–Putting US Debt on Sustainable Path Critical to Stability
–IMF Official: US Debt Downgrade Would Be Very Damaging for US, World

By Heather Scott

WASHINGTON (MNI) – Amid continued uncertainty on when and how the
White House and Congress might strike a deal to raise the U.S. debt
ceiling and agree on a deficit reduction plan, the International
Monetary Fund board stressed the urgency of both, according a report
Monday.

The IMF Executive Board met July 22 to discuss the annual review of
the U.S. economy, and focused on the importance of a credible
medium-term plan to reduce the deficit and get the debt level on a more
sustainable path.

And an IMF official warned of the dangers of a possible downgrade
of U.S. credit ratings, for the domestic as well as world economies.

A “downgrade would be very damaging for both the U.S. economy and
the rest of world,” Rodrigo Valdes, senior advisor for the IMF’s Western
Hemisphere Department, told reporters in a conference call.

He cautioned that there is “a lot of uncertainty. This would be the
first time it happens, so nobody really knows what would be the true
effects” and they are “very difficult to predict with certainty.”

The IMF board said “placing public debt on a sustainable path is
critical to the stability of the U.S. economy, with positive spillovers
to other countries,” according to the statement.

“Directors highlighted the urgency of raising the federal debt
ceiling and agreeing on the specifics of a comprehensive medium-term
consolidation plan. With a well-defined, credible multi-year framework
in place, the pace of deficit reduction in the short run could be more
attuned to cyclical conditions,” the IMF statement said.

“Directors generally concurred that fiscal adjustment should start
in FY2012 to guard against the risk of a disruptive loss in fiscal
credibility. The strategy should include entitlement reforms, including
additional savings in health care, as well as revenue increases,
including by reducing tax expenditures,” the statement said.

Valdes noted in response to a question that some U.S. officials are
concerned about the potential for negative spillovers on the world
economy in the short run of an aggressive fiscal consolidation.

However, he said IMF staff have said “it’s worth the consolidation
even if it has some negative short run effects, because the alternative,
that may be not a high-probability event, but is so complex, so
difficult to digest, that it is better not to go there.”

And Valdes echoed the staff and board recommendations that with a
credible multi-year plan the adjustment does not have to be fully
front-loaded, but can be spread out over several years.

While the main report was released June 29, the IMF released the
detailed staff report as well as the new spillover report, which the IMF
staff are preparing for five key economies — China, Euro Area, Japan,
United Kingdom and the United States — as part of the effort to improve
surveillance and spot risks to the global economy.

The report notes that the U.S. has the potential for “uniquely
large policy spillovers … which directly affect financial conditions
abroad and seep into domestic activity everywhere. These spillovers
strengthen the case for clear communication of U.S. policies and for
better-defined medium-term fiscal policy framework.”

As previously reported, the IMF report said U.S. monetary policy is
likely to remain accommodative for some time.

The report said “given prospects for subdued inflation and
significant resource underutilization, an accommodative monetary policy
will likely remain appropriate for quite some time.”

However, “They called for continued vigilance to inflation
developments and a decisive policy response as appropriate. When
conditions warrant a monetary exit, a gradual reduction of asset
holdings, accompanied by clear communication, was viewed as an essential
first step.”

The U.S. recovery is expected to pick up in the second half of the
year after a soft spot caused by transient factors in the first half,
though growth is expected to remain sluggish — 2.5% in 2010 and 2.7% in
2011. More attention to resolving issues in the labor and housing
markets will be needed, the IMF said.

“With a still-wide output gap and downside risks to the outlook,
especially potential spillovers from European financial markets,
Directors called for a cautious approach to unwinding macroeconomic
support,” the IMF board said.

The board called on U.S. officials to resist efforts to water down
reforms to strengthen financial sector regulation.

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

[TOPICS: M$U$$$,MGU$$$,MFU$$$,M$$CR$,MI$$$$,M$X$$$,MT$$$$]