The euro area recovery is “broadly sound,” even though growth remains “uneven and moderate overall,” the International Monetary Fund (IMF) said Tuesday.
The IMF said in a report that a majority of members is experiencing “solid economic activity supported by increasingly healthy labor markets and relatively sound balance sheets of households and firms”.
It added that their economies are “pulling away from those suffering from sovereign debt crises and working through various combinations of a correction of pre-crisis imbalances, high debt, unemployment and tensions in financial markets, alongside balance sheet adjustment, and deep fiscal austerity measures”.
It noted that “member states’ current account imbalances have been reduced since the crisis mainly reflecting the contraction in domestic demand in deficit countries”.
“However, in many deficit countries private capital inflows have largely been replaced with European Central Bank (ECB) and official financing, which is unsustainable,” it affirmed.
According to the report, “a year after Greece first sought financial support from the official international community, its adjustment problems are once again dominating headlines and many solutions, orderly and disorderly, are still possible”.
“Despite adjustment efforts and support from euro area member states and the ECB, market participants remain unconvinced that a sustainable solution is at hand,” it said.
The IMF stressed that the euro area’s banking system “continues to display weaknesses. Leverage and dependence on wholesale funding remain high,” adding “across the region, banks are significantly exposed to sovereign risks, with a weak tail of banks with low profitability and very thin capital levels remaining particularly vulnerable to further shocks”.
The Fund’s Executive Board noted the risks that the euro area sovereign debt crisis “poses to both the European and the global recoveries, and called for strong policy implementation in the program countries, a more consistent effort across the euro area to restore market confidence, and a significant strengthening of economic governance, building on current efforts”.
Executive Directors agreed that “growth has rebounded but noted the increasing disparities among member states and the large tail risk from sovereign stresses combined with pockets of financial fragility”.
Directors urged a “comprehensive and concerted approach for effectively addressing the sovereign debt crisis”.
At the euro-area level, Directors stressed a number of essential actions, first “a rapid implementation of the commitment to scale up the capacity of the European Financial Stability Facility (EFSF) and supported a more flexible use of the EFSF as a backstop for sovereign and banking problems”.
Second, Directors called for “clarity in the approach to private sector involvement with regard to ongoing programs and in the context of the European Stability Mechanism”.
Third, they called for “immediate measures to strengthen the financial system through adequate capitalization and a strong follow up to the stress-test”.
Directors emphasized “the need to push forward with fiscal consolidation and structural reforms”.
Directors concurred that “spillovers could be large if stress in euro-area crisis countries spreads to other members,” emphasizing the need “to stem contagion through a cohesive and cooperative approach, noting that delays in resolving the crisis could be costly for the euro area and the global economy”.
Directors also noted that “the rest of the world would profit from policies that lift the euro area’s growth potential”.