recommended austerity measures that focus on raising revenue from consumption-related taxes instead of higher direct taxes.

"The whole continent must change its political morale and perhaps is social welfare and state model," Italy finance minister Giulio Tremonti announced at the OECD economic forum. "We are confronted with hard choices. The public coffers are not unlimited."

News and Related Story Links:

• OECD:
  Launch of the Economic Outlook 2010
  
• Bloomberg:
  OECD Lifts Growth Outlook as Emerging Nations Rebound
  
• The New York Times:
  OECD Sees Risks to Recovery From Europe and Asia
  
• Money Morning:
  Why the Yuan Won't Be an Issue at the U.S. China Summit
  
• Money Morning News Archive:
  Eurozone Stories
  
• Money Morning News Archive:
  Greece Stories