IMF Says Recovery Remains Fragile

WSJ: WASHINGTON—Europe could suffer a prolonged economic downturn unless it takes stronger action to fight its debt crisis and prop up growth, the International Monetary Fund said on Tuesday.

The global economy is gaining strength, in part because European nations have taken several steps to reduce the threat of a financial meltdown and the U.S. economy has picked up. Still, the IMF said, the global recovery remains fragile.

An uneasy calm remains," IMF chief economist Olivier Blanchard said. "One has the feeling that any moment, things could well get very bad again."

The European debt crisis was a main concern among finance ministers and central bankers preparing to gather in Washington this week for semiannual meetings of the IMF and World Bank.

In anticipation of the meetings, several nations pledged to send funds to the IMF to boost its financial war chest. Three Nordic countries—Denmark, Norway and Sweden—on Tuesday promised a combined $26 billion on top of Japan's $60 billion commitment on Monday.

The pledges will go toward an effort by IMF Managing Director Christine Lagarde to roughly double the fund's available lending capacity, currently about $380 billion, in case of further trouble. Europe had already pledged $200 billion.

Last week, Ms. Lagarde scaled back her fundraising target by more than $100 billion, to $400 billion, citing improved conditions in the global economy.

In recent weeks, Europe has taken steps to boost its rescue fund to about €700 billion ($913.6 billion), though many non-European nations wanted the Continent to put up even more money. Euro-zone nations have also achieved some progress in implementing budget overhauls in Italy and Spain, while the European Central Bank has opened its spigots to provide the Continent's banks with cheap financing.

The fund said risks from Europe's government debt woes had become "less acute" than they were six months ago, but it pressed for more action, such as taking stronger steps to support the banking sector and considering the issuance of common government bonds to strengthen their ties. The fund also called for the European Central Bank to continue buying bonds of ailing nations and to keep issuing cheap loans to keep the financial system afloat.

"There can be no pause" in euro-zone action, the IMF said, warning that problems could easily flare up again.

The U.S. and other leading economies outside Europe are expected to keep the pressure on the euro zone this week. U.S. Treasury Under Secretary for International Affairs Lael Brainard said Tuesday that Europe "must demonstrate a continued willingness to do whatever it takes" to strengthen the currency union.

The IMF said it expects the global economy to grow 3.5% this year, 0.2 percentage point higher than it forecast in January but still below last year's rate of 3.9%. The fund forecast 4.1% growth for 2013.

But the fund warned that if Europe isn't able to contain its debt and financial crisis, it could shave 2% from global economic output and 3.5% from output in the euro area, which is already in recession. The IMF expects the euro-zone economy to contract 0.3% this year before growing by an anemic 0.9% in 2013.

If any euro-zone country faces a disorderly default, Europe could face "full-blown panic" and "a breakup of the euro zone could not be ruled out," the IMF said. That would send shock waves around the world much worse than the 2008 financial crisis, the fund said.

High oil prices represent another major risk to the global economy. If tensions with oil-exporter Iran boil over and spur prolonged supply disruptions, it could force oil prices to surge above $165 a barrel, potentially causing another Great Depression, the fund said.

Government budget deficits in advanced economies are set to narrow by one percentage point of gross domestic product this year as governments wind down their stimulus programs and cut spending, the fund said.

The IMF said governments should support their fragile expansions by avoiding "excessive" spending cuts, allowing public benefit programs to kick in and letting deficits remain higher in the short run.

Governments should work to shrink their deficits gradually over the long term rather than through short-term cuts, the fund said. The advice appeared to be a message aimed at somewhat stronger economies such as Germany and the U.K, which are cutting their budgets.

The IMF's latest guidance represents a judgment that budget cuts are stifling growth in many economies around the world. Some nations such as Spain and Italy have little choice but to cut spending to tame deficits in an effort to convince markets they can manage their debts.

"The weakened global outlook puts policy makers in a delicate position," the fund said. "Too little fiscal consolidation could roil financial markets, but too much risks further undermining the recovery and, in this way, could also raise market concerns."

Write to Sudeep Reddy