Morgan Stanley chief economist Stephen Roach unveiled his 2007 forecast today and enumerated five chief risks to his outlook.

Roach’s forecast calls for a 3.8% increase in world GDP growth in 2007 — down slightly from an upwardly revised 4.1% increase for 2006 (versus its previous estimate of 3.8%). “On the surface, these are pretty impressive numbers for the world economy — slightly above trend (an average of 3.7% world GDP growth since 1970) and well above the global recession threshold (2.5%). If this forecast comes to pass, it would mark five consecutive years of above-trend growth for the world economy — the longest stretch of global vigor since the late 1980s,” he says.

Within the developed world, he says it sees slowing in European growth from 2.2% in 2006 to 1.8% in 2007, with the US slipping from 3.8% in 2006 to 3.5% in 2007, and Japan from 2.5% in 2006 to 2.3% in 2007. “In the developing world, the biggest shift is an upgrade to our 2006 Chinese growth forecast from 6.7% to 7.8%; while this would still represent a significant downshift from average gains of 9.5% over the 2003-05 period, it is certainly not as draconian a slowdown as we had been expecting,” he adds. “We also look for growth in India to slow somewhat to an average of 6.6% over the 2006-07 interval — impressive gains by most standards but down from the heady 7%-plus pace of 2003-04 and the 8% annualized increase just recorded in late 2005. Elsewhere in the developing world — Asia, Latin America, and Emerging Europe — we see growth in 2006-07 averaging close to the above-trend 2005 pace.”

The five big risks he sees to the baseline outlook are: global rebalancing; a slowdown in China; weakness in the American consumer; weakness in the US dollar; and, damage to central bankers’ credibility.

Roach admits that it blew a call for China to slowdown this year, but says he sees signs of it happening now as lending tightens. “Given China’s outsize claim on global resource demand, such an investment slowdown could also lead to surprising drops in oil and other industrial commodity prices,” he notes.

He also suggests that the days of open-ended US consumption are drawing to a close — sooner rather than later. “While a surging dollar could well be supported by a powerful momentum trade for a while longer, my advice is to watch out for a reversal in early 2006,” he adds.

“I suspect central bank credibility will meet a stern test in 2006 — typically a tough development for financial markets,” Roach notes.

But, global imbalances remain the biggest overall risk, he says.”It is an outgrowth of the excesses of the world’s two main growth engines — the American consumer on the demand side and the Chinese producer on the supply side. It also reflects the persistence of subpar growth in the rest of the developed world and lack of autonomous support from internal demand in the export-led developing world. And it reflects the increasingly precarious asymmetrical distribution of the world’s external imbalances — a record US current-account gap that accounts for 70% of the world’s total external deficits juxtaposed against a far more broadly diffused distribution of surpluses,” he explains.

“Global imbalances have, of course, been building for years, and the longer they continue to fester without major financial market consequences, the greater the conviction this state of disequilibrium is sustainable,” Roach says. “However, with America’s current account deficit likely to widen further over the next year while at the same time the three largest surpluses — Japan, Germany, and China — start to shrink, I believe the presumption of sustainability will be drawn into serious question in 2006.”

“As I look to 2006-07, I see the downside risks outweighing those on the upside by a factor of two to one. Specifically, I think there is a much greater chance that world GDP growth could slip back into the 2.5% to 3.0% danger zone rather than cruise at or above our nearly 4% projection. As 2005 draws to a close, ever frothy financial markets are in the process of discounting an increasingly sweet macro scenario that bears a striking resemblance to our baseline view of the world. If my risk assessment is correct, financial markets could be in for a rude awakening,” he concludes.