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War threatens world economy { March 27 2003 }

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March 27, 2003
War Threatens Economic Recovery, I.M.F. Says

Financial uncertainties related to the Iraqi war threaten to stymie a nascent global economic recovery, the International Monetary Fund said in a semiannual report released today.

Horst Koehler, the I.M.F.'s managing director, also told the German magazine WirtschaftsWoche in an interview published today that "a global economic recession cannot be ruled out" if the Iraqi war proves to be a prolonged engagement.

The I.M.F., a Washington-based agency that advises its 194 member countries on monetary policy and is a lender of last resort for developing economies, noted in its report that international financial markets were less risky than they were about six months ago. But it tempered this view with a warning.

"Normally, this would suggest the potential for a rebound in the economy and financial markets once investor sentiment turns," the report said. "However, this potential is currently overshadowed by the intensified uncertainty about the prospect of war in Iraq and its repercussions on growth and stability."

Specifically, the I.M.F. cautioned that the Iraqi war might lead to higher oil prices, anemic economic growth and depressed investor and consumer confidence, all combining to "reinforce the headwind against global economic recovery."

Some businesses say they have already begun to feel the impact of the Iraqi war and weaker consumer confidence.

"We are seeing reticence on the part of customers," Peter Hartz, a member of Volkswagen's board of management, said today in a written statement. "We're going to be facing some difficult times."

Global financial markets have seesawed in the last week, rising at first on initial expectations that the American-led invasion of Iraq would lead to a quick victory and diminish uncertainty about oil supplies. Then, as coalition forces became bogged down in sandstorms and met resistance from Iraqi soldiers, stock markets in the United States and Europe sank on the growing belief that the war would last much longer than initially anticipated.

On Wall Street today, stocks were little changed in afternoon trading; the Dow Jones industrial average was down 5.68 points, or 0.07 percent, at 8,224.20.

Overseas, Britain's FTSE closed down 64 points, or 1.7 percent, to 3,729.10; Hong Kong's Hang Seng fell 174.77 points, or 1.93 percent, to 8,872.32; and Germany's DAX rose 4.72 points, or 0.18 percent, to 2,584.05.

"While markets may have priced in a short and decisive war, any departure from this scenario could weaken confidence further," the I.M.F. said in its Global Financial Stability Report. "Moreover, markets may have not yet focused on the possibility that uncertainty could persist for some time.

"Uncertainty could also persist despite a short and decisive military conflict owing to the potential for continued geopolitical instability and tangible threats of terrorism," the report added.

Prior to the Iraqi war, the United States economy was already showing signs of slowing from levels reached last fall. The Commerce Department said today that real gross domestic product the output of goods and services produced by labor and property located in the United States rose at a revised annual rate of 1.4 percent in the fourth quarter of 2002. Real G.D.P. in the United States rose by 4 percent in the third quarter.

The I.M.F. said that a weakened dollar, which has fallen in value by about 20 percent against the euro over the last year, poses a threat if it falls precipitously in coming months. A weak dollar makes United States exports less expensive, threatening export-driven economies elsewhere in the world that rely on selling competing products.

Europe's insurance industry, as well as German and Japanese banks, received special attention in the I.M.F. report. The agency said all three sectors needed to address fundamental weaknesses in their structures. Europe's insurers need to be more effectively regulated and policed for risk management practices, Japanese banks need to address a lingering bad debt problem, and German banks need to consolidate, the report advised.

In emerging markets, countries like Brazil and Turkey face difficulty accessing funds in a weakened global economy, the I.M.F. noted, raising the specter of inflation and large debt defaults.

At the consumer level, the I.M.F. said that defined-benefit pensions in the United States, Britain, the Netherlands and Japan were "experiencing sizable funding gaps" because of corporations' overdependence on asset gains tied to the once-booming stock market of the 1990's. Not only will this affect retirees, but it will also dampen corporate profits in the future as companies are required to divert larger sums into pension funds to close funding gaps.

"Subject to geopolitical developments, the improvement of confidence could best be achieved through continued sound macroeconomic policies and a flexible response to renewed signs of an economic downturn," the I.M.F. advised in its report, taking note of repeated corporate scandals at United States companies like Enron. "It will also require the consistent implementation of steps to address the deficiencies in corporate governance, financial market practices and accounting standards, which were starkly revealed with the bursting of the asset price bubble."

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