By SUDEEP REDDY
WASHINGTON—European nations need deeper economic integration to withstand the debt crisis threatening their currency union, the International Monetary Fund said in a stark warning about the region's economy.
In its annual assessment of the euro area released Tuesday, the IMF said the latest debt woes in Greece and other nations are "casting a shadow" over the euro zone's future while European officials struggle to formulate a decisive response.
The report marked the IMF's strongest warning to date about the viability of the 12-year-old euro, as officials in some of the currency bloc's stronger economies fight off a public backlash against expensive rescues of their debt-saddled neighbors.
"Despite genuine efforts to strengthen governance and cooperation," the IMF said, "the reaction by national authorities and economic agents has been one of retrenchment, threatening to turn back the clock on economic and financial integration."
The fund warned that the crisis in a handful of stressed nations risked spilling over into the entire region and the rest of the world. Together, the 17 countries that share the currency account for about a fifth of global economic output and the largest share of world trade. With markets already on edge, a deepening of the crisis risked creating "major global consequences."
The report called for a series of moves that would effectively reduce national sovereignty and that would likely face resistance from some European nations. The IMF staff said central authorities for the euro zone need to conduct more stringent surveillance of members' budgets, have more say in national policies and issue debt—some moves that go beyond the existing agreements binding the euro zone.
"We really need stronger economic governance for the euro area to restore confidence in the European project," said Luc Everaert, the IMF's division chief for euro area policies. "We need more Europe at this point and not less Europe."
"A key lesson is that one cannot really have a monetary union without a fully integrated financial system and proper institutions to deal with it," he said.
The IMF staff said Europe's rescue facility needs to be "more flexible" to allow it to recapitalize banks and buy government bonds on the secondary market. Ahead of this week's European summit, the fund said euro-zone officials must quickly end the uncertainty over the involvement of private-sector debt holders in the Greek rescue.
The IMF report marked the latest recommendations to solidify the strength of the currency area as markets increasingly question its survival. Last month, European Central Bank President Jean-Claude Trichet floated the idea of a European finance ministry and veto power over national budgets by central authorities, as well as other steps toward deeper political union among euro-zone members.
The IMF's warning comes at a pivotal moment for the euro zone. European leaders have struggled for more than a year to resolve the Greek crisis and convince financial markets that the nation's public finances are on a sustainable course. Euro-zone officials plan to meet Thursday for an emergency summit in Brussels to determine the next stage of the Greek rescue package.
The staff report was completed before the IMF's new Managing Director Christine Lagarde—previously France's finance minister—took up her post two weeks ago, the fund said. Ms. Lagarde chaired a board meeting Monday to discuss the findings, at which directors again called for comprehensive action by Europe to address the crisis.
The IMF said troubles in some overstretched nations risked dragging down an otherwise resilient European economy.
Northern European nations, led by Germany, have posted surprisingly strong growth in recent months as private demand picks up and labor markets recover. Overall, the IMF projected that the euro-zone economy would grow 2% this year and 1.7% in 2012.
Greece, Ireland and Portugal—the three euro-zone economies now receiving IMF rescue funds—are struggling as they slash government budgets. Spain is coping with the aftermath of a real-estate bubble, while Italy's economic growth remains chronically disappointing.
"If we can contain the crisis to the periphery, we shouldn't be worried about the rest of the euro area," Mr. Everaert said.
"Despite genuine efforts to strengthen governance and cooperation," the IMF said, "the reaction by national authorities and economic agents has been one of retrenchment, threatening to turn back the clock on economic and financial integration."
The fund warned that the crisis in a handful of stressed nations risked spilling over into the entire region and the rest of the world. Together, the 17 countries that share the currency account for about a fifth of global economic output and the largest share of world trade. With markets already on edge, a deepening of the crisis risked creating "major global consequences."
The report called for a series of moves that would effectively reduce national sovereignty and that would likely face resistance from some European nations. The IMF staff said central authorities for the euro zone need to conduct more stringent surveillance of members' budgets, have more say in national policies and issue debt—some moves that go beyond the existing agreements binding the euro zone.
"We really need stronger economic governance for the euro area to restore confidence in the European project," said Luc Everaert, the IMF's division chief for euro area policies. "We need more Europe at this point and not less Europe."
"A key lesson is that one cannot really have a monetary union without a fully integrated financial system and proper institutions to deal with it," he said.
The IMF staff said Europe's rescue facility needs to be "more flexible" to allow it to recapitalize banks and buy government bonds on the secondary market. Ahead of this week's European summit, the fund said euro-zone officials must quickly end the uncertainty over the involvement of private-sector debt holders in the Greek rescue.
The IMF report marked the latest recommendations to solidify the strength of the currency area as markets increasingly question its survival. Last month, European Central Bank President Jean-Claude Trichet floated the idea of a European finance ministry and veto power over national budgets by central authorities, as well as other steps toward deeper political union among euro-zone members.
The IMF's warning comes at a pivotal moment for the euro zone. European leaders have struggled for more than a year to resolve the Greek crisis and convince financial markets that the nation's public finances are on a sustainable course. Euro-zone officials plan to meet Thursday for an emergency summit in Brussels to determine the next stage of the Greek rescue package.
The staff report was completed before the IMF's new Managing Director Christine Lagarde—previously France's finance minister—took up her post two weeks ago, the fund said. Ms. Lagarde chaired a board meeting Monday to discuss the findings, at which directors again called for comprehensive action by Europe to address the crisis.
The IMF said troubles in some overstretched nations risked dragging down an otherwise resilient European economy.
Northern European nations, led by Germany, have posted surprisingly strong growth in recent months as private demand picks up and labor markets recover. Overall, the IMF projected that the euro-zone economy would grow 2% this year and 1.7% in 2012.
Greece, Ireland and Portugal—the three euro-zone economies now receiving IMF rescue funds—are struggling as they slash government budgets. Spain is coping with the aftermath of a real-estate bubble, while Italy's economic growth remains chronically disappointing.
"If we can contain the crisis to the periphery, we shouldn't be worried about the rest of the euro area," Mr. Everaert said.
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