The head of the International Monetary Fund said on Monday the euro zone needed a bigger firewall to prevent Italy and Spain sliding towards default, underlining Europe’s responsibility in solving its own sovereign debt crisis.
In a speech in Berlin, Christine Lagarde, IMF managing director, said that without a larger bail-out fund, fundamentally solvent countries like Italy and Spain could be forced into a financing crisis.
“This would have disastrous implications for systemic stability,” she said.
Ms. Lagarde said that the euro zone authorities needed “a clear and credible timetable” to fold the existing European Financial Stability Facility (EFSF) into the new European Stability Mechanism (ESM), increase its size and ensure support from the European Central Bank.
Her speech directly addresses one of the most central issues in the euro zone sovereign debt crisis - the size and scope of official bail-out funds designed to stop instability spreading.
The ESM, whose launch leaders are trying to bring forward to July, is planned at around €500-billion. That is unlikely to be large enough to finance big bail-out program for Italy and Spain, should they be required.
Reports in the German magazine Der Spiegel suggested that Mario Monti, Italian prime minister, and Mario Draghi, ECB president, have asked for the ESM to be doubled to €1-trillion.
But in a television interview on Sunday evening, Wolfgang Schaeuble, German finance minister, said that increasing the size of the fund was not under discussion at the moment.
Although the IMF has not explicitly stated a target size for the euro zone bail-out fund, a paper presented last week to the fund’s executive board implied that the euro zone would need to find an extra $500-billion (U.S.) on top of existing resources.
The paper said there was likely to be an additional global demand for bail-out funds of around $1-trillion over the next two years, of which it said the IMF itself should aim to raise enough cash to meet half.
The IMF, which has provided about a third of the money for bail-outs in Ireland, Greece and Portugal, has been under increasing pressure from its emerging market shareholders and the U.S. not to extend more lending to western Europe without a credible commitment from the euro zone authorities to lead an effective solution to the crisis.
In an apparent reference to Germany, Ms. Lagarde on Monday suggested that fiscal consolidation should be delayed in euro zone countries which had the ability to do so.
“Yes, several countries have no choice but to tighten public finances, sharply and quickly,” she said. “But this is not true everywhere. There is a large core where fiscal adjustment can be more gradual.”
Ms. Lagarde said: “Those with fiscal space should support the common effort by reconsidering the pace of adjustment planned for this year.”
The IMF is due to release the latest versions of its global economic forecasts on Tuesday.
Ms. Lagarde said they would be lower than previously estimated for most of the world. “Even these lower forecasts assume a constructive policy path that is by no means assured,” she said.