IMF Warns Sovereign Risk Could Prolong Crisis

Concern over public debt could prolong the credit crisis although Greece is a special case and should not be compared to other euro zone members, the International Monetary Fund said on Tuesday.

The IMF said the health of the global financial system had improved alongside a fragile recovery in the world economy, but that investors' nerves over rising levels of public debt could undermine stability gains made so far.

"Advanced country sovereign risks could undermine stability gains and take the credit crisis into a new phase," the IMF said in an update of its Global Financial Stability Report.

The IMF said there was a danger that deteriorating sovereign credit risk could quickly spill over to domestic banking systems and feed through into the real economy, triggering fresh financial instability.

The concern is that investors will demand higher interest rates to buy government debt, driving up borrowing costs for both the public and private sector.

Questions over Greece's ability to finance a national debt greater than its annual economic output have shaken confidence in the country, forcing the government to seek talks with the IMF and European Union that could lead to a bailout.

Jose Vinals, director of the IMF's monetary and capital markets department, said the IMF was not indicating another crisis was imminent.

"We're saying that as a result of the crisis, the accumulation of public debt has been significant and there is concern now in the market with sovereign risk," he told reporters.

He said countries must act now and design credible medium-term fiscal consolidation plans that have public support.

But he dismissed concerns that problems in Greece could be replicated in other countries such as Portugal and Spain.

"Greece is a special case and we can't say other countries are in that situation," he said. "These other countries have solid fiscal institutions and don't have the fiscal uncertainties that Greece had," he added.

"Greece is a wakeup call, basically saying that in some extreme cases, such as Greece, this could lead to serious problems," he added.

The IMF reduced estimates of global bank write-downs to $2.3 trillion from the $2.8 trillion it forecast in October 2009, a reduction that reflects improvements in the global economy and in bank balance sheets, it said.

This is significantly below previous estimates as high as $4 trillion a year ago. However, that figure included losses for insurance companies as well, and also reflected a point when the stock market and other assets were in the doldrums.

Asset prices have rallied since then, allowing banks to recoup some of those predicted losses.

In the United States, estimated loan write-downs for 2007-2010 were revised down by $66 billion to $588 billion. Still, it warned that mortgage delinquencies and foreclosures are rising as unemployment persists.

For the euro-area banks, improvements in growth and unemployment forecasts have lowered the estimated total loan writedowns and provisions by $38 billion to $443 billion since the October 2009 estimate.

It said while most banks were now adequately capitalized, some segments of national banking systems remain poorly capitalized mainly due to losses related to commercial real estate.

The report said banks, however, face new challenges including from more stringent regulation that may require them to raise further capital and make their balance sheets less risk.