IMF Warns Europe’s Sovereign Debt Crisis Could Spread to Other Parts of Europe

Sources:
Guardian: Fix Banks to Avoid Eurozone Meltdown, IMF Warns
IMF: IMF Calls for Strengthened Policy Response, Stronger Financial Integration to Bolster Europe’s Recovery
WSJ: IMF Weighs Extending Greek Repayments

Last week, the International Monetary Fund (IMF) published the latest Regional Economic Outlook for Europe. The IMF expects that economic growth in Europe will not be fast “but still solid and sustainable.” It estimates that economic growth for Europe will be 2.4 percent and 2.6 percent in 2011 and 2012, respectively. In the case of emerging market economies, they are expected to grow at 4.3 percent both in 2011 and 2012. However, the IMF also warns that sovereign debt problems in Greece, Ireland and Portugal could spread to “the core euro area, and then onwards to emerging Europe,” calling for comprehensive and strong policy actions to restore confidence and fix vulnerabilities in the financial sector and accelerate reform efforts.

As banks in other countries in Europe hold substantial amounts of bonds of the governments with sovereign debt problems, “a shock to confidence” could spread to other European countries, said the IMF. According to Morgan Stanley, BNP Paribas in France holding around €5billion of such bonds would be hit the hardest. In order to contain contagion risk, the IMF emphasized a need to strengthen the banking system in Europe and it also said that the 2011 EU-wide bank stress test will be a great opportunity to identify and fix weaknesses in the banking sector. Antonio Borges, Director of the European Department said that while systemic risk in the European banking sector had been reduced, banks in Europe would have to raise additional capital and accelerate their efforts to consolidate. Also, the IMF called for more financial integration, arguing that the incomplete financial integration as well as the lack of effective institutions to handle cross-border problems at the regional level had contributed to the worsening of the financial crisis in Europe.

As for Greece, the IMF showed optimism, saying that there would be no possibility of a default and that any type of debt restructuring would be necessary at this point. Mr. Borges said, he did not think that restructuring would provide a “miraculous” solution. Instead, Mr. Borges pointed out that the Greek government “has an extraordinary portfolio of assets” and it can raise additional cash through privatizing such assets. Currently, the Greek government is in the process of privatizing its assets amounting to €50 billion. Also, the IMF said that Greece will likely meet it deficit target of 6.2 percent of gross domestic product in 2012.