IMF praises Spain's reforms but warns of risks

 

Spain and Ireland have made strong progress in fixing their economies but recovery will hinge on their capacity to clean up ailing lenders, create jobs and maintain investor confidence, the IMF said on Wednesday.

Both countries were forced to seek international financial support after a decade-long boom fuelled by cheap credit ended abruptly in 2008, leaving their banks struggling with bad property loans and their economies in slow or negative growth.

While praising Madrid and Dublin, as on previous occasions, for their efforts to implement spending cuts and structural reforms, the IMF said in its annual reviews that the outlook remained difficult in both cases.

Echoing European Commission recommendations made last month, the Fund said Spain should further reform labour laws to make it easier for firms to modify shifts or reduce wages rather than dismiss workers and cut taxes to promote job creation.

The country, in or close to recession for the past five years and with an unemployment rate above 27%, should also make its deficit-reduction programme more growth-friendly.

The IMF said while Spain would probably return to growth later this year, weak activity would weigh on the banks, with loan quality worsening and less credit flowing into the economy.

The challenge is somewhat similar in Ireland.

The 2nd euro zone country to seek an EU-IMF rescue in 2010, after Greece, it has a good chance of exiting its €85 billion bailout this year thanks to tight budgets and restored growth, the IMF said.

In contrast to many euro zone peers, the Irish economy has expanded for much of the last two years, and the Fund kept its growth forecasts for 2013 and 2014 unchanged, at 1.1% and 2.2% respectively.

But, as in Spain, Ireland has still not restored its banks to health, a task which could be made easier if Europe moves quickly towards the creation of a full banking union.

BANKS

Both countries agreed to a detailed review of their troubled banks' loan books this year ahead of stress tests in 2014.

The IMF's Irish mission chief Craig Beaumont said the first exercise was not expected to lead to a need for capital injections. However, Spain's Economy Minister Luis de Guindos said this week Spanish banks may need an extra 2 billion euros of capital, which Madrid could cover without new EU money.

The Spanish government also insisted that the worst of the economic crisis had passed, but higher debt costs and bad loan rates in the banking sector cast doubt on that assertion.

The IMF's Spanish mission chief James Daniel said Spain's banks should reinforce the quantity and quality of their capital and quickly sell distressed assets, as non-performing loans are likely to increase and weigh on their performance.

He also recommended regular and rigorous bank stress tests.

CHALLENGES

Both countries also face specific challenges: creating jobs for Spain and regaining full market access for Ireland.

Unemployment has risen steadily across Europe as the economic crisis has dragged on, and job creation will top the agenda at a regional summit next week, with leaders meeting again to discuss the issue in Berlin on July 3.

The IMF insisted Spain should amend last year's flagship labour reform, something PM Mariano Rajoy has said he unwilling to do. Rajoy has instead called for the ECB to take more measures to help reduce the high borrowing costs faced by Spain's private sector.

The IMF backed this call on Wednesday and said the option of an ECB bond-buying programme for Spain should be kept open.

Ireland, which has consistently hit targets set under its bailout, came closer to weaning itself off emergency aid by raising €5 billion with a 10-year bond sale in March.