IMF releases regional outlook for Europe

The International Monetary Fund says greater integration of the EU financial system – including cross-border mergers and acquisitions of banks – is needed to restore confidence the banking system.

IMF – Calls for ‘bold steps’ to assuage market concerns

In its regional economic outlook for Europe, the IMF says: ‘Bold steps are needed to assuage market concerns about sovereign and financial risks, and to tackle the underlying root causes of the crisis.

‘Ultimately, more, rather than less, economic and financial integration will be key to the regions success.
The IMF says further progress in strengthening pan-European institutions and governance is also needed.

‘Stepping back from financial integrations would be wrong.

‘Instead integration should be completed and adequate supportive policies put in place’, it says.

While welcoming the series of EU-level steps agreed at the March summit of EU leaders, the IMF says ‘clear rules for allocating losses to private stakeholders and sharing the burden of potential public support among member states are still missing’.

It says restoring confidence to the Euro area’s banking system is a prerequisite to turning a page on the crisis.
The next round of European bank stress tests – due out in June – are an opportunity to address remaining vulnerabilities in Europe’s banks.

But to be effective the stress tests need to be followed by credible restructuring and recapitalization programmes.

It calls for the creation of a European Bank resolution agency, to deal with troubled cross-border institutions.

It says that public debt sustainability is vital to an enduring solution to the financial tensions in the Euro area, and to breaking negative feedback loops between sovereign and banking-sector instability.

The IMF says deep-rooted financial and structural problems in the most vulnerable euro are countries are likely to keep European confidence volatile, and new spells of anxiety could emerge if the political will to resolve the crisis disappoints.

It says a major pressure point in the immediate future is the large debt-rollover needs of banks and governments in Greece, Spain and Portugal.

Combined bonds due in these states amount to 10% of GDP – roughly twice the amount needed in 2007.

Rollover needs have also increased in Ireland, Belgium and the UK.

It says banks’ funding problems and their reluctance to engage in deleveraging has led to increasing competition for deposits, with banks in Spain and Greece in particular offering high interest rates to attract deposits.

It says reliance on ECB funding has become entrenched for ‘a number of second-tier banks in large European countries; nearly all banks in Greece Ireland and Portugal; and some small and mid-sized Spanish savings banks’.

It warns that with liquidity pressures remaining acute, a negative shock could rapidly spill over through the so-called peripheral states (Ireland, Spain, Greece, Portugal) and potentially beyond, into the so-called core states.

It says cross-border exposures remain sizeable and concentrated in Euro area creditor countries; ‘hence the system would still be severely tested if euro area stresses were to intensify’.

On interest rates, it says the countries that are most advanced in the recovery cycle – such as Norway, Sweden and Israel – have already started to raise rates.

The ECB has also started with a rates rise last month.
But it says that in the UK, where the recovery is ‘more tepid’ and fiscal tightening stronger, policy-rate normalization may need to proceed more slowly.

In its outlook for growth, the IMF says all of Europe (which includes Turkey and Russia) will grow at 2.4% this year and 2.6% in 2012.

It says advanced Europe (effectively the EU) will grow by 1.7% this year and 1.9% next year.

It says private demand will increase in northern Europe, but will remain weak in Greece, Ireland Portugal and Spain, with the Greek and Portuguese economies projected to be in recession this year.

It says restoring growth to these countries will overcome the crisis, and says first results are apparent in the Baltic States, Bulgaria, Spain and Ireland, where export growth is picking up sharply and competitiveness indicators are improving.