IMF cuts US growth outlook, warns on budget paralysis

WASHINGTON (AFP) - The International Monetary Fund (IMF) warned Washington on Tuesday that the political showdown over the budget could damage the global economy, as it cut its United States (US) growth forecast.

The Fund, in its new World Economic Outlook, projected the US economy would grow 1.6 per cent this year and accelerate to 2.6 per cent in 2014, down respectively 0.1 and 0.2 percentage points from its July forecast.

It said the reduction was due to the impact of the sharp sequester spending cuts instituted by the government earlier this year that were aimed at trimming the federal deficit.

But it said things could turn worse if the week-old government shutdown, due to lack of agreement by warring political parties over the budget, continues much longer.

And it warned that if the political paralysis prevents an increase in the US borrowing ceiling, the government could be forced to default on its debt, which would rock the global economy.

Not raising the debt ceiling "will lead to an extreme fiscal consolidation and almost surely derail the US recovery", said IMF chief economist Olivier Blanchard at a press conference.

If the US then defaulted on debt payments, he added, it "will be felt right away, leading to potential major disruption in financial markets both in the US and abroad".

Mr Blanchard called a US default "a low-probability event", but another slump in US stocks on Tuesday, with no end in sight to the political stalemate in Washington, showed investors were growing nervous.

The US Treasury has said the US$16.7 trillion (S$20.8 trillion) borrowing ceiling needs to be raised by Oct 17 or it would run out of cash.

In its newest economic forecast, the IMF said the US economy still needs the Federal Reserve's easy-money policy, including its US$85 billion a month bond-buying programme, which the Fund said should be trimmed only slowly over the next year.

It said growth will pick up over next year as the Fed's ultra-low interest rates and its stimulus aid economic activity and help boost stock and property prices, strengthening household finances.

It also expects unemployment to slowly improve without any parallel rise in inflation, so that the Fed could afford to keep supporting growth.

Sill, the IMF said the risks to the US outlook "remain tilted to the downside". It cited the ongoing government shutdown and the debt ceiling fight, as well as the sequester cuts which have held back growth this year and will continue to retard potential over the next year.

"Private demand continues to be strong, although growth has been hobbled this year by excessive fiscal consolidation," Mr Blanchard said in a preface to the report.

"The sequester is a bad way to consolidate, and conflicts around increasing the debt ceiling could lead to another bout of destabilising uncertainty and lower growth."

The report also pointed to the effect the expected reduction in the Fed's stimulus has already had, sharply pushing up loan rates and helping spark capital outflows from emerging economies.

While the IMF warned once again that the US central bank should go slow in reducing the stimulus, it acknowledged that it was time to begin doing so to normalise monetary policy from its crisis footing.

But Mr Blanchard said that by necessity this will press up long-term interest rates and feed some turbulence in emerging-market economies.

"Normalisation of interest rates in advanced economies is likely to lead to a partial reversal of previous capital flows. As investors repatriate funds to the United States, countries with weaker fiscal positions or higher inflation are particularly exposed," he said.