IMF cuts global forecast, warns on deflation

The International Monetary Fund on Wednesday forecast the world economy would slow to a near standstill this year, warning that deflation risks were rising and saying toxic assets need to be removed from the banking system.

It cut its forecast for global growth in 2009 to a slight 0.5 percent, the weakest since World War Two, from a November estimate of 2.2 percent.

"Despite wide-ranging policy actions, financial strains remain acute, pulling down the real economy," the IMF said in an updated forecast.

"A sustained economic recovery will not be possible until the financial sector's functionality is restored and credit markets are unclogged," the Fund added.

The outlook was even worse for advanced countries such as the United States and the euro area, whose economies are seen contracting by 1.6 percent and 2 percent respectively.

The IMF said emerging market economies would be the only source of growth, expanding 3.3 percent in 2009 and 5 percent next year, but those forecasts as well were below projections made less than three months ago.

The IMF said it expects the world economy to gradually recover in 2010 and growth to resume to around 3 percent.

Still, the IMF said the outlook was highly uncertain and the timing and pace of the recovery depends on policy measures adopted by governments.

"For this purpose, new policy initiatives are needed to produce credible loan-loss recognition, sort financial companies according to their medium-run viability, and provide public support to viable institutions by injecting capital and carving out bad assets," it added.

The IMF said that the risks of deflation were heightened because of a housing slump in many key economies and a global financial crisis but said that the most likely outcome was that the world will escape a sustained bought of falling prices, as it did after the last scare in 2002-2003.