IMF warns of gloomy eurozone outlook

http://www.theguardian.com/business/2015/jul/27/imf-warns-of-gloomy-eurozone-outlook

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The International Monetary Fund has warned the eurozone faces a gloomy economic outlook thanks to lingering worries over Greece, high unemployment and a banking sector still battling to shake off the financial crisis.

The IMF’s latest healthcheck on the eurozone found it was “susceptible to negative shocks” as growth continues to falter and monetary policymakers run out of ways to help. It called for an urgent “collective push” from the currency union to speed up reforms or else risk years of lost growth.

“A moderate shock to confidence – whether from lower expected future growth or heightened geopolitical tensions – could tip the bloc into prolonged stagnation,” said Mahmood Pradhan, the IMF’s mission chief for the eurozone.

Related: IMF appears to be only one looking out for Greece's long-term future

Near-term fillips such as the European Central Bank’s (ECB) massive money-printing programme, low oil prices and a weak euro could only spur the economy for so long, IMF staff said after its annual discussions with eurozone policymakers. In the Fund’s view the medium-term looks subdued because of “a chronic lack of demand, impaired corporate and bank balance sheets, and deeply rooted structural weaknesses”.

The IMF’s review said: “The recovery is strengthening, underpinned by lower oil prices and the ECB’s expanded asset purchase programme. But the medium-term outlook remains weak, weighed down by the legacies of insufficient demand, lagging productivity, and weak bank and corporate balance sheets.

“As one-off factors driving the cyclical recovery fade, there is a risk that low growth and limited policy space leave the euro area vulnerable to shocks.”

Stagnation worries

The IMF “mission” to the eurozone took place between 18 May and 3 June, long before an apparent stopgap to the the Greek debt crisis was hammered out this month. Since that deal to start talks on a new bailout for Greece, the Washington-based Fund has been fiercely critical of what eurozone leaders have offered to Athens and has called for substantial debt relief.

The Fund’s eurozone report, published on Monday, described the situation in Greece as “fluid” and as still “a key source of uncertainty”.

“To manage contagion risks, policymakers should stand ready to deploy, and if necessary adapt, the full arsenal of available instruments; the ECB in particular should ensure that banks continue to have access to ample liquidity and maintain orderly conditions in sovereign debt markets,” the report said.

It urged the ECB to stand ready to expand its quantitative easing (QE) programme, where it buys eurozone governments’ bonds using electronically created money, if financial conditions get significantly tighter and also said the scheme might need to go beyond September 2016, currently pencilled in as the end-date.

High unemployment

The IMF is forecasting eurozone GDP growth of 1.5% this year and 1.7% next year. It expects inflation to remain close to zero this year and rise to 1.1%. The forecasters are gloomy about the prospects for a strengthening economy to lift employment in many eurozone countries. In the meantime, the unemployment rate remains high, above 11% for the whole eurozone and near 25% in Greece and Spain.

“The share of long-term unemployed continues to increase, raising the risks of skill erosion and entrenched high unemployment. High youth unemployment could also damage potential human capital, and give rise to a “lost generation’. While weak demand plays a major role, more spending on active labour market policies would help increase employment opportunities, especially for the young,” the report notes.

Bad loans

The IMF’s other policy recommendations include helping to clean up bank balance sheets, which have in many cases been left with non-performing, or “bad”, loans after the financial crisis where the borrowers are no longer keeping up interest payments.

The Fund urges eurozone policymakers to do more, such as shake up insolvency rules, to get bad loans off banks’ balance sheets and so free up the financial sector to lend more. Stronger banks would also amplify the benefits of QE, the report says.

Benchmark or bust?

The Fund also urges eurozone officials to find ways to better measure and encourage progress in areas of structural reform. For example, it wants the currency bloc to use benchmarks, such as how long it takes to launch a business or the number of days it takes to enforce a contract.

“Shifting to outcome-based benchmarking, stronger EU oversight with less discretion in applying existing rules, and better financial incentives for delivering on reform commitments could help accelerate progress on reforms,” the report says.

In a plea to better-off members of the region, the IMF calls for more measures to stimulate demand.

“Those countries with fiscal space, including from lower interest costs due to QE, should use it to raise investment and pursue structural reforms,” the report said.