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December 1, 2020

IMF calls for more support to tackle risks to eurozone economy

Business

December 1, 2020

Frankfurt: The second wave of coronavirus infections and lockdowns poses “a considerable risk” to the eurozone economy, the IMF has warned, adding that recent progress on vaccines will not deliver a recovery in the near future.

The gloomy short-term outlook for the eurozone meant the bloc needed more support from both fiscal and monetary policy, the fund said in a report on the conclusions of its latest official visit to the eurozone.

The EU should provide “solvency support” to businesses, the IMF said, and called on the European Central Bank to give “direct support” to companies.

Governments need to switch from shielding economies from the impact of the pandemic to prioritising support for companies that are most likely to prove viable once the crisis is over, “while facilitating the exit of unviable companies” and boosting overall demand, the fund said.

The launch of the EU’s €750 billion recovery fund — which has been delayed by disagreements between member states — could provide “a meaningful boost” to growth if implemented effectively, the IMF said, although it warned that “further delays would damage euro area recovery prospects”.

The eurozone economy contracted by a record 16 per cent in the first half of the year, before rebounding more strongly than expected with growth of 12.6 percent in the third quarter.

The IMF said output in the final three months of this year and the first quarter of 2021 was likely to be weaker than expected because “rising infections and reimposed lockdowns have damaged confidence and lowered mobility”.

The ECB is due to announce its latest monetary policy decision on December 10, when it is widely expected to expand its €1.35 trillion emergency bond-buying programme and its €1.5 trillion of ultra-cheap loans to banks. The IMF said a further cut in the ECB’s deposit rate from its record low of minus 0.5 percent “should also be considered”.

“With the ongoing second wave, national fiscal policies will likely need to provide broad-based support for longer than initially envisioned,” the IMF said, adding that “as the recovery gains traction, the focus should gradually shift to facilitating reallocation of labour and capital, sustainably boosting inclusive growth, and reducing fiscal vulnerabilities”.

The IMF said the EU’s fiscal rules, which restrict the size of public deficits and debt levels but which were suspended at the start of the pandemic, should only be reintroduced once the recovery has firmly taken hold and then only once they have been simplified.

It said there was a risk of “adverse market reactions” for countries with high debt levels that provide extra fiscal support to their economies and have “sizeable contingent liabilities”.

The EU recovery fund and the European Stability Mechanism, which provides bailout loans to governments, “can help to mitigate such pressures”, the IMF said. “In a severe downside scenario, augmentation or expansion of defences may be needed,” it added.

Eurozone banks have been blocked from paying dividends or buying back shares since the start of the pandemic and the IMF said regulators should maintain these restrictions until the recovery was “well under way”.

“While bank capitalisation is appropriately high, a broader deterioration of asset quality is likely to reduce banks’ lending capacity through its impact on profits and capital buffers,” it warned. “The prudential measures toolbox should be strengthened to address vulnerabilities in nonbank financial institutions.”

The IMF said the impact of that scheme would depend on the scale, quality and efficiency of national spending it supports and structural reforms aimed at transforming economies to be greener and more digital.

The Fund praised the monetary policy response of the ECB to the economic downturn caused by the pandemic as appropriately bold, but said further support was likely to be needed, possibly including more cheap TLTRO loans and other help for banks.

“Expanding asset purchases will be the first line of defence, but other options -- including further relaxation of Targeted Longer-Term Refinancing Operations’ terms and a deposit rate cut -- should also be considered,” it said.

“Even greater accommodation would be needed to counter deflation risks and ensure smooth monetary transmission in a downside scenario,” the IMF report said.

Euro zone consumer prices have been falling year-on-year since August for the first time since 2016, further challenging the ECB which wants to keep inflation just under 2 percent in the medium term but has for years failed to reach that target.

The Financial Times Limited 2020