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IMF urges euro countries to integrate more

The 17 countries that use the euro have to integrate their economies further if they are to emerge from their economic crisis intact, the International Monetary Fund said on Wednesday.

In its latest assessment of the eurozone, the Washington D.C.-based institution urged Europe’s leaders to “demonstrate shared and unequivocal commitment — with a clear, credible roadmap — to a deeper integration of the euro area.”

Among the measures it is calling for is a cross-border deposit insurance scheme that could shore up the banking systems of the more indebted European countries.

Though conceding that the first priority is to minimize the reliance of indebted governments and banks on each other by using emergency funds to directly invest in lenders, the IMF said the eurozone must push on with its efforts to strengthen the monetary union and promote economic growth. The organization is predicting that the eurozone’s economy will shrink 0.3 percent this year and grow only 0.9 percent next. The downside risks, it added, are severe.

Mahmood Pradhan, deputy director of the IMF’s European Department, said the eurozone is not working properly and what is needed is to “complete the union.”

Countries such as Germany can borrow money from the markets for 10 years at a rate of little more than 1 percent as investors look for somewhere safe to park their cash. However other members of the eurozone such as Italy and Spain are finding it increasingly hard to sell their debt at manageable interest rates. Others— notably Greece, Ireland and Portugal — are not able to tap the long-term bond markets at all.

“These developments are not consistent with a properly functioning economic union,” said Pradhan.

The IMF highlighted three areas where more eurozone integration was needed while the region presses on with austerity programs:

• Eurozone leaders must push through with the plan they agreed in late June to create a banking union with a common supervisory framework. The IMF also said a pan-European deposit guarantee scheme is required, with the European Central Bank possibly playing an initial key role. At present, each country in the eurozone sets its own insurance schemes on bank deposits. In addition, it said a common resolution framework was needed so that there are resources in place to deal with weak banks.
• The drive to greater fiscal integration has to continue to “reduce the tendency for economic shocks in one country to imperil the euro area as a whole.” This needs to be backed up by stronger pan-European oversight and enforcement. The eurozone countries have already agreed to strict budgetary controls, which in theory should prevent governments from running up too much debt.
• The eurozone countries have to reform their economies to boost their long-term growth prospects and balance out the big differences in trade performance across the region. Among possible measures, Pradhan suggested labor market reforms to reduce costs and increase the size of the region’s pool of available workers, particularly in the southern economies of the eurozone.

“These moves would help stem the decline in confidence engulfing the region, lower borrowing costs for countries facing severe market pressure, break the downward spiral between sovereigns and banks, and reduce the risk of contagion across the euro area,” Pradhan said.

Until these measures are introduced, the IMF said the eurozone must continue to use (euro) 500 billion emergency bailout funds and maintain a supportive monetary policy. It also said that those countries that are not under intense market pressure should ease off their austerity measures.

Pradhan also expressed the hope that a sharing of debt could eventually be agreed — provided strict rules are in place to prevent any one country from abusing the system. Many in the markets think that the creation of eurobonds — which would effectively allow countries like Greece and Spain to benefit from Germany’s super-low borrowing rates — is the ultimate answer to the eurozone’s problems.

The European Central Bank also came under scrutiny, with Pradhan saying that it still has room to cut its main interest rate further from the current record low of 0.75 percent as well as introducing more “unconventional” policies.

He said it could step up its program to buy up bonds of Europe’s more indebted countries in the markets and pursue a monetary stimulus, similar to what other central banks such as the U.S. Federal Reserve and the Bank of England have enacted.

Pradhan also said the ECB could also offer the banks another batch of super-cheap long-term loans. The previous two so-called Long Term Refinancing Operations, or LTROs, helped ease the debt crisis for a while at the start of this year with an injection of almost (euro) 1 trillion in cheap loans.