The IMF urged EU policymakers to deepen the financial and fiscal ties within the eurozone with some urgency to restore sagging confidence in the global financial system.
In its semi-annual check on the world’s financial health, the IMF said the eurozone’s debt crisis was the main threat and the risks to global financial stability had risen in the past six months, leaving confidence “very fragile.”
The eurozone’s plodding progress means European banks are likely to offload US$2.8 trillion in assets over two years to cut their risk exposure, an increase of US$200 billion from a prediction six months ago, the IMF estimated. That could shrink credit supply in the periphery by 9 percent by the end of next year, crimping economic growth.
“Despite many important steps already taken by policymakers, this agenda remains critically incomplete, exposing the euro area to a downward spiral of capital flight, breakup fears and economic decline,” the IMF said in its Global Financial Stability Report, released yesterday.
Jose Vinals, director of the IMF’s monetary and capital markets department and the main author of the financial stability report, said Europe’s troubles should serve as a lesson to the heavily indebted US and Japan that delaying the necessary policy adjustments until markets force their hands would lead to “harsher economic outcomes.”
“We should not let the current market conditions, which have improved, lead to a false sense of security,” Vinals said in a press briefing.
The report adds to the gloomy backdrop ahead of the IMF’s semi-annual meeting to be held in Tokyo later this week. On Tuesday, the IMF said the global economic slowdown was worsening as it cut its growth forecasts for the second time since April and warned US and European policymakers that failure to fix their economic ills would prolong the slump.
Risks from the eurozone could also spill into emerging markets, where growth is already slowing. Countries in central and eastern Europe are the most vulnerable to financial shocks, given their exposure to the eurozone and their own entrenched external debts, the report said.
And while the US and Japan have benefited from safe-haven flows away from the eurozone, the IMF said both countries need to do more to reduce their fiscal burdens in the medium term.
The US faces a so-called “fiscal cliff” — government spending cuts and tax rises due to take effect early next year. Japan is carrying the biggest public debt burden among leading industrialized nations at twice the size of its US$5 trillion economy at a time when its social welfare spending is under constant pressure from a rapidly aging population.
“The choice today is between making the necessary, but tough policy and political decisions or delaying them — once more — in the false hope that time is on our side,” Vinals said. “It is not.”