The International Monetary Fund is boosting its GDP growth estimates for the global economy, but warns that downside risks are on the rise.

In its economic outlook report released Thursday, the IMF projects world growth for 2010 will be 4.5%, up about 50 basis points from its April projection. The IMF says the revision reflects strong activity in the first half, particularly in Asia. It is also maintaining its call of 4.25% growth in 2011.

However, even as it raises its forecast, the IMF warns that downside risks “have risen sharply”, and so these new forecasts “hinge on implementation of policies to rebuild confidence and stability, particularly in the euro area.”

For Canada, the IMF has bumped up its call for 2010 growth by 50 bps to 3.6%, but has dropped its 2011 forecast by 40 bps to 2.8%. Overall, output in advanced economies is now expected to expand by 2.5% this year, which is also an upward revision; although it now sees lower growth in the second half due to financial turbulence. For 2011, growth in advanced economies remains broadly unchanged from its previous prediction, at 2.5%.

Overall the IMF says that its forecast “continues to be consistent with a modest recovery in advanced economies, albeit with substantial differentiation among them. Challenging the recovery in these economies are high levels of public debt, unemployment, and in some cases, constrained bank lending.”

Indeed, it notes that downside risks have risen sharply. “In the near term, the main risk is an escalation of financial stress and contagion, prompted by rising concern over sovereign risk. This could lead to additional increases in funding costs and weaker bank balance sheets and hence to tighter lending conditions, declining business and consumer confidence, and abrupt changes in relative exchange rates,” it says.

Additionally, it warns that the growth prospects of advanced economies, “could suffer if an overly severe or poorly planned fiscal consolidation stifles still-weak domestic demand”. It also warns that uncertainty about regulatory reforms in the financial sector, and their potential impact on bank lending and economy-wide activity, is another significant concern. And, another downside risk is the possibility of renewed weakness in the U.S. real estate market.

Policy efforts in advanced economies, the IMF counsels, “should focus on credible fiscal consolidation”, along with continued accommodative monetary conditions, financial sector reform, and structural reforms to enhance growth and competitiveness. And, it says that policies in emerging economies should also help rebalance global demand.

In terms of financial sector reform, the IMF says that in many advanced economies, “more progress is needed on bank recapitalization; bank consolidation, resolution, and restructuring; and regulatory reform. In some cases, larger capital buffers are required to absorb the ongoing and potential future deterioration in credit quality and to meet expected higher capital standards.”

Greater transparency is also a priority, it says. And it calls for policymakers to pick up the pace on other planned reforms to reduce uncertainty about the regulatory environment.

IE