WASHINGTON, May 28: The US economy has “solidified” over the past year and the outlook is favourable, but is relying on “unprecedented borrowing” from foreign sources, the International Monetary Fund said on Friday. The IMF staff’s latest report card on the US economy said it remains “the main locomotive of global growth,” outperforming the other Group of Seven industrialized.

The US economy should grow at a pace of around 3.5 per cent in the next two years as the expansion matures, the IMF report said.

“Over the past year, the expansion has solidified as robust productivity growth and high corporate profits have contributed to a strong rebound in business investment and an acceleration in employment,” the report said.

But it added that there is no sign that the large current account deficit will be reduced.

Returning to a familiar theme, the IMF staff said the low household savings rate and large federal budget deficit creates a number of vulnerabilities for the economy, including the possibility of a large slowdown of household spending especially if the housing market were to cool.

At the moment, foreign investment flows are taking the place of low US savings. But an abrupt shift in these flows could lead to higher interest rates and disorderly capital markets, the IMF staff warned.

“A record-low household saving rate and a large federal fiscal deficit are being supported by unprecedented borrowing from foreigners and domestic firms,” the IMF said.

“This unusual constellation of financial flows has sustained growth by keeping long-term interest rates low and stimulating house prices. However, this creates a number of vulnerabilities, including the possibility of a marked slowdown of household spending, particularly were the housing market to cool.”

A more detailed report on the US economy from the IMF will be written after the IMF executive board reviews and comments on the staff report. The IMF staff praised the Fed’s handling of monetary policy, saying that its “skilful communications strategy” has allowed a gradual pace of tightening.

The IMF said that reduced slack in the economy now implies a less benign inflation outlook. It said the Fed was right to warn financial markets in its May 3 statement that more forceful tightening might be required if price pressures continue to intensify. The staff repeated the IMF statement that the US administration’s plan to cut the deficit in half by fiscal year 2009 is welcome but not ambitious enough.

It said Washington should “explore options for revenue enhancements” and not just examine ways to simplify and improve the efficiency of the tax code in a revenue-neutral manner.—AFP

IMF economists also warned that President George W. Bush’s plan to let workers divert money into personal savings accounts as part of a proposal to overhaul the Society Security retirement program could push the deficits higher if enacted. The IMF assessment said the US current account deficit was likely to remain near its recent record high and warned there were limits to global demand for US assets.

America’s current account gap widened more than expected in the fourth quarter of 2004 to a record $187.9 billion, driving the full-year trade gap to new high of $665.9 billion, according to the government’s most recent estimates.

The current account is the broadest measure of US trade with the world, as it includes investments flows. Worries about the shortfall have contributed to the dollar’s three-year decline against the euro and a basket of currencies. The IMF cautioned that if investors’ appetite shifted from US assets, it could have adverse effects on interest rates and global capital markets.

“The challenge is to support the adjustment by stronger US national saving to avoid the burden falling on investment and growth, both in the United States and abroad,” IMF staff said.

They said tax reform should be part of the US effort to lower the deficits and backed legislated rules to enforce budget discipline. The IMF staff said they supported the gradual and flexible approach to monetary tightening by the US Federal Reserve.—AFP/Reuters