IMF Urges U.S. Debt-Ceiling Increase to Avoid a ‘Severe Shock’ to Economy

The International Monetary Fund said today global markets will suffer if the U.S. Congress fails to approve an increase in the $14.3 trillion debt ceiling and cautioned about the risk of a downgrade in the country’s credit rating.

“The federal debt ceiling should be raised expeditiously to avoid a severe shock to the economy and world financial markets,” the IMF said in a report on the U.S. economy. The report said a failure to reach a budget and debt compromise could result in a “sudden increase in interest rates and/or a sovereign downgrade.”

The IMF, in releasing a statement on the annual report, said that risks to the U.S. include housing market weakness and the European debt crisis.

“These risks would also have significant global repercussions, given the central role of U.S. Treasury bonds in world financial markets,” the IMF said.

“We’re confident that the participants are well aware of the potential risks of a debt default in the U.S. and will avoid those dangers,” John Lipsky, IMF acting managing director, said at a news conference today after the statement’s release. “It should be self-evident a debt default by the U.S. government debt market would have very serious, far-reaching, dramatic repercussions and that’s why we’re confident that it will be avoided.”

‘Upside’ Surprise

The Washington-based lender also said that “recovery could surprise on the upside” if confidence improves and hiring picks up.

“An excessively frontloaded fiscal adjustment could hurt the recovery and as we know a worsening of the financial turmoil in European sovereign and bank debt markets could hurt U.S. growth through financial sector linkages,” Lipsky told the news conference.

Democrats and Republicans have been negotiating to find a way to cut the long-term deficit and raise the nation’s debt ceiling.

Standard & Poor’s in April put the U.S. government on notice that it risks losing its top credit rating unless policy makers agree on a plan by 2013 to reduce budget deficits and the national debt. Moody’s Investors Service this month said it will put the U.S. government’s Aaa credit rating under review for a downgrade unless there’s progress on increasing the limit by mid-July.

U.S. Slowdown

The U.S. economy grew 1.9 percent last quarter, a slowdown from 3.1 percent at the end of last year. Unemployment unexpectedly climbed to 9.1 percent in May, homebuilder confidence plunged to the lowest level in nine months and economists cut their estimates for 2011 gross domestic product growth to 2.5 percent from 3.2 percent in February.

The IMF today projected U.S. gross domestic product growth of 2.5 percent in 2011 and 2.75 percent in 2012, with a slow decline in unemployment. The 2011 projection is identical to one forecast by the IMF on June 17, when the lender also projected a 2.7 percent increase next year.

U.S. Treasury Secretary Timothy F. Geithner, in an interview with CNBC television last week, said that with long- term U.S. economic growth of about 2.5 percent, the unemployment rate “will gradually come down.”

U.S. employers added 54,000 jobs in May, the slowest pace in eight months, according to June 3 Labor Department figures.

Jobless Rate

Fed officials cut their projections for economic growth this year and raised their estimates for the jobless rate after their June 21-22 meeting, noting that “the damping effect of higher food and energy prices on consumer purchasing power and spending” contributed to the slowdown.

The IMF endorsed the Federal Reserve’s current monetary policy stance.

“With subdued inflation prospects and ample resource underutilization, the extraordinary monetary policy accommodation will likely remain appropriate for quite some time,” the IMF said.

“Going forward, the Fed should remain vigilant to the risk of an unmooring of long-term inflation expectations, and respond decisively should the risk materialize in either direction,” the IMF said.

Housing Market

The IMF also warned of problems in the U.S. housing market and said policy efforts, including mortgage principal “cramdowns,” may be needed. Banks have resisted efforts to force principal write downs and succeeded in defeating such legislative efforts. Home foreclosures fell 33.4 percent in May from a year earlier, according to RealtyTrac Foreclosure report released June 16.

“Allowing for the terms of residential mortgages to be changed in courts -- cramdowns -- would create incentives for voluntary modifications,” the IMF said. “In addition, parametric changes to federal mortgage modification programs and expanding state programs that assist unemployed homeowners could usefully foster more participation.”

To contact the reporters on this story: Cheyenne Hopkins in Washington at Chopkins19@bloomberg.net

To contact the editor responsible for this story: Chris Wellisz at cwellisz@bloomberg.net

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