IMF warns debt standoff to hit growth

In its sharpest intervention in the US budget shutdown, the International Monetary Fund has warned that a loss of market confidence in US Treasury bonds could lead to a global recession.

In its half-yearly World Economic Outlook, the IMF warns that a failure by Congress to raise the US debt ceiling "could be very damaging" to the global economy.

"Reassessment of US sovereign risk could reduce global output by several percentage points of GDP," the IMF says. On its new forecasts released on Tuesday night, that would wipe out global growth.

The forecasts assume that Washington's warring parties will reach a deal to keep funding the US budget and raise the debt ceiling by the deadline of October 17, and that the stalemate between the White House and Congress will have no lasting impact. Even on that assumption, the IMF has yet again cut its forecasts for global growth in 2013 and 2014, this time mainly because of slowing growth in India, Russia and China, but also shaving its forecasts of growth in the US.

It now expects the world economy will grow by just 2.9 per cent in 2013, then pick up to 3.6 per cent in 2014. In July it had forecast growth to be 3.2 and 3.8 per cent respectively.

Australia's growth outlook has been downgraded by half a percentage point in each year since its April forecasts, to 2.5 per cent in 2013 and 2.8 per cent in 2014. That is roughly in line with Treasury and Reserve Bank forecasts.

But the IMF warns that the cut in China's projected growth rate from its historical average of 10 per cent to its new target of 7.5 per cent would slow Australia's future growth more than that of any other trading partner, except Mongolia.

By 2025, it estimates, Australia's GDP will be 3 per cent less than it would have had China remained on its old growth path. That implies a reduction of about 0.25 percentage points a year in our baseline growth.

In a rare event, the IMF upgraded its forecasts of growth in the European Union to zero this year and 1.3 per cent in 2014.

As the standoff in Washington enters a second week, the markets and the ratings agencies continue to assume a peaceful ending. US stock markets fell only modestly on Monday, while Moody's chief executive Raymond McDaniel said in a TV interview he did not believe the US would default on its debt payments.

"[It] feels a lot like we've seen this movie before," Mr McDaniel said. "Hopefully it is unlikely that we go past October 17 and fail to raise the debt ceiling, but even if that does happen, we think the US Treasury is still going to pay on those Treasury securities." The participants, however, showed no sign of backing down. The administration said ensuring supply and a lift in the debt ceiling were non-negotiable, and it would not make policy concessions.

"If you sanction through negotiation the legitimacy of somebody threatening default, then that is going to happen over and over again," said Gene Sperling, the veteran director of the National Economic Council.

But House majority leader John Boehner said he would not allow a vote on either issue until President Barack Obama agreed to cut spending, particularly on his affordable healthcare reform, which began operating last week.

"It is time for us to stand and fight," Mr Boehner said.

The IMF has called repeatedly on both sides in Washington to change tack, and focus on medium-term fiscal reform by cutting entitlements, rather than through short-term draconian spending cuts like those implemented earlier this year, and again last week.

"The biggest policy priority is to adopt a comprehensive fiscal consolidation plan to place public debt on a sustainable path over the medium term, while supporting near-term growth," it said.

"A longer [than expected] shutdown could have sizeable adverse growth implications. A failure to promptly raise the debt ceiling could also adversely affect financial markets and economic activity, with spillovers to the rest of the world."

Unless Democrats and Republicans can agree on a medium-term strategy to reduce entitlements and bring down the deficit, the IMF warns, "reassessment of US sovereign risk could reduce global output by several percentage points of GDP".