OTTAWA (Reuters) - Canada took a gloomy look at what could go wrong with the global economy on Thursday, warning of prolonged recession or a new debt-driven crisis unless countries push ahead with promised reforms.
In a discussion paper for a meeting of officials from the Group of 20 industrialized and emerging nations, Canada highlighted likely problems if countries like China maintained fixed exchange rates, or if G20 nations stalled on economic and financial reforms agreed at a 2009 summit in Pittsburgh.
If the world returns to its pre-crisis normal, the lack of change could bring unsustainable debt levels, higher interest rates and another crisis, the document said.
But if rich countries rein in budget deficits and emerging markets don't take up the spending slack, there would be deflation and recession.
"Advanced countries need to engage in fiscal consolidation over the medium term, but we also need the cooperation of emerging market economies," the paper said.
The Pittsburgh summit agreed that the G20 would become the main agent of reform, but the grouping is new and it is unclear how much it can achieve. China, a key member, is under growing international pressure abandon its fixed currency peg, which has helped it run up a huge trade surplus.
The Canadian discussion paper did not mention China by name. But it outlined a scenario where rich countries cut deficits, but emerging markets neither let their currencies float, nor encourage their own consumers to spend more.
"In such a scenario, a deflationary spiral sets in... By 2011, deflation would occur in advanced countries, real interest rates would increase sharply, and growth would stall," said the paper, which was obtained by Reuters.
"Global imbalances would effectively be eliminated, but at the cost of a prolonged world recession."
The G20 officials are holding two days of closed-door meetings in the Canadian capital Ottawa where they will help prepare the ground for a G20 summit in Toronto in June.
A senior G20 diplomat said that while the yuan was not on the formal agenda of the Ottawa meeting, the Chinese currency could be discussed on the sidelines.
"Could you really talk about financial sector reform, this framework for balanced growth, without talking about those kinds of currency issues?" the diplomat told Reuters.
Canadian Prime Minister Stephen Harper took the rare step of personally addressing Thursday's meeting, urging countries keep stimulus funds flowing because the world economic recovery is still not fully assured. His comments were televised.
The paper said world economic output could grow 3.6 percent in 2010 and 4.5 percent in 2011 if reforms went through. Without reform, growth could fall to 2.7 percent by 2013.
A diplomat from another G20 nation said Canada wanted the June summit to agree on the need for a global rebalancing. This would be translated into policy actions at a second summit in Seoul in November.
The diplomat noted Harper's decision not to mention currency manipulation on Thursday. "The Chinese would just take that as proof they are being singled out," he told Reuters.
Editing by Janet Guttsman