The fund projected the world will grow by 4.6 percent, up from its 4.2 percent forecast in April, reflecting "stronger activity" during the first half of 2010 and expectations of fiscal action, especially in Europe.

The higher forecast was due to "expectations of a modest but steady recovery in most advanced economies and strong growth in many emerging and developing economies," the Washington-based International Monetary Fund said.

It maintained its 2011 growth forecast at 4.3 percent in an update of its World Economic Outlook projections.

The fund however warned that "downside risks have risen sharply amid renewed financial turbulence" sparked by a severe Greek budget crisis that threatened to spread across the eurozone.

"Looking forward, strong clouds have appeared on the horizon," Olivier Blanchard, economic counsellor of the IMF, told a press conference in Hong Kong.

A potential spill-over of sovereign risk to European banking sectors and fiscal policy challenges "give us reasons to be less optimistic than we were three months ago," he said.

In the near term, the main risk was an escalation of financial stress and contagion prompted by rising concerns at sovereign risk -- the prospect of governments reneging on borrowing terms, the report said.

This could lead to additional increases in funding costs and weaker bank balance sheets that induce tighter lending conditions, declining business and consumer confidence and abrupt changes in exchange rates, the IMF said.

"At this juncture, the potential dampening effect on growth of recent financial stress is highly uncertain," it said, adding that so far, there was "little evidence of negative spill-overs to real activity at a global level."

The new economic forecasts hinged on implementation of policies to rebuild confidence and stability, particularly in the eurozone, the report said.

The IMF called on advanced economies to focus on "credible fiscal consolidation" supported by accommodative monetary conditions and financial sector and other reforms to enhance growth and competitiveness.

Emerging economies, on the other hand, were urged to implement structural reforms and, in some cases, greater exchange rate flexibility -- an apparent echo of international calls for China to allow its yuan currency to trade more freely.

Downside risks to growth in advanced economies could also "complicate macroeconomic management" in some of the larger, fast-growing economies in emerging Asia and Latin America, which faced some "risk of overheating," the IMF said.

"Against this uncertain backdrop, the overarching policy challenge is to restore financial market confidence without choking the recovery," it said.

But Blanchard said the recent decrease of capital flows and repatriation of funds to emerging markets would only be short-term.

"We expect this decrease and reversal to be temporary. The future will be a trend of strong capital flows to emerging markets."

In 2010, the United States, the world's largest economy, was expected to grow by 3.3 percent, the eurozone by 1.0 percent and developing Asia by 9.2 percent.

China and India were forecast to lead Asian growth with rates of 10.5 percent and 9.4 percent respectively.

In Latin America, Brazil is expected to spearhead growth at 7.1 percent and Mexico at 4.5 percent.

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