Worldwide warnings of escalating risk

The International Monetary Fund (IMF) and the European Systemic Risk Board (ESRB) have both issued stern warnings on global risk.

Since the previous ESRB general board meeting on June 22, 2011, "risks to the stability of the European Union (EU) financial system have increased considerably", said the board in a statement on Wednesday.

"Key risks stem from potential further adverse feedback effects between sovereign risks, funding vulnerabilities within the EU banking sector, and a weakening of growth outlooks both at global and EU levels," it added.

In its Fiscal Monitor, released on Wednesday, the IMF has warned that "despite progress in addressing key fiscal weaknesses in many countries, the global fiscal environment remains subject to a high degree of risk".

Within the eurozone, the IMF found many countries had made "good progress in reducing high deficits and specifying medium-term plans and have committed to enhancing fiscal institutions". Nevertheless, it said: "Borrowing spreads have risen significantly in larger economies, including Italy and Spain, showing that market sentiment can change abruptly."

The ESRB agreed there had been troubling developments in the EU. "During the past months, sovereign stress has moved from smaller economies to some of the larger EU countries," the organisation said.

But the panic has clearly gone further, said the ESRB. "Signs of stress are evident in many European government bond markets, while the high volatility in equity markets indicates that tensions have spread across capital markets around the world. The high interconnectedness in the EU financial system has led to a rapidly rising risk of significant contagion. This threatens financial stability in the EU as a whole and adversely impacts the real economy in Europe and beyond."

The IMF lamented the "more limited" progress in Japan and the United States in defining and implementing fiscal adjustment plans. The Fund also said the political impasse reached in the US when trying to agree a deal to raise the country's debt ceiling, "illustrates the significant challenges to implementing fiscal adjustment going forward".

It was not only developed economies in the firing line, however. The report said that in emerging economies, the fiscal stance is "insufficiently tight" in some cases in view of "inflationary pressures and rapid growth, fuelled in part by strong capital inflows".

The IMF called for other countries to learn from seeing the effects of contagion in Europe. "The speed and severity with which financial pressures spread in the euro area should serve as a cautionary tale to Japan and the US," said the report.

For the eurozone, the challenge was to "sustain fiscal consolidation, minimise growth fallout and address concerns about the adequacy of crisis-resolution mechanisms", the report stated.

Those under "severe market pressure" should implement deficit reduction plans "in full and without delay", while those with more fiscal space could "choose a more back-loaded profile", said the report.

With respect to the crisis resolution measures agreed in Europe on July 21, the IMF said the decision to take steps to increase the flexibility of the European Financial Stability Facility was welcome. "Countries need to act quickly to implement them," said the report.

The ESRB also threw its weight behind speedy implementation of these measures. "Decisive and swift action is required from all authorities," it said.

Going forward, the advice from the IMF to the US and Japan was to issue "sufficiently detailed and ambitious" plans to reduce their deficits and debts. If these are not forthcoming, the countries risk losing credibility, the report said.

For emerging countries, the Fund's message was to make "faster progress in strengthening fiscal fundamentals before cyclical factors or spillovers from advanced economies turn against them". The IMF warned developing countries to use the good times wisely and not to become complacent, as in some, "signs of overheating are arising".

With this report taking on a cautious tone, the IMF cemented its gloomy outlook for the global economy. On Tuesday, in its World Economic Outlook report, the IMF cut growth figures and warned of a "weak and bumpy" recovery.