International Monetary Fund Managing Director Dominique Strauss-Kaho has said that the global economy has made remarkable progress and now stands at the cusp of recovery.  However, he warned that it still remains  highly vulnerable to shocks and policy missteps. In a speech delivered at the Annual Conference of the Confederation of British Industries (CBI) in London, Mr Strauss-Kaho said policy makers stand at a critical juncture where the sustainability of the global recovery will depend on the decisions they make in the months to come.

“Today the storm has passed.  T he worst has been averted.  And yet the economy remains very much in holding pattern-stable, and getting better, but still highly vulnerable”, Mr Strauss-Kaho said.  For policymakers “the challenges are great” during the crisis, everyone was united by a common purpose.  Going forward, this might dissolve.  So the road ahead will be less clear cut.  We will need some debt  maneuvering, and perhaps some out-of-the-box thinking. We will certainly need continued collabora tion”, he added.

Mr Strauss-Kaho said policy makers will face  four main challenges, which include existing from accommodative policies, adapting to increasing capital flow to emerging market, developing a  new global grown modes, and designing and implementing financial sector reforms.

On exit strategies, Mr Strauss-Kaho stressed the importance of waiting for a sustained recovery in private demand, as well as clear indications of financial stability before accommodative measures are withdrawn.  “It is too early for a general exit.  We recommend erring on the side of caution, as exiting too late”, he said. Plans for fiscal consolidation should be the top priority, especially in advanced economies.  And monetary policy can afford to stay accommodative for some time, given little sign of inflation on  the horizone.

A related challenge to exit strategies is managing capital flows to emerging markets. “In many countries appreciation should be the key policy response other tools include lower interest rates, reserves accumulation, tighter fiscal policy, and financial sector prudential measures.  Capital  controls can be part of the package  of measures”, he said in his speech. “But we should recognize that all tools have their limitations.

we should be pragmatic”, he added.

Moving to the challenge of creating a new global growth model, Mr Strauss-Kaho said the old paradigm of growth generation based on household in the US was dead.  “If we are to have sustained global growth, somebody else needs to step into the breach.  The leading candidates are the surplus countries.  And we can see some shifts in the right direction.  China and other emerging Asian economies are shifting from exports to domestic demand.  But they have some way to go.

Mr Strauss-Kaho underscored the importance of forging ahead with a number of reforms to make the financial sector a more stable place.  He stressed the challenge posed to policy makers by increased risk taking in the financial sector while financial institutions are still in poor shape while regulators seek to impose tough new standards that may jeopardize recovery.

“How do we square the circle?  One possible answer is to reduce regulatory uncertainty.  It is throwing up some perverse incentive and might be encouraging a risk taking culture”, he said.  Also on addressing risk management in the financial sector, he added t hat it was essential to break the  link between risky behaviour and compensation. “In this cont- ext we have been asked by the G-20 to look into financial sector taxes.  There are a number of ways to think about this and we will look at it from various angles and consider all proposals he said.