In its latest Global Financial Stability report, the International Monetary Fund (IMF) said that the European Union should increase the size of its rescue fund to ensure that the momentum of the worldwide economic recovery initiated by the emerging markets and the US is sustained.
The latest World Economic Report prepared by IMF revises global economic growth to 4.4 percent from its October forecast of 4.2 percent. Growth for 2012 has been pegged at 4.5 percent.
“Problems in Greece, and now Ireland, have reignited questions about sovereign debt sustainability and banking sector health in a broader set of euro-area countries and possibly beyond”, IMF said while releasing the report. EU banks need to undergo stricter stress-test regime to restore market confidence, the report said.
The report also puts a question mark on the adequacy of the European Financial Stability Fund (EFSF), which has an effective lending capacity of nearly half of its headline value of €440 billion (£377 billion), arguing that a bigger European contingency could prove grossly inadequate.
The EU has been in discussions to expand the lending capacity of the fund, although Germany has been resisting the effort saying additional measures must be formulated first with more accountability from member countries.
The report says EU banks which fail stress test and are unviable should be closed.
The report said the link between the weak balance sheet of the banks and widening budget deficit may cause another sovereign debt crisis thus risking a global economic recovery.
The report said that US tax cuts enacted late last year helped accelerating the pace of recovery adding a stimulus package from Japan will also help.
“More generally, signs are increasing that private consumption … is starting to gain a foothold in major advanced economies”, indicating consumer confidence is slowly gathering momentum in advanced economies. However, they still pose a major threat to world economic recovery, the report said.
The report pegged the growth rate of advanced economies at 2.5 percent saying it will hardly make any difference to the high unemployment rate currently being witnessed now. It advised rich countries to follow loose monetary policies and maintain the low interest rate regime in order to sustain the recovery.
“As long as inflation expectations remain anchored and unemployment stays higher, this is the right policy from a domestic perspective”, the report said.
It revised the US economic expansion to 3 percent for the year, a sharp rise from 2.3 percent it had forecasted earlier in October for the world’s largest economy. However, the report is less optimistic about other advanced economies such as Europe and Japan. Europe’s growth rate has been projected at 1.5 percent while Japan will see a growth of 1.6 percent. However, the situation will improve considerably in 2012, the report says.
It says the emerging economies of China, India, Brazil and Russia will lead the recovery, although high inflation will remain a cause of worry.
“Many countries are close to potential. That probably means that in a number of countries monetary policy may need to be tightened in order to maintain inflation under control”, said Olivier Blanchard – head of research at IMF.
The emerging economies growth rate has been revised up to 6.5 percent for 2011 and 2012. However, China will be able to maintain its growth rate at a high of 9.6 percent in 2011, the report said. High inflation in these economies will however, necessitate tighter monetary policies.
A slowdown of emerging economies “would deal a serious blow to the global recovery”, since they account for 40 percent of world consumption, the report said.