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Decisive Action Needed in Europe to Restore Confidence—IMF

European Parliament in Strassbourg. The sovereign debt crisis in the euro area has undermined confidence, according to the IMF (photo: Lex van Lieshout/ANP)

EUROPE

Decisive Action Needed in Europe to Restore Confidence—IMF

IMF Survey online

September 25, 2011

  • Sovereign debt crisis entering “worrisome phase”
  • When Greece implements commitments, financial support will be there
  • Call for reforms aimed at improving long-term economic performance

The economic situation in Europe has deteriorated markedly in the past few months. The economy is now experiencing a significant slowdown, and the sovereign debt crisis is entering a new, more worrisome phase, Antonio Borges, the IMF’s European Director, said.

To a large extent, developments in Europe reflect what is happening throughout the world, with a slowdown in global trade and slower growth the United States. But there has also been a softening in consumer spending and a loss of confidence in the markets. The current drive for fiscal consolidation is further dampening growth, he said.

The IMF is projecting growth of 1.6 percent in the euro area in 2011, and 1.1 percent in 2012, with significant differences between countries.

“If things were to stay this way, the economy would simply go through a soft patch. But every time the economy slows down, there is always a risk that the economy will slow down further, and it is that risk that keeps us awake at night,” Borges said September 23 at a press briefing held as part of the World Bank-IMF Annual Meetings. In that context, the IMF has been recommending a nuanced change in policy.

Given the absence of inflationary pressure, the IMF would welcome a more expansionary monetary policy to address downside risks to the outlook. On the fiscal front, some countries have no option but to continue putting their budgets in order. But other countries have more leeway and should allow automatic stabilizers to operate fully, he said.

Addressing the sovereign debt crisis

Europe’s sovereign debt crisis has now entered a different and more worrisome phase. We are seeing the first elements of contagion, with Spain and Italy now paying higher interest rates, Borges said.

As we see deteriorating market sentiment, we hope to stop it before it becomes overwhelming. Decisive action needs to take place, and take place soon.” He called on Europe’s leaders to restore confidence through measures that will convince investors that their investments will be safe and profitable.

Borges noted that some countries have made significant progress in addressing concerns about deficits and debt—progress that markets are too often ignoring. “There is an element of market fear, which to a large extent we consider excessive.” Spain is one such example. Remarkable progress has been achieved in terms of economic policies, although the labor market is still terrible, he said.

As for Italy, it has had problems of growth for more than a decade, but its public accounts have never been as good as they are now, he said. Among all European economies, Italy was one of the few with a positive fiscal balance before interest rate payments.

Greece must live up to its commitments

Greece, the country in the eye of the storm, is currently in discussions with its international partners―the European Commission, the European Central Bank, and the IMF―over the next review of its economic program. We are concerned about the budget, but also concerned about the lack of progress in reforming the economy to make it more open and competitive, Borges said.

If the Greeks do what they have to do, if they are on track, they can count on the full support from the rest of Europe.” Europe’s willingness to stand behind Greece was reaffirmed at the July 21 European Summit.

In Ireland, which also turned to the European Union and the IMF for financial assistance, the picture is brighter. The battle is far from won but moving in the right direction. Confidence is returning, interest rates are coming down, and growth has been surprisingly strong, in part because of an improvement in the country’s competitiveness.

For Portugal, the third euro area country with an international bailout program, it is still too early to pass judgment. “We have a good program in place, and the government seems determined to make progress,” Borges said.

Policies to support growth

Borges also called for reforms aimed at improving long-term economic performance. “There are reforms that can be put in place in Europe that will have substantial impact in the long term equilibrium of public finances, and that is what should drive all the attention of policymakers.” For example, pension reform still has a long way to go in many European countries. Such reforms enhance credibility by improving fiscal sustainability in the medium term, without affecting growth in the short term.

The IMF is in the process of looking more closely at the wide discrepancy in Europe in terms of growth performance. Many countries in Central and Eastern Europe have good growth rates, and a few―such as Turkey―may even be in danger of overheating. In Western Europe, Sweden is a star performer whereas other countries, such as Italy, have underperformed for more than a decade.

These findings will be published as part of its Regional Economic Outlook, due to be released in early October.


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