THE world faces a "lost year" of growth that could spark a fresh crisis as investors start to lose faith in policymakers' ability to revive the global economy, according to the International Monetary Fund.
In its bluntest warning to date on the costs of policy inaction, the IMF said "financial and economic stagnation" could take hold unless governments prevented a "pernicious feedback loop of fragile confidence, weaker growth, low inflation and rising debt burdens" from forming.
Jose Vinals, the head of the IMF's financial stability division, said a prolonged slowdown could knock around 4pc off global output relative to current expectations over five years amid repeated bouts of market turmoil.
"This would be roughly equivalent to forgoing one year of global growth, he said at the launch of the IMF's global financial stability report.
Mr Vinals said more "potent" fiscal and structural policies could add the equivalent of half a year of output.
"We could either lose a full year, or gain half an additional year of economic growth at a global level. In a world where there is still so much unemployment and where economic growth is still weak, they cannot afford to forgo this opportunity."
It came as a separate IMF report laid bare the challenges facing governments. The fund said public finances had "worsened significantly" over the past year as it revised up its public debt share projections in most countries over the next two years, including the UK.
The IMF's Fiscal Monitor said urgent action was needed to stop the global economy from slipping into a "downward spiral".
Staff warned that borrowing had also been higher than expected, with emerging market deficit ratios in 2015-16 now expected to exceed the levels seen at the start of the 2008 global financial crisis.
Speaking yesterday, Mr Vinals said a $1.3?trillion (pounds 912bn) corporate debt time bomb in China also posed "potentially serious challenges" to financial stability if defaults pushed banks over the edge.
The IMF warned that a "loss of market confidence" would drag global bourses into a bear market.
Under this scenario, stocks in the UK, US, eurozone and China would lose a fifth of their value over two years, it estimated.
The triple threat of slower growth, rising risks from China and diminished faith in policymakers' ability to prevent a fresh downturn meant households and businesses were likely to save more and spend less in the uncertain global environment.
Economic powerhouses such as China and India would see output losses of more than 4pc by 2021 compared with current IMF forecasts, it said.