PARIS (MNI) – The Eurozone economy is likely to contract slightly
this year and register modest growth in 2013, but a renewed escalation
of the debt crisis could cause a much sharper downturn, the
International Monetary Fund said on Tuesday.

In its spring World Economic Outlook report, the IMF said it
expected the euro-area economy to shrink by 0.3% this year before
recovering to a 0.9% growth rate in 2013.

But the IMF also outlined a “downside scenario” in which weak
growth raises doubts about governments’ ability to meet deficit targets,
forcing them to impose even tougher austerity measures on their
economies. Under such a scenario, euro area growth could be 3.5% lower
than its baseline forecast, the Fund said.

“The balance of risks to Europe’s near-term growth prospects
remains to the downside,” the report said. “Despite the progress in
strengthening crisis management in recent months, a renewed escalation
of the euro crisis remains a possibility as long as the underlying
issues are not resolved.”

The IMF said the euro area requires a policy mix that supports
growth while addressing the need to cut deficits and strengthen banks.
It noted that Spain’s 2012 deficit target, set at 5.3% of GDP, “could
have accommodated more fully the impact of the weak growth outlook.”

In order to support growth in the euro area as whole, countries
with stronger finances, like Germany, “should consider slowing the pace
of fiscal consolidation,” the IMF said.

With much of the burden of fostering growth falling on monetary
policy, the IMF also urged the European Central Bank to cut interest
rates further and to continue its use of non-standard policy measures to
address banks’ funding problems.

And to reduce the drag on the euro-area economy caused by bank
deleveraging efforts, government money should be used to help banks
raise capital, the IMF said.

There is also a need, it said, “for a pan-euro-area facility with
the capacity to take direct stakes in banks, including in countries with
little fiscal room to do so themselves.”

–Paris newsroom; +33142715540; jduffy@marketnews.com

[TOPICS: M$$CR$,M$X$$$,MFX$$$,M$S$$$,M$$EC$,MGX$$$]