IMF warns US against cutting deficit too fast

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The International Monetary Fund on Tuesday pared its growth forecast for the US economy and warned that the Obama administration could be slicing the deficit too fast for the weak economy.

It also said the economy was under threat from the pre-programmed “fiscal cliff” combination of sharp spending cuts and tax increases at the year-end, and a worsening of the eurozone crisis.

The IMF estimated 2012 US economic growth at a “tepid” 2.0

percent, down from April's forecast of 2.1 percent, and said even that outlook was at risk from both domestic and international threats.

“It is critical to remove the uncertainty created by the 'fiscal cliff' as well as promptly raise the debt ceiling, pursuing a pace of deficit reduction that does not sap the economic recovery,” the fund said in its annual report on the US economy.

The fiscal cliff is the result of Congress's failure to agree on a deficit reduction plan, resulting in mandated tax increases and spending cuts to take effect by January 1, 2013.

Congress remains deadlocked over how to avoid the mandated measures, and the political impasse was not expected to lift before the November 6 presidential election.

The IMF warned that leaving the measures to take effect could force a contraction early next year and “significant negative repercussions on an already fragile world economy.”

It noted the nation's debt ceiling will need to be raised in early 2013, after a historic battle in Congress last year that roiled markets and cost the United States its coveted triple-A rating for the first time.

The looming need to hike the limit was “bringing back the risk of heightened uncertainty and financial market disruption,” the Washington-based institution said.

The IMF criticised President Barack Obama's proposed fiscal 2013 budget, which calls for slashing the nation's deficit by three percentage points to about 5.5 percent of gross domestic product.

Even if as expected the deficit cutting comes in less than three points, the IMF warned that “this smaller reduction would be too rapid, given the weak economy.”

“The composition of spending should be as growth-friendly as possible,” the IMF said, suggesting a larger deficit of about 6.25

percent of GDP would be appropriate.

“It is critical to ensure a pace of fiscal adjustment in the short run that is supportive of the recovery, removing the threat of a very large fiscal adjustment in 2013, and to adopt a credible medium-term plan restoring fiscal sustainability.

The global lender cited a litany of risks to US growth, including the limited room for monetary policy to counter the drag of deficit cutting.

The distressed labor market could also be further battered if the economy falters. The IMF said there was a risk “that prolonged economic slack could reduce potential output through skill erosion” and the exit of discouraged workers from the labor force.

But the IMF emphasised that weak consumer spending, which accounts for about 70 percent of the economy, remained a key obstacle to recovery three years after the Great Recession.

“Consumption is expected to be held back by households continuing to repair their balance sheets amid a sluggish recovery of house prices” after a price bubble collapsed six years ago.

The IMF lowered its 2013 growth forecast by a tenth point to 2.3 percent. - Sapa-AFP