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Published: Thursday, 9/22/2011 - Updated: 3 years ago

Warnings mount on euro crisis as G20 gathers

Pressure growing to recapitalise European banks

BY SAKARI SUONINEN AND DAVID LJUNGGREN
REUTERS

FRANKFURT/OTTAWA — Seven world leaders demanded Europe take more decisive action against its debt crisis and a European Central Bank study warned on Thursday that the entire euro currency project was now in peril.

As ministers gathered in Washington for meetings of the Group of 20 and International Monetary Fund, an open letter to G20 president France from the leaders of Australia, Canada, Indonesia, Britain, Mexico, South Africa and South Korea stressed the threat of the euro zone crisis spreading worldwide.

"Euro zone governments and institutions must act swiftly to resolve the Euro crisis and all European economies must confront the debt overhang to prevent contagion to the wider global economy," the seven leaders wrote.

"The euro zone must look at all possible options to ensure long-term stability in the world’s second largest international currency."

The ECB study, perhaps the most strongly-worded warning about the future of the euro by a central banker, was a parting shot from ECB chief economist Juergen Stark, who resigned this month after opposing the bank’s policy of buying troubled countries’ bonds.

"Greatly increased fiscal imbalances in the euro area as a whole and the dire situation in individual member countries risk undermining stability, growth and employment, as well as the sustainability of EMU (Economic and Monetary Union) itself," said the research paper, which was published by the ECB but not endorsed by it.

The study co-authored by Stark recommended euro zone countries face tough new debt rules, have their deficits approved at a European level and if they reneged, should face automatic fines.

More urgent is the need to bolster Europe’s banks and enable new powers for the euro zone’s bailout fund given many economists expect Greece to be unable to avoid default indefinitely.

The European Union’s new super-watchdog, the European Systemic Risk Board, warned that the knock-on effects of the debt crisis that began in Greece in 2009 had led to considerably higher risks of financial instability in Europe.

"The high inter-connectedness 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 board chaired by ECB President Jean-Claude Trichet called for "decisive and swift action" from policymakers, widely seen as being slow in the fight to contain the crisis.

It said supervisors "should coordinate efforts to strengthen bank capital, including having recourse to backstop facilities, taking also into account the need for transparent and consistent valuation of sovereign exposures."

The IMF last month called for a recapitalisation of European banks — a move that was fiercely criticised by bank executives and EU governments at the time.

Speaking on the eve of IMF and G20 meetings, Canadian Finance Minister Jim Flaherty joined a chorus of non-European officials warning that a new global credit crunch could bite unless Europe tackles Greece’s debt problems, the most acute in the 17-nation currency area.

"The number one thing we’ll talk about tomorrow night at dinner — as we did in Marseilles with the G7 — is that Europe has to pick a lane here, they’ve got to deal with that issue respecting Greece," he told the Canadian Broadcasting Corp.

"Otherwise the markets will get ahead, we will have some sort of a crisis, it will become a banking crisis, it will affect banks all around the world, we could be into another credit crisis which will cause contraction in the real economy. So we’ve got to deal with that," he said.

Flaherty said European nations could "get ahead of the game" if they were prepared to increase the euro zone’s bailout funds to 1 trillion euros from 440 billion euros.

The crisis has raised pressure on European banks, and particularly French lenders, which are heavily exposed to Greece and other troubled euro zone sovereigns.

France’s biggest bank, BNP Paribas (BNPP.PA) denied a Reuters report that it was in talks with the Gulf state of Qatar on taking a stake in the bank.

The report highlights efforts by European governments and companies to seek support from sovereign wealth funds and big emerging economies to counter a worsening sovereign debt crisis which the IMF says could plunge the West back into recession.

BNP chief executive Baudouin Prot, asked about the report that the bank was seeking an investment from Qatar, told BFM radio: "I formally deny this. We have no particular contact because we don’t need a capital increase."

Concerns over French banks’ exposure has wiped tens of billions of euros off their market value in recent weeks and restricted their access to wholesale funding, particularly from U.S. funds.

A Qatar-based source close to the situation told Reuters late on Wednesday: "They (Qatar) have been talking to banks across France, given the tremendous need for capital."

Shares in BNP fell a further 4.5 percent and the other two big French lenders, Societe Generale and Credit Agricole, were both down 7 percent by 1200 GMT.

Data released on Thursday highlighted the prospect of a sharp slowdown in the euro zone economy in the second half of the year, raising pressure on the ECB to hold or cut interest rates and use its resources to stimulate the economy.

The euro zone flash composite purchasing managers index fell in September, marking the first contraction in private sector business activity in two years, with the second successive monthly fall in the manufacturing sector.

"With ongoing fiscal austerity and political leaders still way behind the curve in terms of resolving the debt crisis, we cannot dismiss the risk of a full-blown recession," said Martin Van Vliet, senior economist at ING.

"Today’s data will amplify pressure on the ECB to come to the rescue and use the remaining scope for monetary stimulus."



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