Press Release No. 11/169
IMF Calls for Strengthened Policy Response, Stronger Financial Integration
To Bolster Europe’s Recovery
May 12, 2011
“The main message of the outlook is one of quiet confidence. Europe is doing well overall -- both western Europe and eastern Europe -- and our projections for the coming months are actually quite positive,” Antonio Borges, Director of the European Department, said.
“One of the most surprising elements of the outlook for Europe is the export performance of some of the core countries, which has been remarkable. Europe is of course benefiting from the general recovery that is underway. But it also proves an important point: European integration is delivering efficiency gains, which some countries are taking advantage of to become more competitive.”
“In advanced Europe, policy makers need to take steps to restore confidence—structural reforms, fiscal consolidation, and strengthening of the financial system, most notably in the euro area periphery. Emerging Europe has so far proved resilient to spillovers from the euro area periphery, but it will need to continue reducing its fiscal and financial vulnerabilities and reorient growth towards the tradable sector,” Mr. Borges added.
In the latest Regional Economic Outlook (REO) for Europe: Strengthening the Recovery, the IMF sees growth for all of Europe at 2.4 and 2.6 percent for 2011 and 2012, respectively, after 2.4 percent last year. The IMF projects growth in advanced Europe to expand by 1.7 and 1.9 percent this year and next, compared with 1.7 percent in 2010. Growth in emerging Europe1 is expected to be stronger, at 4.3 percent in 2011 and 2012, after 4.2 percent in 2010, with all countries posting growth for the ﬁrst time since the 2008–09 crisis.
The REO sees European inflation at 3.8 percent this year on the back of the economic upturn and buoyant commodity prices before easing back to 3 percent in 2012. The REO assumes that the increase in food and energy prices remains temporary without second-round effects on inflation, obviating the need for sharp monetary tightening, which could hurt the recovery.
Unemployment rose sharply in the euro area periphery and youth and temporary workers everywhere were particularly hard hit by the crisis. The rise in unemployment during the crisis also led to an increase in inequality and the REO calls for more inclusive labor markets, in particular where dual markets are prevalent, to narrow income inequalities,.
To prevent new crises, more vigilance is called for, better institutions to deal with financial sector problems must be developed, and more, rather than less financial and economic integration is needed. Furthermore, restoring productivity growth in the affected countries will be key—a task that, the REO notes, goes well beyond the changes in European governance frameworks and the completion of financial integration.
The main risk to the outlook for Europe arises from tensions in the euro area periphery. Other global worries also pose risks, but concerns about overheating in the continent’s emerging economies are more muted than in other regions.
Advanced Europe: Tackling the Sovereign Crisis
Strong national policies remain the best line of defense to restore confidence. The REO notes that fiscal consolidation plans—essential to secure medium-term sustainability—are rightly differentiated across countries. But structural reforms will be needed to generate solid and sustainable growth—the best antidote against entrenched unemployment and declining standards of living. Meanwhile, monetary policy can remain accommodative, though normalization lies ahead as growth recovers and the balance of inflation risks shifts.
Most of all, restoring confidence in the euro area’s banking system is a prerequisite to turning the page on the crisis. The upcoming round of stress tests provides an opportunity to address remaining vulnerabilities and will need to be followed by credible steps to increase capital buffers of viable banks. Efforts to strengthen the banking systems in vulnerable countries will need to accelerate, and policies to promote deeper integration of the EU financial system, including cross-border merger and acquisitions—should be part of the solution too, along with further progress in strengthening EU institutions and governance.
An additional strengthening of the EU-wide policy response, building on the March 24–25 decisions, will also be essential. Stronger economic governance and an integrated financial stability framework at the EU level will help prevent the buildup of macroeconomic imbalances as witnessed prior to the crisis.
Emerging Europe: Underwriting a Solid Recovery
Emerging Europe returned to a solid growth performance last year, although countries differed in their stages of recovery. Solid growth is expected to continue this year and next. Intraregional growth disparities should diminish as the legacies of the 2008/09 crisis fade and domestic demand takes over as the main driving force.
Policymakers’ main challenge is to protect the recovery against downside risks. In the aftermath of the crisis public finances have suffered, banks’ lending capacity has been dented, and unemployment remains too high. Moreover, inflation is picking up across the region.
Consolidation needs to rebuild fiscal buffers. This will improve key fiscal indicators and thus diminish the risk of financial tensions in euro area spilling eastward. It will also help contain inflationary pressures and support the monetary tightening that is already underway in several countries.
Financial sector policies should aim at restoring healthy credit growth and bolstering banks’ defenses. High non-performing loan ratios and scarce funding from foreign parents weigh on a revival of credit growth. This in turn holds back domestic demand and complicates creating new jobs in the tradable goods sector to replace those lost in nontradable sector. A second wave of bank consolidation and the prospective introduction of Basel III offer opportunities to strengthen the sector.
Financial Integration, Growth, and Imbalances
In a chapter dedicated to financial integration, the REO argues that what made the crisis in Europe so protracted was the incomplete integration of the financial system and the absence of a centralized mechanism to deal with a crisis. The EU fostered financial integration by adopting a common currency in the euro area, but it did not put in place effective instruments to handle cross-border risks or mitigate the build-up of imbalances financed by cross-border financial flows. With banking problems addressed at the national rather than EU level, banking and sovereign problems in euro area periphery countries exacerbated each other.
Stepping back from financial integration would be wrong. Instead, integration should be completed and adequate supportive policies should be put in place. To prevent the next crisis, more vigilance is needed, both nationally and across borders, together with better pan-European institutions to deal with financial sector problems, and, correspondingly more, rather than less financial integration.
1 For the purposes of the REO emerging Europe comprises (i) central, eastern and southeastern Europe with the exception of the Czech Republic and countries that have adopted the euro, (ii) the European Commonwealth of Independent States and (iii) Turkey.