Breaking News

Tweet TWEET

Lagarde Joins Warning on Austerity as Leaders Head to Davos

International Monetary Fund Managing Director Christine Lagarde joined world financial and trade organization chiefs in warning policy makers gathering in Davos, Switzerland next week against fiscal cuts that jeopardize growth.

“The world faces significant and urgent challenges that weigh heavily on prospects for future growth,” Lagarde and members of the Global Issues Group of the World Economic Forum said in a statement. “We worry about decelerating global growth and rising uncertainty, high unemployment” and a potential shift to protectionist policies, they said.

While governments need to stem contagion in Europe and restore confidence in financial institutions to end the sovereign-debt crisis and spur expansion, they should manage fiscal consolidation to promote rather than reduce growth prospects, the group said. Its members also include World Bank President Robert Zoellick, World Trade Organization Director- General Pascal Lamy and the heads of eight other multilateral and regional institutions.

Policy makers and business leaders will meet at the World Economic Forum starting on Jan. 25 after the World Bank cut its global growth forecast this month by the most in three years, saying that a recession in the euro region threatens to exacerbate a slowdown in emerging markets. The IMF proposed this week to raise its lending capacity by as much as $500 billion to insulate the world against any worsening of Europe’s debt crisis.

ECB’s Role

Lagarde and the heads of the institutions highlighted an expanded role of the European Central Bank as one option for helping resolve the region’s crisis.

“Different options are being considered for stemming contagion in the euro area,” the Global Issues Group said. “They have involved greater recourse to the European Central Bank’s balance sheet and require a strengthening of the European Financial Stability Fund. Governance reforms are needed to offset the risk of moral hazard involved in short-term support packages and to ensure longer-term fiscal discipline.”

The ECB’s decision to offer banks unlimited three-year loans and the central bank’s purchase of sovereign bonds helped balloon its balance sheet to a record 2.73 trillion euros ($3.5 trillion) in December.

In the short term, confidence in financial institutions can be restored by recapitalizing banks quickly where necessary and ensuring that deleveraging by lenders doesn’t impair trade and project finance, the Global Issues Group said.

Banks Hoarding

Banks are hoarding the European Central Bank’s record 489 billion-euro injection into the banking system, thwarting attempts by policy makers to avert a credit crunch in the region. Almost all of the money loaned to 523 euro-area lenders last month wound up back on deposit at the Frankfurt-based central bank instead of pouring into the financial system, according to estimates by Barclays Capital based on ECB data.

Governments are urging European banks to keep lending to companies and individuals while requiring them to raise an additional 114.7 billion euros of core capital by June to weather a deepening sovereign-debt crisis. Instead of raising equity, most lenders across Europe have vowed to meet capital rules by trimming at least 950 billion euros from their balance sheets over the next two years, either by selling assets or not renewing credit lines, according to data compiled by Bloomberg.

Ensure Funding

Continuing the ECB’s measures to secure bank funding and liquidity will help stem financial contagion and stabilize the region’s fiscal frameworks, while enhancing the European Financial Stability Facility and European Stability Mechanism will “ensure governments can fund at sustainable rates,” the Global Issues Group said.

European governments have redoubled efforts to set up the 500 billion-euro European Stability Mechanism by July, a year ahead of schedule, after a credit rating downgrade raised concerns over the strength of the temporary European Financial Stability Facility aid fund created at the outset of the crisis.

The world economy will grow 2.5 percent this year, down from a June estimate of 3.6 percent, according to the World Bank. The IMF will cut its global growth forecast for 2012 to 3.3 percent from 4 percent when it publishes its World Economic Outlook report next week, the Daily Telegraph said yesterday, citing a leaked draft of the publication.

Leaders of the Group of 20 should intensify efforts to develop a “more comprehensive action plan” for economic expansion and job creation ahead of a planned summit in June in Mexico, the Global Issues Group said.

Political Energy

“We call on leaders to devote the necessary political energy to deliver concrete actions to exit the crisis and boost growth,” they said.

The other members of the group are Mark Carney, chairman of the Financial Stability Board; World Health Organization Director-General Margaret Chan; Angel Gurria, Secretary-General at the Organization for Economic Cooperation and Development; African Development Bank President Donald Kaberuka; Asian Development Bank President Haruhiko Kuroda; Inter-American Development Bank President Luis Alberto Moreno; Josette Sheeran, executive director of the United Nations World Food Programme and International Labour Organization Director-General Juan Somavia.

To contact the reporter on this story: Shamim Adam in Singapore at sadam2@bloomberg.net

To contact the editor responsible for this story: Stephanie Phang at sphang@bloomberg.net

Press spacebar to pause and continue. Press esc to stop.

Bloomberg reserves the right to remove comments but is under no obligation to do so, or to explain individual moderation decisions.

Please enable JavaScript to view the comments powered by Disqus.