Europe pressed to deliver debt fix

Global finance chiefs pressed Europe on Saturday to take advantage of newly increased financial buffers and make the lasting reforms needed to tackle its debt crisis, which is threatening the world recovery.

A day after advanced and emerging countries agreed to double the firepower of the International Monetary Fund to help contain Europe’s debt crisis, the IMF’s governing panel said the 17-nation euro area must make more cuts to government debt burdens, push bold economic reforms and stabilize financial systems.

Debt problems will resurface and growth will stumble unless these steps are taken, the head of the IMF’s governing panel, Singapore’s finance minister, Tharman Shanmugaratnam, warned.

An uneasy calm returned to world financial markets after the Greek crisis subsided but the IMF is concerned that without strong action fresh tensions will erupt, sapping global growth.

The IMF panel said the outlook was one of “moderate growth globally, and the risks remain high.” While it said all advanced economies must take further action, it singled out the euro area as crucial to revitalizing strong growth.

The euro area, the world’s second-largest economic bloc, already has slipped into a mild recession, weakening its major export partner China and other parts of emerging Asia, while growth in the United States remains sluggish.

Unless stronger growth is restored and investor confidence returns, the IMF and finance chiefs from around the globe said the world will not break out of a vicious debt-driven cycle.

“What was really critical in all our minds was to get back to normal growth over the medium term and preferably sooner rather than later, in other words within two to three years,” Tharman told a news conference.

“If we don’t get back to normal growth, if we don’t get GDP back to its potential levels, then fiscal sustainability is not possible either,” he warned.

The United States piled the pressure on Europe to take advantage of the breathing space provided by building financial firewalls against financial contagion.

“The success of the next phase of the crisis response will hinge on Europe’s willingness and ability, together with the European Central Bank to apply its tools ... flexibly and aggressively to support countries as they implement reforms,” US Treasury Secretary Timothy Geithner told the IMF’s panel.

But in what participants said was an intense discussion, Germany pointed the finger back at the United States, the world’s largest economy. The US budget problems are worsening and could reach the boiling point at year’s end when expiring tax cuts and plans for deep budget cuts could throw the economy into recession. Yet, a presidential election in November has resulted in political stalemate on budget plans.

“We understand the political constraints but there is no way around it and there is urgency,” said German Finance Minister Wolfgang Schaeuble.

Japan, with a staggering debt-to-GDP ratio of 230 percent, also needs a credible budget plan, he said.

Room to act

Europe presents the most urgent challenge and was the only economy singled out for policy advice by the IMF panel.

The two-fold action of piling a further $430 billion into the IMF and European leaders’ decision three weeks ago to finance their own $1 trillion bailout fund has erected defenses designed to contain the crisis by assuring investors there is money to back any country that runs into financial trouble.

At the same time, the IMF panel stressed that budget consolidation must be balanced to avoid overly harsh cuts that undermine growth and make the deficits even worse - a tricky act that Italy and Spain currently are facing.

“There has been a big discussion about how to make it possible to have fiscal strengthening and growth,” said Italy’s deputy finance minister, Vittorio Grilli. While the timing matters, fiscal tightening must come first, he said.

The panel, made up of finance ministers who advise the IMF on policy, called upon major central banks to help by keeping interest rates low and monetary stimulus in place, as long as growth remains weak and inflation under control.

The message came ahead of a Federal Reserve meeting on Tuesday and Wednesday, at which US policymakers will review whether additional bond buying may be needed to support growth. A call by the IMF for lower euro zone interest rates met resistance from some ECB policymakers in Washington. Germany in particular is concerned that loose monetary policy will stir inflation and is no panacea for budget cuts.

Emerging markets power

The IMF committee called on its members to ratify “expeditiously” a 2010 plan to increase representation of emerging economies on the IMF’s executive board, reflecting their growing clout in the world economy. Brazil said this was an essential condition for it to provide the IMF funding.

But voting reforms are unlikely to get approved by the IMF’s October meetings because the US Congress is unlikely to agree in the current highly partisan climate.

“I did not hear any clear announcement from the US that they will be able to deliver before the annual meetings (in October),” Schaeuble said, adding that Europe will have agreed by then.

That would add to tensions between the United States, which had insisted upon the reforms, and emerging markets.

Britain said its $15 billion contribution would only become available once the 2010 IMF reforms were completed, which it did not expect to happen before the US elections.