By Brai Odion-Esene

WASHINGTON (MNI) – The Washington-based Institute of International
Finance warned Tuesday that ongoing deleveraging, lingering financial
sector vulnerabilities and pressure to move ahead with fiscal
consolidation will all be potential headwinds to economic growth.

In a statement released Tuesday but following a meeting last week,
the IIF’s Market Monitoring Group said given the limited further support
available from monetary policy and a number of significant potential
headwinds to growth, a period of extended economic weakness could pose
“notable risks” for financial stability.

The group is chaired by former central bankers Jacques de Larosiere
of France, also former head of the International Monetary Fund, and
David Dodge of Canada, and with representatives from the world of
international finance.

The group warned that a sustained period of weak growth “would also
exacerbate existing financial sector vulnerabilities, particularly for
many smaller, regional U.S. and EU banks.”

These weaknesses include significant exposure to real estate and
sovereign debt, high upcoming refunding needs, heavy reliance on central
bank funding in some cases, and more stringent capital requirements.

The MMG also noted the heavy budgetary pressures on many
sub-national entities, including U.S. state and local governments and
some European regions and cities, are adding to the challenges for
fiscal consolidation.

Market pricing, they cautioned, such as spreads on U.S. municipal
bonds, may not reflect the full degree of fiscal risk for the entities
and for their sovereigns as well.

The group called for more to be done with regards to the crafting
of medium-term fiscal consolidation plans, a move needed in order to
avoid the markets shifting focus to the U.S. and other major economies
with large fiscal deficits and rising debt-to-GDP levels.

“A consequent rise in long-term interest rates in these key
countries would push up sovereign borrowing costs generally,” the
statement warned. “This would both weigh on global economic growth
prospects and add to the challenges of ongoing fiscal adjustment.”

According to the MMG, the need for fiscal consolidation remains
urgent in some of the Euro Area’s smaller economies. The likelihood of
an extended period of slow growth in major economies in 2011 and beyond
has risen, it said, making the task of deficit and debt reduction more

The group went on to underline the importance of “firm and
unambiguous support” from international institutions such as the IMF
and major central banks in the fiscal adjustment process. It described
it as essential to ensure continued progress — and to prevent contagion
from affecting other similarly placed economies.

Coming up with “credible, politically supported” fiscal plans with
specific timetables, the MMG said, would allow the pace of fiscal
adjustment to be more measured if necessary in the immediate future.

The group also sounded a warning on the yet to be fully factored in
cumulative impact of regulatory changes — such as the Dodd-Frank Act
and Basel capital requirements — on economic growth.

Areas of note that will be impacted, they said, include the
availability and cost of bank credit, banks’ cost of funding, and
including losses from fragmentation and potential regulatory arbitrage.

“The role of banks in supporting economic growth — particularly in
Europe, which is far more reliant on bank financing — is essential and
should not be jeopardized,” the MMG said.

It called for detailed impact assessments — including all
important reform measures at both national and international levels —
to be updated and taken into account in the configuration and
implementation of these reforms.

** Market News International Washington Bureau: 202-371-2121 **

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