IMF warns of continued risks to world economy

By Dow Jones Newswires
Posted Oct. 5, 2010 at 8:10 a.m.

Risks to financial stability remain elevated due to a combination of slow global growth, high sovereign debt burdens and continuing weakness in the banking sector, the International Monetary Fund warned in a report released Tuesday.

In a report published during its annual meetings in Washington, the IMF highlighted persistent risks to the banking system from high debt levels in mature economies and resulting tensions on sovereign bond markets, particularly in Europe.

“Policymakers in many advanced countries will need to confront the interactions created by slow growth, rising sovereign debt indebtedness and still-fragile financial institutions,” the IMF said.

Despite lowering the estimated cost of the global financial meltdown to the banking sector to $2.2 trillion between 2007 and 2010 from $2.3 trillion due to a decline in securities losses, the IMF noted progress toward financial stability has suffered a setback since its report in April, citing the the public finances crisis in Europe. “The financial turmoil that engulfed parts of the euro area in April-May provided a stark reminder of the close linkages between sovereign risk and the financial system.”

Credit woes in Europe have prompted governments to put in place tough debt reduction programs, which has heightened risks to the global growth outlook, the IMF said. It added the global recovery is losing steam after a better-than-expected start to 2010.

Deteriorating growth prospects could also put an additional strain on the ability of some countries to refinance their debt, the IMF cautioned. “Sovereign balance sheets are highly vulnerable to growth shocks, making debt sustainability less certain,” the IMF said.

Sovereign bond markets have remained skittish in recent weeks as investors have questioned the ability of certain peripheral European countries such as Spain, Portugal or Ireland to enact harsh budget cuts needed to reduce their debt load.

In the current context of uncertainties, the IMF said extraordinary support measures for the banking sector, as well as non-standard monetary policy, may have to be maintained longer than initially envisaged. “Planned exit strategies from unconventional monetary and financial policies may need to be delayed until the situation is more robust.”

However, in the longer term, unwinding fiscal stimulus and outlining credible debt reduction strategies, as well as fixing the banking system through the recapitalization or the closure of ailing banks, is key to financial stability, the IMF stressed. Addressing “legacy” problems in the banking sector will ensure funding markets return to normal and the real economy is properly financed, the IMF said.

The IMF also urged governments to step up their efforts to complete the global regulatory overhaul started in 2008, stressing a lot remains to be done. “In the absence of such progress, regulatory inadequacies will continue for some time, increasing the chances of renewed financial instability,” the IMF said, calling on nations to better coordinate national financial reforms in the interest of global financial stability.

The IMF welcomed new and tougher capital and liquidity ratios for banks recently unveiled by the Basel committee of international banking regulators. But it reiterated recent remarks that these new standards could be introduced over a shorter phase-in period as the recovery becomes more entrenched. The new rules will be introduced gradually over a period of several years starting in 2013.

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