Euro zone at critical stage, reforms needed for growth - IMF

The debt crisis in Europe has reached a "critical stage", and a forceful move toward a more complete monetary union - particularly a banking union - and more fiscal integration is needed to arrest the decline in confidence engulfing the region, the International Monetary Fund said.

"Despite extraordinary policy actions, bank and sovereign markets in many parts of the euro area remain under acute stress, raising questions about the viability of the monetary union itself," the Washington-based organisation said.

The IMF called for "wide-ranging structural reforms throughout the euro area to raise growth, while demand support should be maintained in the short term to cushion the impact of the region’s adjustment efforts".

Greece's new government, elected last week on the promise it would renegotiate terms of the country's bailout, and the unpopular austerity measures it stipulates, along with debt problems in Spain that saw the government pay more than 5 percent on 12 month bonds, the highest since the launch of the euro, coupled with questions about ability of Italy, whose economy remains sluggish to manage its €1.9 trillion debt, do little to calm jittery market fears about the future of the euro and the potential impact its collapse may have on the global economy.

Europe's economy is expected to contract this year by about 0.7 percent according to the Economist Intelligence Unit. Investor sentiment in the euro zone is wavering and there is considerable uncertainty about the ability of the 17 countries that use the euro to agree on a how to find a solution to the two-year debt crisis at their meetings this week. Germany is against issuing eurobonds while France believes the debt instruments should be seriously considered.  

"Investors are withholding funding from member states most in need, moving capital to safe havens and driving risk premiums to new records," the IMF said in its most recent report. "Demand is weakening and unemployment increasing across the euro area. Lower growth and heightened market stress are compounding the difficulties in reducing debt burdens. The risk of stagnation and long-term damage to potential growth will increase as unemployed workers lose skills and new workers find it difficult to join the active labor force."

Though important actions have been taken like the European Central Bank lowering policy rates and conducting special liquidity interventions to address immediate bank funding pressures and averting an even more rapid escalation of the crisis, the crisis calls for a stronger and more collective effort, the organisation said.

"Downward spirals between sovereigns, banks, and the real economy are stronger than ever," the IMF said. "As concerns about banks’ solvency have increased - because of large sovereign exposures and weak growth prospects in many parts of the euro area - the effectiveness of liquidity operations has diminished. Sovereigns, in turn, are struggling to backstop weak banks on their own. Absent collective mechanisms to break these adverse feedback loops, the crisis has spilled across euro area countries."

Contagion from further intensification of the crisis "would be sizeable globally," it said, adding "spillovers to neighbouring EU economies would be particularly large. A more determined and forceful collective response is needed".

The IMF said the immediate priority should be concrete action toward a banking union for the euro zone area, including the establishment of a deposit guarantee scheme to help break the links between domestic banks and their sovereigns, and support depositor confidence in conjunction with a series of steps that include the introduction of a limited form of common debt, which would boost fiscal integration and risk sharing.