Oct 10, 2012 12:48 PM

Euro Crisis Harms Economic Confidence, IMF Says

(Tokyo) – Risks to financial stability have increased since April, and the euro area crisis is one of the major threats to confidence in the global economic system, the International Monetary Fund says.

"Confidence in policy-making has faltered, despite significant and continuing efforts by European policy-makers," the IMF said in a report released on October 10.

The IMF credited actions taken by the European Union, United States and Japan to combat their financial crises as having a positive impact on investor sentiment and rebounding markets.

However, it said more needed to be done. "Further policy efforts are needed to gain lasting stability," said Jose Vinals, financial counselor and director of the capital markets department at the IMF.

Concerns over a possible euro area breakup have led to extreme fragmentation between the funding markets in the core and the periphery of the euro zone, the report said. To combat such fragmentation, the IMF advocated the need for safer banks, well-timed fiscal consolidation and economic structural reforms, strong firewalls and a stronger union.

"A clear road map to a complete banking union is required to guide market expectations and help break the pernicious link between sovereign and bank balance sheets," Vinals said.

The IMF warned that despite safe-haven flows resulting in low interest rates, Japan and the United States should not delay enacting fiscal policies. The looming debt ceiling, "fiscal cliff" and related uncertainty were cited as the main immediate risks for the United States.

"A key lesson for the United States and Japan from the euro area crisis is that delaying policy adjustments until market strains become evident leads to financial turmoil and harsher economic outcomes," Vinals said.

The Spanish economist said that while emerging markets have been more successful in combating the crisis they cannot afford to become lax in their policies.

Countries in central and eastern Europe were the most vulnerable of the emerging market economies because of their direct exposures to western Europe and some vulnerabilities shared with countries in the euro area's periphery, the report said.

"Asian and Latin American emerging markets are less impacted by shocks emanating from Europe, but are not immune to adverse external spillovers," Vinals said.

The IMF said such emerging markets should be aware of both external and domestic pressures to provide buffers against financial risks.

"There is a need for a continued strong commitment to the regulatory reform agenda," the report said. "Without more resilient institutions, recovery will continue to lag."

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