The world economy is entering a major downturn in the face of the most severe financial shock in mature financial markets since the 1930s. Global growth is projected to slow substantially in 2008, and a modest recovery would only begin later in 2009. Inflation is high, driven by a surge in commodity prices, but is expected to moderate. The situation is exceptionally uncertain and subject to considerable downside risks. The immediate policy challenge is to stabilise financial conditions, while nursing economies through a period of slow activity and keeping inflation under control. Many advanced economies are close to or moving into recession, while growth in emerging economies is also weakening.
The financial crisis that first erupted with the US sub-prime mortgage collapse in August 2007 deepened further in the past six months and entered a tumultuous new phase in September this year. The impact has been felt across the global financial system, including in emerging markets to increasing extent. Intensifying solvency concerns have led to emergency resolutions of major US and European financial institutions and have badly shaken confidence.
Against this backdrop, the baseline growth projections have been marked down by 20 basis points for 2008 and a sharper 90 basis points for 2009, relative to the July 2008 WEO Update. Global growth is now expected to moderate from 5.0 per cent in 2007 to 3.9 per cent in 2008 and 3.0 per cent in 2009, its slowest pace since 2002. The advanced economies would be in or close to recession in the second half of 2008 and early 2009, and the anticipated recovery later in 2009 will be exceptionally gradual. Growth in most emerging and developing economies would decelerate below trend. On the inflation front, the combination of rising slack and stabilising commodity prices is expected to contain the pace of price increases, bringing inflation back to below 2 per cent in 2009 in advanced economies. In emerging and developing economies, inflation would ebb more gradually, as recent commodity price increases continue to feed through to consumers.
The principal downward risk revolves around two related financial concerns: that financial stress could remain very high and that credit constraints from deleveraging could be deeper and more protracted than envisaged in the baseline. Inflation risks to growth are now more balanced because commodity prices have retreated as the global economy slows.

Turbulent markets
While extraordinary measures have been taken by US and European authorities for stabilising markets, including massive liquidity provisions, prompt intervention to resolve weak institutions, extension of deposit insurance etc., financial conditions are likely to remain very difficult and restrain global growth prospects. Financial institutions' ability to raise new capital will remain challenged and de-leveraging will continue to be a protracted process, implying that limits on the pace of credit creation-and on activity-will be present at least through 2009.
Policymakers around the world face the daunting task of stabilising financial conditions while simultaneously nursing their economies through a period of slower growth and containing inflation. In an increasing number of emerging and developing economies, the balance of risks has now shifted toward concern about slowing activity as external conditions deteriorate and headline inflation starts to moderate. This shift would justify a halt to the monetary policy tightening cycle, particularly where second-round effects on inflation from commodity prices have been limited. Countries with heavily managed exchange rate regimes are facing significant challenges in managing monetary adjustment. Greater restraint in public
spending could help ease inflation pressures in a number of countries still facing overheating concerns. This is particularly important for current account deficit countries with pegged exchange rates.
Nonetheless, several factors are expected to help gradual recovery in 2009:
u Commodity prices are projected to stabilise, albeit at 20-year highs.
u The US housing sector is expected to finally reach bottom in the coming year, ending the intense drag on growth that has been present since 2006.
u Notwithstanding cooling of momentum, emerging economies are still expected to provide a source of resilience, benefiting from strong productivity growth and improved policy frameworks. Of course, the longer the financial crisis lasts, the more they are likely to be affected.
The WEO also notes the possibility of global de-leveraging reducing the availability of external financing for emerging economies. In fact, many econo-mies with large current account deficits have already experienced a much greater impact from the financial market turmoil than those with small current account deficits or surpluses.