LONDON (MarketWatch) — The International Monetary Fund on Thursday said additional “bold steps” are needed to tackle the euro zone’s sovereign debt crisis.
“Unrelenting reform efforts at the national level of the crisis-afflicted countries need to be the first line of defense,” the IMF said in its twice-yearly Regional Economic Outlook for Europe. “Restoring fiscal health, squarely addressing weak banks, and implementing structural reforms to restore competitiveness are key.”
Greece — new deal in the works?
Greece expects that a June audit of its budgets will show that a new financial-aid package of nearly $86 billion will be needed to cover its financial needs stretching into 2013. The euro has fallen sharply since late last week as worries about Greece’s ability to rein in its public finances mounted, despite last year’s 110 billion euro ($156.2 billion) bailout from the IMF and European Union. The euro /quotes/comstock/21o!x:seurusd EURUSD -0.37% traded at $1.4183 versus the dollar, down 0.2% from Wednesday.
Ireland and Portugal were also forced to seek bailouts.
The IMF said policy responses to the crisis have successfully contained sovereign-debt and financial-sector troubles to the periphery of the euro zone so far, “but contagion to the core euro area, and then onward to emerging Europe, remains a tangible downside risk.”
The IMF said fiscal consolidation and the repair of bank balance sheets are crucial to defusing downside risks, while moving to public debt sustainability is vital to easing financial tensions in the euro zone and breaking negative feedback loops between banks and sovereign debt.
Crisis-hit countries must see through their plans for "front-loaded” fiscal adjustments, while other countries can afford to phase in gradually their fiscal consolidation.
The IMF also appeared to urge the European Central Bank to go slow in raising interest rates.
“Monetary policy in the euro area can afford to remain relatively accommodative, though normalization lies ahead as economic slack gradually dissipates,” the report said, while observing that re-emerging inflation risks “pose an additional challenge.”
The IMF also raised a warning flag over banks’ increasing reliance on funding from the ECB, which it said has become entrenched for a number of second-tier banks in large European countries as well as nearly all banks in Greece, Ireland and Portugal and some small and mid-sized Spanish savings banks.
“With liquidity pressures remaining acute, a negative shock could rapidly spill over through the periphery and potentially beyond,” the report said. “Despite some reduction during the last year, cross-border exposures remain sizable and concentrated within euro-area creditor countries.”
The IMF said financial integration in European Union banking markets remains incomplete and should be accelerated and lamented that cross-border mergers and acquisitions remain limited.
“This is unfortunate because deeper financial integration carries the potential to alleviate some of the current banking-sector weaknesses, allowing, in particular, for the injection of fresh capital in circumstances where domestic sources are constrained,” the report said.
