MercoPress. South Atlantic News Agency

IMF warns credit crunch is extending to the whole world

The global credit crunch shows no signs of abating, according to the International Monetary Fund (IMF). In its latest global financial stability report the IMF says that falling house prices and slowing economic growth are hitting credit.

It warns that banks are under renewed stress, and further cutbacks in bank lending could deepen the slowdown. IMF also says that emerging markets like China may also suffer more pain in the future from the credit crunch. There were further signs of the problems facing many economies with news that the White House is expected to raise its forecast for the US budget deficit in 2009 to a record 490 billion US dollars. The US government is spending large amounts on stimulus packages to limit the severity of the economic downturn, but that extra spending will have to be largely funded by borrowing. The deficit is also likely to increase as companies hit by the credit crunch and cash-strapped individuals pay less in taxes. The IMF's report makes for gloomy reading nearly one year after global financial markets froze in August 2007. In April, the IMF said that banks and other financial institutions could lose one trillion US dollars from the credit crisis as mortgage-backed assets lost most of their value, and it is still sticking to that estimate. The current report says that that the banks have now acknowledged these risks and written off nearly 500 billion US dollars worth of assets. But it points out that they have only been able to raise new capital to cover about two-thirds of those losses, so the likelihood is that they will have to restrict their lending further. The IMF warns that "as banks seek to de-leverage and economize on capital, assets are being sold and lending conditions tightened, resulting in slower credit growth in the US and the Euro area." In the US, private sector borrowing has dropped to the lowest level since the 2001 recession. And there is now less scope for central banks to cut interest rates to boost economic growth because of the higher risk of inflation. The IMF also warns that credit risks in the US are spreading from sub-prime lending to other types of mortgages and to all other major credit categories, such as car loans and credit card loans. Overall, "global financial markets continue to be fragile and indicators of systemic risk remain elevated." The IMF is particularly worried about the crisis that has engulfed the US government-sponsored mortgage lenders Fannie Mae and Freddie Mac, which fund half of all US mortgages. Fears about their under-capitalization caused their share prices to collapse, and forced the US Treasury to agree to a government guarantee which has just been approved by the US Congress. This could cost upwards of 100 billion US dollars, and the IMF says that "the challenge is now to find a clear and permanent solution while continuing to support US mortgage securitization." Former US Treasury Secretary Larry Summers argues that ultimately the only solution is for the US government to temporarily re-nationalize the two institutions, bankrupting the shareholders but generating more cash to disperse to people facing foreclosure. However, that solution would triple the US national debt from 3 trillion to 9 trillion US dollars, something financial markets might not find easy to swallow. The IMF also warns that the "resilience of emerging markets to the global turmoil is being tested" by a combination of inflationary pressures, currency readjustments, and a slowing world economy. While China and India are both projected to grow much faster than the old industrial countries, they are both raising interest rates to cope with rising inflation and their exports are being hit by a rising currency. China is also the largest single holder of bonds issues by Fannie Mae and Freddie Mac, and has seen their value drop sharply as the crisis deepens. And the banking systems in both India and China are coming under renewed strain, while their nascent stock markets have suffered significant volatility, with China's main Shanghai index falling by 50% since the beginning of the year. Two weeks ago, the IMF raised its forecast for world economic growth in 2008 to 4.1%, but warned that the US would be growing by just 1.3%. However the IMF latest report suggests that the slowdown will be more prolonged into 2009 than previously thought, especially if emerging market country growth slows down. And the IMF has again warned that the "policy trade-offs between inflation, growth and financial stability are becoming increasingly difficult". Such problems are evident in the three-way split among members of the Bank of England's monetary policy committee over the future direction of interest rates, as well as in the decision of the European Central Bank to raise rates this month. From Washington the White House announced it had cut the growth prediction for the US economy this year from 2.7% to 1.6%, and for next year from 3% to 2.2%. The administration has accepted that the problems in the housing market and financial markets, as well as rising oil prices, will take their toll. The jobless rate is forecast to hit 5.3% this year and 5.6% in 2009. This is up from the administration's previous prediction of 4.9% for both years. It was 4.7% in 2007. Consumer price inflation is expected to hit 3.8% this year, up from the previous forecast of 2.7% and well above the Federal Reserve's target of 2%. And George W Bush's successor as US president after this November's election is expected to face a record federal budget deficit of 482 billion US dollars. "The housing slump, tighter conditions in credit markets and continuing energy price shocks have cut into the expected growth rate" the White House report said. The US economy depends heavily on consumer spending, which is why there is such concern about the way rising energy, food and housing costs could hit it. Earlier in the year, a stimulus package was enacted that included giving tax rebates to millions of households. The estimated $168bn cost of that programme may help keep Americans shopping, but with a record federal budget deficit the next US president will have little room to pay for any additional measures. The figures "confirm the dismal legacy of the Bush administration: under its policies, the largest surpluses in history have been converted into the largest deficits in history", said House Budget Committee chairman John Spratt.