IMF forecasts 7.5 percent growth for Sri Lanka

After a setback in 2011 global economic prospects are gradually strengthening but downside risks remain elevated the IMF World Economic Outlook 2012 released last week said.

Improved economic activities in the US in the second half of last year and better policies in the Euro area in response to its deepening economic crisis have reduced the threat of a sharp global slowdown, the report said.IMF has forecast 7.5 percent economic growth for Sri Lanka in 2012, a higher figure compared to the Central Bank estimate of 7.2 percent and the ADB outlook of 7 percent released recently.

Recovery in advanced economies will remain weak while relatively solid economic activities continue in developing and emerging economies. However, since recent improvements are very fragile policy makers need to continue to implement the fundamental changes required to achieve healthy growth over the medium term.

Global growth forecast has been projected 3.5 percent in 2012 against 4 percent in 2011 due to weak activities in the second half of 2011 and the first half of 2012. Global growth will return to 4 percent in 2013 as re-acceleration of activity during the course of 2012. Euro area is still projected to go into mild recession in 2012 as a result of sovereign debt crisis and a general loss of confidence, the effect of banks de-leveraging on the real economy and the impacts of fiscal consolidation in response to market pressure. Growth in advanced economies as a group will be only about 1.5 percent in 2012 and 2 percent in 1013.

Real economic growth in emerging and developing economies is projected to slow from 6.25 percent in 2011 to 5.75 percent in 2012 but then re-accelerate to 6 percent in 2013 helped by easier macro economic policies and strengthening foreign demand.

IMF warned that crude oil prices will increase by 30 percent on average in 2012 compared with last year on possible supply disruption from Iran.

“Iran-related geo-political oil supply risks extend beyond the reduction in oil production and exports that appears to be in the making already and is priced in by markets” the report said.

The impact on oil prices of a potential or actual disruption in oil supplies involving the Islamic Republic of Iran––the world’s third largest exporter of crude oil––would be large if not offset by supply increases elsewhere.

A halt of Iran’s exports to Organisation for Economic Cooperation and Development (OECD) economies (if not offset) would likely trigger an initial oil price increase of about 20 to 30 percent, with other producers or emergency stock releases likely providing some offset over time a part of this is likely priced in already.

Further uncertainty about oil supply disruptions could trigger a much larger price spike.

A negative supply shock raises the real price of oil by slightly more than 50 percent on average over the first two years. This reduces the already sluggish growth of real household income and raises production costs, eroding profitability.

These factors undermine the recovery in private consumption and investment growth for economies in all regions, except for net oil exporters.

At the global level, output is reduced by about 1¼ percent. The short-term impact could be significantly larger if the adverse oil shock damages confidence or spills over to financial markets, effects that are not included in this scenario.

Oil prices rose sharply during 2010 and early 2011 to about $115 a barrel, then eased to about $100 a barrel, and now are back up to about $115 a barrel.

Production recovered in Libya but fell in various other Organisation of Petroleum Exporting Countries (OPEC) producers, and non-OPEC output remained relatively weak. In addition, geopolitical risks notably those centered on the Islamic Republic of Iran—have boosted oil prices.

Projections for 2012–13 assume that oil prices recede to about $110 a barrel in 2013, in line with prices in futures markets, but in the current environment low stocks and limited spare capacity present important upside risks.

In the current environment of limited policy room, there is also the possibility that several adverse shocks could interact to produce a major slump reminiscent of the 1930s.

For instance, intensified concern about an oil supply shock related to the Islamic Republic of Iran could cause a spike in oil prices that depresses output in the euro area, amplifying

adverse feedback loops between the household, sovereign, and banking sectors.

In the meantime, the oil price shock could also trigger a re-assessment of the sustainability of credit booms and potential growth in emerging Asia, leading to hard landings in these economies.

This could, in turn, prompt a collapse in non-oil commodity prices that would hurt many emerging and developing economies, especially in Latin America and Africa. More generally, a concurrent rise in global risk aversion could lead to a sudden reversal of capital flows to emerging and developing economies.

As a result of the recent EU oil import embargo, other countries’ tighter sanctions, and Iran’s partial oil export embargo, the potential Iranian oil supply shock is morphing into an actual shock because lower Iranian oil production and exports seem inevitable during 2012 and beyond. The extent and speed of the decline, however, are difficult to predict: outcomes will

depend on economic and strategic considerations of a small number of players, including major emerging net importers.

The larger the reduction in the Iranian oil supply, the greater the risk of global oil market tightening. For example, a reduction in oil exports equal to total exports to OECD economies would amount to about 1½ million barrels

a day, equivalent to a shock of about 2.4 times the standard deviation of regular fluctuations in global production

Iran-related geopolitical oil supply risks extend beyond the reduction in oil production and exports that appears to be in the making already and is priced in by markets. Iran’s location at the Strait of Hormuz, the choke point for shipment of about 40 percent of global oil exports (25 percent of global production), and its geographic proximity to other major oil

producers means that there is a risk of a large-scale, possibly unprecedented, oil supply disruption in the event of military conflict or attempts to close the strait.

Given the low responsiveness of global oil demand to price changes in the short term, such oil supply disruption would require a very large price response to maintain global supply-demand balance.