The fund said sovereign debt woes were spilling into the broader Spanish economy, risking a “pernicious feedback loop” for private companies. The danger is another bout of capital flight combined with a “credit shock” as banks deleverage drastically to meet higher capital ratios.
Olivier Blanchard, the IMF’s chief economist, said Madrid was courting fate by trying to muddle through without a bail-out – and without the tough terms it would bring – now that borrowing costs had fallen on hopes of bond purchases by the European Central Bank.
Mr Blanchard said investors had most likely anticipated a rescue by the ECB and the European Stability Mechanism (ESM). “If so, we can’t be sure that yields will stay low for much longer,” he said.
The IMF said capital flight from Spain reached €296bn (£238bn) in the 12 months to June, or 27pc of GDP. It matches the intensity of “sudden stop” crises seen in emerging markets.
Banks in Spain, Italy, and the EMU fringe cannot easily make up the shortfall by turning to the ECB because they are short of usable collateral.
The biggest risk is that Europe’s banks will have to slash balance sheets by €4.5 trillion by the end of 2013, largely concentrated in the Club Med bloc.
The fund said Europe’s failure to flesh out promises for a banking union – needed to break the “vicious circle” between banks and states – risked a violent credit crunch, slashing an extra 4pc off output in southern Europe next year. Most economists say a shock of this magnitude would push Spain into a death spiral.
The IMF said asset shrinkage could be limited to €2.3 trillion but only if the eurozone showed “unflinching commitment to implement already adopted measures”. This means sticking to its June summit deal to clean up legacy debts from banking crises in Spain and Ireland, preferably with a pan-EMU deposit insurance scheme .
Mr Rajoy and French president Francois Hollande seized on the warning , demanding the AAA core stands behind its pledge to let the ESM recapitalise Spain’s banks directly. “We have to show we’re serious people and that we do what we say we are going to do,” said Mr Rajoy . Germany, Austria, Finland, and Holland reneged on the accord two weeks ago .
The Franco-Spanish tete-a-tete comes two days before leaders of a newly-dubbed “Mediterranean Front” gather in Malta to thrash out a Latin strategy and plot ways to break the German lockhold on policy. Portugal’s prime minister, Pedro Passos Coelho, will join France, Spain, and Italy for the first time, suggesting that the free-market advocate may have lost its enthusiasm for the German austerity view. Diplomats say the meeting marks a break with EU tradition. For decades, France and Germany pre-cooked agendas before EU summits.
The Latin revolt has been made easier by the IMF’s admission that the fiscal tightening is doing more damage than expected, and may be self-defeating in some countries if not offset by monetary stimulus.
Vitor Constancio, the ECB’s vice-president, said the EU must be careful not to push austerity beyond the therapeutic dose. “The whole balance has to be continuously under observation,” he said, marking a shift in ECB thinking.
Telegraph
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