Eurozone facing crisis that may stall recovery
THE eurozone is facing a severe crisis that may stall recovery in the 16-nation monetary union, leading to persistent unemployment and subdued investment, the International Monetary Fund (IMF) says in its latest analysis.
The IMF said "decisive action" is needed after euro governments failed to respond to the global crash, or in some cases pursued inappropriate stimulus policies.
"Consequently, divergences in economic performance have been allowed to fester, building up imbalances and leading to the recent dramatic wake-up call from markets," the report stated.
It called for more transparency in the Eu banking stress tests.
"There should be a more detailed disclosure of inputs and outcomes, possibly at the institution level," the IMF stated and the transparent use of stress tests should be applied beyond the largest institutions.
The official response to the sovereign debt crisis, which has seen penal interest rates on Greek debt, and expensive ones for Ireland, Portugal and Spain, has been much better, the IMF analysts said.
But spillovers into the banking system from the government debt crisis have increased market and credit risk, and could fuel the adverse feedback loop between the banking system and public finances.
That could lead to a sharp rise in risk premiums and a "disorderly depreciation" of the euro.
Eurozone officials told the IMF that with the "bailout" European Stability Mechanism now in place, such a disorderly scenario could be avoided.
But they agreed with the IMF analysts that there was a "distinct possibility" of a prolonged period of stagnation, with lacklustre demand, low inflation and high public debt.
"Credible fiscal adjustment must be at the core of the response," the IMF said.
"Countries facing market pressures have no option but to adjust forcefully and meet their deficit targets."
Countries' budget corrections should vary according to the degree of market pressure they are under, but fiscal consolidation will start everywhere by 2011 at the latest.
"The quality and composition of fiscal consolidation will be important to support the recovery as much as possible, with reforms to entitlements (such as welfare and pensions) featuring prominently."
Banks that remain overly reliant on central banks' funds or other government support should be forced to recapitalise, restructure, or face being wound down, but the report does not advocate immediate withdrawal of support.
"Blanket financial support measures may need to be reinstated or extended, though care should be taken that they do not put off the urgency to restructure," it stated.
The IMF praised the ECB for its actions, and said it had "remained an anchor of stability" but urged it to be cautious about raising interest rates.
The IMF believed controversial EU proposals for monitoring national budgets do not go far enough.
"The focus should be on enforcing budgetary discipline, helped by fundamental legislative reform, including at the national level."