IMF lifts forecast but debt worries remain

The International Monetary Fund (IMF) lifted its forecast for the global economy by 0.3 percentage points to 4.2% for 2010, noting that activity so far this year is coming in at a pace that has been better than expected.

Emerging and developing economies are leading the pack, with China expected to see GDP soar by 10.0% this year followed by India at 8.8%. Growth in the U.S. is forecast to be much more modest, at 3.1%, while Europe and Japan lag behind.

The IMF pointed out that "a global depression has been averted," but it warned that the outlook remains "unusually uncertain." The banking system is still fragile, the IMF said, while it aimed its biggest concerns at advanced economies who have taken on large debt in order to bailout large financial institutions and prop up aggregate demand.

The increase in sovereign risk could hit the banking system and the real economy, the IMF warned. And if nervous investors worried about long-run government solvency cause a decline in sovereign (or government) bond prices in the advanced economies, still-recovering banks, which are major investors in government debt, could face new hits to the value of assets on their balance sheets.

There is still time to deal with exploding government debt levels in the U.S. and now is not the time to begin draconian fiscal cutbacks, as the U.S. unemployment rate remains stubbornly high. However, politicians must consider ways to pare back programs, even popular ones, or risk an even bigger meltdown in the future.