IMF warns of fresh crisis over Europe debt woes

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The IMF predicts growth of 6.4 percent in developing economies this year and 6.1 percent next year, down from 6.6 percent and 6.4 percent forecast in June.

Richer nations will grow 1.6 percent this year instead of the 2.2 percent expected in June, and 1.9 percent next year instead of 2.6 percent, the IMF said.

Japan was the only Group of Seven economy to have its forecast raised for this year, with the IMF now predicting a 0.5 percent contraction, compared with a 0.7 percent decline in June. Growth in 2012 should reach 2.3 percent, 0.6 percentage point less than in June.

In the euro area, where the IMF cut its prediction to 1.6 percent from 2 percent this year and to 1.1 percent from 1.7 percent next year, injecting capital into banks and restructuring or closing down others is “essential,” the IMF said.

The IMF is “very worried” that banks will seek to increase their capital buffers “by decreasing the assets that they hold, by deleveraging, which would lead to a decrease in bank lending and a credit crunch,” Blanchard said.

The European Central Bank should lower interest rates if risks to growth persist from the current benchmark of 1.5 percent.

Asked about the ECB’s sovereign bond purchases, Blanchard said the bank is playing a “very important role” in making sure Italy’s borrowing rates remain low and its debt sustainable.

In its downside scenario, the IMF assumes that banks need to absorb losses resulting in a 10 percent decrease of their capital as a result of “major financial turbulence in the euro area, combined with a downscaling of expectations for US medium-term growth prospects and real-estate-related financial stress in emerging Asia.”

In the US, where the IMF now sees expansion of 1.8 percent next year as the housing market also weighs on the recovery, the fiscal plan is a priority, the IMF said. The Federal Reserve should also stand ready to “deploy new unconventional support for the economy.”

The IMF urged emerging economies to roll back fiscal deficits and to continue raising interest rates, though situations vary across countries. It said that China’s currency remains “substantially undervalued.”

The IMF now assumes oil at $103.20 a barrel in 2011, based on the average prices of U.K. Brent, Dubai and West Texas Intermediate crudes, compared with $106.30 in June.

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