Tuesday, Jul 26, 2011
(From THE WALL STREET JOURNAL)
By Sudeep Reddy
A loss of investor confidence in U.S. debt could have "universally large and negative" effects on the rest of the world, the International Monetary Fund said Monday in its annual assessment of the U.S. economy.
The IMF delivered its warning as the White House and Congress struggled to reach a deal to increase the federal government's borrowing limit before an Aug. 2 deadline.
The large credit-rating firms have warned they will lower their top-notch ratings on U.S. debt if the government defaults. Standard & Poor's has also said it might downgrade the debt if no credible plan is reached for reining in deficits over the long term.
A debt downgrade or failure to raise the debt ceiling would have "significant global repercussions, given the central role of U.S. Treasury bonds in world financial markets," the fund said in a staff report.
A downgrade would be "very damaging for both the US economy and the rest of the world" by hitting stock markets and pushing interest rates higher, IMF senior adviser Rodrigo Valdes told reporters. It would be new territory for U.S. debt, so "there's a lot of uncertainty," he said. "Nobody really knows what would be the true effect."
The fund said officials from other nations feared that a reassessment by markets of U.S. government finances "could lead to a rapid deterioration in global financing conditions, capital flows and possibly the value of the dollar."
The warning comes amid slowing U.S. economic growth and high unemployment. The fund said risks to the nation's economic outlook had increased because of its fiscal troubles, renewed weakness in the housing market, higher commodity prices, constraints on credit and concern in financial markets about overseas debt woes overseas, such as in Europe.
The IMF said it expected the U.S. economy to expand at a modest pace, with inflation-adjusted growth of 2.5% this year and 2.7% next year.
The report also highlighted the uneven nature of the U.S. recovery. The financial industry and businesses -- particularly large companies -- have improved, while housing and labor markets remain weak. The recovery's slow pace "is consistent with past international experience in the aftermath of housing and financial crises," the IMF said.
The fund's report said board members -- representing governments around the world -- generally agreed that the U.S. should start a budget overhaul in the fiscal year that begins in October. They said the strategy should involve changes to health-care spending and entitlement programs, which include Social Security, as well as revenue increases, for example by curbing some tax breaks.
At the same time they called for "a cautious approach" to unwinding measures to support the economy -- such as extremely low interest rates from the Federal Reserve and a temporary payroll tax cut for workers -- given the weakness in the economy and renewed risks to growth.
The fund largely backed the central bank's policies, despite criticism from abroad that it has aggravated inflation and pushed commodity prices higher. The IMF said the Fed's $600 billion bond-buying program, which ended in June, had "limited spillovers" on the rest of the world.
That effort, introduced last fall to boost the U.S. economy by keeping market interest rates lower, faced intense criticism from some emerging-market nations that blamed the program for strengthening their currencies and accelerating unhealthy capital inflows.
(END) Dow Jones Newswires
26-07-11 0414GMT
