This note, prepared ahead of the G20 Summit (November 15), builds upon the points laid out in the Managing Director’s letter to the Heads of State and Government (November 9). It lays out two tasks ahead for policymakers. Policies, for now, should cover: (i) implementing and coordinating policies to sustain demand; (ii) providing liquidity support to emerging economies; and (iii) protecting low-income countries. Longer-term reforms of the financial architecture should touch upon: (i) the design of financial regulation; (ii) a better way of assessing systemic risk; and (iii) mechanisms for more effective actions for crisis prevention and resolution. Global economic prospects have deteriorated further over the past month as the global financial crisis took a sharp turn for the worse. The financial crisis has undermined consumer and business confidence, triggering a sharp decline in domestic demand. Momentum continues to drop, with activity cooling further in the third quarter and confidence indicators for October falling to levels not seen in decades. In financial markets, despite the adoption of bold and comprehensive policy measures by major advanced economies, funding markets remain strained, reflecting the deep shock to confidence in counterparties. Deleveraging and forced asset sales continue unabated. These difficult financial conditions coupled with the slump in economic activity portend sharp increases in corporate defaults in advanced economies.

Emerging economies have also come under severe strain, as seen in rising spreads on sovereign and corporate debt and serious pressures on exchange rates. Given present policies, the world economy is projected to grow by 2¼ percent in 2009, down by some ¾ percentage points from the IMF’s projection in last month’s World Economic Outlook. This sharp slowdown in global activity is led by advanced economies, many of which are in or close to recession, with output projected to contract on an annual average basis in 2009, an outcome not seen since the 1970s. Growth in emerging economies is also slowing sharply, reflecting weakening global growth prospects and an abrupt reversal of capital inflows, although it is still projected to reach 5 percent in 2009. On the positive side, headline inflation is now receding rapidly across advanced and most emerging economies amid cooling activity and declining commodity prices. This has opened room for monetary policy responses, although deflation risks are starting to become a concern in some advanced economies.