DUBAI (KT) -- The International Monetary Fund has forecast a slowdown in Middle East region's combined Gross Domestic Product (GDP) growth and current account surplus next year.

While real GDP growth in the Middle East, which is to reach 5.8 percent in 2006, will decline to 5.4 percent in 2007, the current account surplus will start declining in 2007, the IMF said in its World Economic Outlook. The current account surplus is projected to rise further to 23 percent of GDP in 2006 to around $280 billion.

However, the regional GDP forecast is 14 percent better than the 5.1 percent growth predicted for the global economy in 2006 and 10 percent above the 4.9 percent global forecast for 2007.

"With continued prudent financial policies and little growth in oil production, GDP growth is expected to moderate slightly to 5.5 percent in 2007," the report said.

IMF said with non-oil sector growth running at eight percent, inflation has begun to pick up, although it remains generally well contained by the combination of pegged exchange rates, open product and labor markets, a low global inflation. Equity markets in the region faced major corrections in early 2006 — prices fell by some 25 to 35 percent from their peaks— but so far, financial stability has been preserved and the macroeconomic impact is likely to be contained, it said. "With many oil exporters in the region pegging their currencies to the US dollar, inflation will inevitably rise somewhat with higher expenditure, as prices of locally produced goods and services will increase compared to those traded internationally. However, if expenditure increases are appropriately aligned with macroeconomic conditions and are accompanied by structural reforms, any pick-up in inflation should remain contained and temporary."

However, in contrast to the generally low inflation in the region, inflation is running at about 12 percent in Iran, reflecting the combination of rising government expenditure and expansionary monetary policy. With monetary control hampered by multiple, internally inconsistent policy objectives and limited operational autonomy of the central bank, some fiscal policy tightening will be required to reduce inflation, with additional support from greater exchange rate flexibility.

According to the report, near-term prospects for oil exporters are generally more propitious than for non-oil exporters in the Mashreq (Egypt, Syria, Jordan and Lebanon) which account for about 20 percent of regional GDP.

"On the upside, surging oil revenues could provide for higher government expenditure, while possible further corrections in some still richly valued asset prices are a downside risk. For the non-oil exporters, the external balance implications of the large terms-of-trade losses add an element of vulnerability to the outlook. Finally, geopolitical risks remain a serious concern," the report said.

"However, the central policy challenge for the oil-exporting countries remains managing booming oil revenues. Most countries have appropriately begun to use the opportunity provided by higher revenues to increase spending to address long-standing structural problems, in particular the need to generate employment for the rapidly growing working-age population and to boost infrastructure and human capital development.

In addition, national oil companies in the region have developed plans for ambitious capacity expansion and are ratcheting up investment," the IMF report said. "At the current juncture, there seems ample scope for this buildup of spending, given high unemployment in many countries and still low inflation, although with continued rapid credit growth, the risks of overheating need to be carefully monitored." Cautioning on the prudential risks in the financial sector, the report said with oil export proceeds partly flowing into the domestic banking system and substantial net capital flows to non-oil exporters, broad money and credit growth have accelerated sharply in many countries over the past three years and remain very high. "At the same time, the favorable oil market outlook and buoyant investor confidence have underpinned large increases in equity and property prices relative to GDP in 2004-05, even though some of these gains were reversed in the first half of 2006. This combination has raised concerns about increased leverage in private sector balance sheets, including in the household sector, rising financial sector exposure to asset price corrections, and a possible deterioration in credit quality." IMF said the region's central banks need to monitor such risks carefully and ensure adequate prudential standards. "At the same time, reforms aimed at improving market liquidity and transparency will help to reduce asset price volatility that is not related to fundamentals. The recent lifting of restrictions in equity markets for foreign investors in Saudi Arabia was a welcome step in this regard."

The IMF cut its 2007 growth forecast for the U.S. to 2.9 percent from 3.3 percent, the weakest since 2003. China's economy will expand 10 percent in 2006, its fourth straight year of double-digit growth. It also raised its forecast for India to 8.3 percent this year, from a 7.3 percent estimate in April. The Indian economy grew 8.5 percent in 2005.