Europe, inflation pose risks to recovery

Johannesburg: Europe needs to strengthen its financial rescue fund to reduce the risk of renewed global instability as US tax cuts and buoyant emerging economies help propel the recovery elsewhere, the IMF said yesterday.

Rich nations should nurture their slower growth rates by keeping monetary policy loose, while inflation pressures may force a number of emerging economies to raise borrowing costs, and global growth engine China should look to revalue its yuan currency sooner rather than later, it said.

In an updated World Economic Outlook, the International Monetary Fund said the global economy would likely expand 4.4 per cent this year, a touch higher than the 4.2 per cent forecast in October.

It expects growth of 4.5 per cent in 2012.

But, in an update to its Global Financial Stability Report, the Fund said the effective size of Europe's financial rescue fund should be increased and that its banks needed rigorous stress-testing to help restore market confidence.

"Problems in Greece, and now Ireland, have reignited questions about sovereign debt sustainability and banking sector health in a broader set of euro area countries and possibly beyond," it said as it released the reports in Johannesburg.

The worry is that the European Financial Stability Facility, which has a headline value of €440 billion (Dh2.20 trillion) but an effective lending capacity of around half that, could be wiped out if a larger European economy needed rescuing.

There have been EU discussions on beefing up the fund so it can lend the full amount, but there has been resistance from Germany, which says it must be part of a wider set of measures expected in March.

The IMF said Europe's banks needed further stress-testing — as scheduled by the region's policy makers — to ensure they could withstand any future shock. Non-viable banks should be closed, it said. The link between weak balance sheets of European banks and governments was a primary reason why the International Monetary Fund said global financial stability was still at risk nearly four years after the financial crisis struck.

The Fund forecast a lift in global economic recovery which began to gain pace in 2010 from a package of US tax cuts late last year.