IMF steps up pressure for dollar depreciation

Financial Times
Apr. 19, 2006

The International Monetary Fund on Wednesday stepped up the pressure for far-reaching shifts in exchange rates, declaring that the dollar will have to depreciate “significantly” over the medium term if global economic imbalances are to be resolved in an orderly fashion.

In its clearest statement to date on this highly-charged subject, the IMF said it was essential that currencies in Asia and of oil exporters were allowed to appreciate as part of the required “realignment of exchange rates”. But it shied away from giving any specific figures as to the extent of appreciation required.

The statement came in the IMF’s twice-yearly World Economic Outlook, published on Wednesday, which highlighted global imbalances as the biggest threat to what was otherwise an “unusually favourable” economic environment.

It said global growth had been surprisingly robust in late 2005 and raised its estimates from September for 2006 and 2007 by 0.6 percentage points and 0.3 points to 4.9 per cent and 4.7 per cent respectively. This year is set to be the fourth in a row in which global growth has exceeded 4 per cent.

The IMF sharply increased its estimates for growth in Japan, to 2.8 per cent this year and 2.1 per cent next, declaring that the expansion there is now “well-established”. It also raised its forecasts for China and India significantly, with other increases for oil exporters.

But the IMF remained sceptical on the strength of the rebound in the eurozone, inching its growth forecast up to 2 per cent this year, but down to 1.9 per cent next. It said growth remained heavily reliant on exports, with domestic consumption particularly weak in Germany.

The IMF now sees the US growing at 3.4 per cent this year and 3.3 per cent next, a little faster this year and slower next than earlier estimates. It cautioned that a flattening out in US house prices could have a bigger effect on consumption than some studies show.

It expects the UK economy to recover to 2.5 per cent growth this year, followed by 2.7 per cent in 2007.

In keeping with the stronger pace of expected global growth, the IMF now expects consumer price inflation in industrialised economies to remain at 2.3 per cent this year and ease back only to 2.1 per cent next. It correspondingly revised up its estimates of short term market interest rates over the next two years.

The IMF said global financial market conditions “remain very favourable, characterised by unusually low risk premiums and volatility”. It argued that a flattening yield curve need not signal a slowdown ahead, though increased investment - and therefore lower corporate savings - could push up long term interest rates.

The IMF said this year could prove a “watershed year” in which countries either capitalised on benign circumstances to address global imbalances, or spurned the opportunity. Exchange rate shifts would have to be accompanied by rebalancing of demand across the world, with steps to increase savings in the US, raise consumption in China, investment in the rest of Asia and boost productivity growth in the non-tradeable goods sectors in Europe and Japan.

The World Economic Outlook also cautioned against becoming complacent about high oil prices. It said consumers may still be treating current increases as temporary, rather than permanent losses. With excess capacity low, the market is vulnerable to shocks.

Moreover, it said recent price increases had been driven not by a surprising strength of demand for oil, but deepening fears about both short- and long-term supply.