WASHINGTON - The global economy is in a holding pattern and vulnerable to more upheaval, the head of the IMF said on Monday, adding a lasting recovery will depend on policymakers taking the proper steps in the coming months.

Dominique Strauss-Kahn, the International Monetary Fund's managing director, said the top priority in rich countries should be making plans to clean up the fiscal mess left by more than a year of crisis-fighting efforts, although he thought it was still too early to remove such emergency supports.

We recommend erring on the side of caution, as exiting too early is costlier than exiting too late, Strauss-Kahn said in remarks prepared for delivery to the Confederation of British Industry's annual conference in London.

Since the financial crisis intensified following the messy collapse of Lehman Brothers (LEHMQ.PK) in September 2008, governments and central banks have committed trillions of dollars in stimulus money and financial sector guarantees as well as interest rate cuts to record lows in most advanced economies.

Those efforts helped to stem the crisis, he said.

So, we stand at a critical juncture, Strauss-Kahn said. The sustainability of this recovery will depend on the decisions taken by policymakers in the months to come.

He cautioned that the sense of global policy unity forged during the darkest days of the financial crisis might dissolve going forward, and urged close cooperation even though exit strategies differ from country to country.

For advanced economies, where debt burdens have grown sharply over the past year, the IMF wants governments to design and communicate plans to get their respective finances back in order.

That means ensuring stimulus measures are temporary and putting entitlement programs on a sustainable path. Eventually, more drastic measures will be necessary, Strauss-Kahn said, including spending cuts and -- in some cases -- tax hikes.

I see fewer problems with monetary policy, he said, adding that central banks had the proper tools to unwind the trillions of dollars worth of emergency lending programs they cobbled together in the midst of the financial panic.
Especially in many advanced economies, monetary policy can afford to stay accommodative for some time, given little sign of inflation on the horizon, he said. But some emerging economies face different challenges and monetary policy might need to move sooner.

Since emerging economies recovered more quickly from the global recession than industrialized economies did, capital flows have swelled, posing a threat to stability in some markets.

Strauss-Kahn said capital controls can be part of a package of measures that countries use to limit inflows, but cautioned that all tools have their limitations.

'MARDI GRAS EFFECT'

With unemployment high and rising in many countries, growth will probably be subdued for some time, and the crisis might remain etched in the collective memory, Strauss-Kahn said.

U.S. consumers, who were the driving force behind the last economic boom, will not return to their free-spending ways any time soon, so the world economy will need a new growth engine.

He said surplus countries, particularly China and other emerging Asian economies, were the leading candidates and had already begun shifting away from export-led growth. Still, he said they had some way to go, and urged China to allow its yuan currency to appreciate more rapidly.

By reducing global imbalances, the world will be a safer place, less prone to crises, he said. It will also be in China's long-term interest.

On financial reform, he said it was essential to put tougher rules in place to avoid a repeat of the crisis, but policymakers must take care not to clamp down too hard or too quickly because that could derail the recovery.
He suggested laying out future requirements and the timetable for implementation to reduce regulatory uncertainty, which might be inadvertently encouraging more risk-taking.

Strauss-Kahn described that as a Mardi Gras effect whereby financial institutions party now in expectation of lean times to come.

Clearly, this is dangerous, not least for emerging markets. And we may run out of time -- if we wait too long to implement these reforms, it might be too late, he said.

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