IMF warns of threats to economic recovery

Financial uncertainly could persist and undermine a fragile economic recovery even if the war in Iraq is over quickly, the International Monetary Fund warned today.

In its twice-yearly report on global financial stability, the IMF cited continued geopolitical instability and threats of terrorism as factors that could dampen investor confidence even in the event of a short and decisive war.

Gerd Haeusler, the IMF director responsible for the report, said of the conflict: "What it will mean for the region, whether or not the likelihood of terrorist attacks might diminish or, as some say, even increase... are issues which are far more important than the question of whether the war may take a week longer or not."

As the IMF released its gloomy report, official US figures showed that the American economy grew at an anaemic 1.4% annual rate in the final quarter of 2002. The latest official data underlined the sluggish nature of the recovery in the world's largest economy after the 2001 recession.

The 1.4% growth rate marked a sharp slowdown from the 4% pace registered in the third quarter of 2002. Since the end of 2001, US economic growth has been highly uneven, with a quarter of strength followed by a quarter of weakness.

Many economists believe that the US economy will not perform much better - and may even worsen - in the current quarter as the job market stagnates and American consumers and businesses turn cautious because of the uncertainties thrown up by war in Iraq.

With US businesses cutting back on capital spending after the over-investment of the 1990s, consumers have been the main force keeping the US economy going. But consumer confidence is weakening - especially as the job market has worsened. The US jobless rate rose to 5.8% in February as the economy lost 308,000 jobs.

"Markets may not have focused on the possibility that uncertainty could persist for some time," the IMF report said. "Consequently, prolonged uncertainty could keep risk aversion at a high level, depress financial markets, and reinforce the headwind against global economic recovery."

The IMF pointed to the reversal of the market rally from mid-January to early March as an indication of fragile investor sentiment and the urgent need for policies to boost market confidence. World markets did shoot up in the immediate run-up to war, but have since trod water as Iraq's anticipated military collapse has failed to materialise.

The IMF report also highlighted the danger of financial instability should the dollar fall sharply. With US interest rates at historical lows, the fund said that foreign holders of American government bonds might turn away from such investments because of low returns, putting pressure on the US currency.

"A precipitous fall in the dollar could have potentially destabilising consequences, given the build-up over time of large holdings by foreigners of US financial assets," the IMF said.