IMF warns eurozone to do more

Wednesday, 10 June 2009


The eurozone needs to do more to shore up its banking system in the wake of the financial crisis, the International Monetary Fund has warned in its annual health check of the European economy .

Whereas the US and UK governments have run stress tests and pushed banks to clear up their balance sheets, in the euro area authorities are criticised for failing to tackle blockages in the financial system.

“To secure recovery and a return to self-sustaining growth, policymakers need to take further decisive action, especially in the financial sector,” the IMF said in its Article IV assessment.

“A key missing element is a proactive strategy to deal with a weakened financial system, involving a review of capital needs to manage the recession, a cleansing of the financial system of its impaired assets, and a restructuring of weakened institutions.”

The Washington-based agency said economic data suggested a moderate decline in the eurozone economy that would give way to a “modest recovery” in the first half of next year.

However, it warned that the rebound “is likely to be slow and its shape and timing highly uncertain”. Unresolved financial problems, the solvency of some countries and the threat of negative feedback effects between economies could all present a drag to the recovery.

Analysts have been concerned that because bank lending is more important to the economies in the euro area than in the US and UK, which have been more dependant on the capital markets, a paralysed banking system could lead to a deeper credit crunch on the Continent.

Although eurozone countries had made strides towards dealing with their financial systems, the IMF said that “sizeable losses lie ahead as the recession unfolds.”

It criticised the “piecemeal approach” to the clean up and said that banks need to undergo stress tests that would assess their capital needs and viability, force them to reveal their impaired assets and restructure if necessary.

The IMF’s warning comes after members of the French Council of Economic Analysis and the German Council of Economic Experts warned in an article in the FT that the reluctance of European governments to conduct harmonised stress tests of their banks and publish the results is delaying economic recovery

On monetary policy, the IMF congratulated the European Central Bank for its “impressive response to the financial crisis” but said that “the supportive monetary stance now needs to be sustained”. In particular, it provided a counterweight to the harsh criticisms by Angela Merkel, the German chancellor, of loose and unconventional monetary policy at the ECB. “To deal with contingencies, all unconventional options ... will need to remain under consideration,” the IMF said.

But it warned of the need to make sure that fiscal policy returned to a sustainable path over the medium term. Proposed levels of discretionary spending were “broadly appropriate” in addition to the fiscal stimulus delivered by automatic rises in welfare spending and falls in tax revenies. However, “to address solvency concerns, short-term actions need to be embedded in credible medium-term consolidation programs,” the IMF said.


Courtesy: Financial Times