IMF assails US budget cuts, lowers 2014 growth forecast

The International Monetary Fund assailed US government spending cuts as "excessively rapid and ill-designed" on Friday as it cut the economy's growth forecast for 2014. Warning that the country still faces downside risks to its recovery, the IMF cheered the Federal Reserve's stimulus efforts and urged Congress to help firm up growth by repealing the severe "sequester" budget cuts. In its annual report on the US economy, the IMF said growth would be only 1.9 percent this year, due to the sequester's impact, when it had the potential of growing as much as 1.75 percentage points faster. For next year, it lowered its forecast made in April of 3.0 percent to just 2.7 percent. "We had assumed that the sequestration would be phased out," when the prior forecast was made, said IMF Managing Director Christine Lagarde. But the Fund no longer makes that assumption, with political parties still deadlocked over how to cut the budget deficit and debt burden over the medium term. That means that, after $85 billion for the March-September period, another $109 billion has to be pared from fiscal 2014 spending. The Fund called on Congress to revoke the sequester, saying that stronger growth in the short term is important both for the US and global economies. "The automatic spending cuts not only exert a heavy toll on growth in the short term, but the indiscriminate reductions in education, science, and infrastructure spending could also reduce medium-term potential growth," the IMF said. The sequester cuts for this year have had one beneficial outcome, cutting the fiscal deficit by a huge 2.5 percent, according to the report. But that is likely too much in a short period. "The deficit reduction in 2013 has been excessively rapid and ill-designed," it said. "A slower pace of deficit reduction would help the recovery at a time when monetary policy has limited room to support it further." Despite encouraging a looser fiscal stance now, and despite the narrowing of the fiscal gap, the IMF still warned that Washington needs to do more to address its longer term fiscal imbalances. With the economy picking up, gross US government debt was projected to peak at 110 percent of gross domestic product in 2015 and start to decline. "But the longer-term debt profile remains unsustainable," the report said. "Despite the slowdown in growth rates over the past few years, spending on major health-care programs and Social Security, absent additional reforms, is expected to increase by two percentage points over the next decade." That will cause the deficit to begin widening and start pushing the debt ratio back up. It suggested fundamental tax reforms as part of actions to confront the longer term fiscal shortfall, including eliminating many exemptions and loopholes, and introducing a value-added tax and a carbon tax. It credited the Federal Reserve's aggressive quantitative easing -- its $85 billion-a-month bond purchases, to hold down interest rates -- with keeping the economy on a sure footing as the government slashes spending. Lagarde said the Fed program merited holding in place through this year, noting that the US central bank was still not close to targets on reducing unemployment and on inflation to need to rein in the QE purchases. "We believe that the monetary policy has been necessary and helpful," she told a news conference. When, further down the road -- the IMF predicts early next year -- the Fed begins reducing its bond purchases and holdings to tighten policy, Lagarde urged extreme care in designing and communicating how it does that. "The unwinding when it comes should be very carefully managed," she said. The IMF report said the long period that interest rates have been held exceptionally low has complicated policy-making for emerging-market countries and has risks for the United States as well. Most important will be acute timing and "effective communication" in its strategy to begin gearing down the QE program. That will be critical to lower the risk of abrupt shifts and higher volatility in long-term interest rates "which could have adverse global implications," the IMF said.