Europe Failed to Clear 'Skepticism' on Debt Crisis, IMF Says

Europe has yet to allay investor “skepticism” about the sustainability of the region’s debt, and any spread of the crisis would cloud global economic prospects, the International Monetary Fund’s number three official said.

“At least for now it looks like the spillover from the European sovereign crisis to areas outside of the region will be limited,” Naoyuki Shinohara, deputy managing director at the IMF, said in an interview in Tokyo yesterday. “However, if the European sovereign debt problems were to become bigger, we need to keep in mind that that could bring about considerable downside risks.”

European officials have indicated they’re ready to expand their efforts to contain the crisis that erupted last year and has so far led to bailout packages for Greece and Ireland. German Chancellor Angela Merkel this week expressed willingness to take whatever steps are needed to stem the turmoil.

The extra yield investors demand to hold Greece and Ireland bonds rather than German bunds “still remain very high, despite the rescue packages,” Shinohara said.

“That means that skepticism over the sustainability of their debt in the market hasn’t been cleared away,” said Shinohara, 57, a former top currency official at Japan’s Ministry of Finance. “It’s important that countries reduce their budget deficit, but they also need to tackle structural issues including boosting growth and lowering unemployment.”

Euro Declines
The euro declined against the dollar in reaction the IMF official’s remarks. It weakened to $1.3335 as of 10:56 a.m. in Tokyo from $1.3364 yesterday, when it touched $1.3383, the highest level since Jan. 4.
“The steps that the European Union officials can announce in terms of increasing the fund’s size that they have to help the peripheral countries can still take a few weeks to happen,” said Mansoor Mohi-uddin, Singapore-based head of global currency strategy at UBS AG, in a Bloomberg Television interview. “I’d rather still be a seller of the euro on the rallies.”

The extra yield investors demand to hold 10-year Spanish government bonds rather than German bunds touched a record 298 basis points on Nov. 30 compared with an average of 15 basis points over the first decade of the monetary union. The spread was 233 basis points after Spain yesterday sold 3 billion euros ($3.95 billion) of bonds in its first debt auction of the year.

‘Stand by’ Euro

Merkel said Jan. 12 that “we’re saying what we’ve always said since the Greek crisis: We will stand by the euro.” She was responding to remarks made by European Union Economic and Monetary Affairs Commissioner Olli Rehn, in which he called for a “comprehensive” plan to contain the sovereign debt crisis.

His proposals included an expansion of the “size and scope” of the EU’s 440 billion-euro ($577 billion) rescue fund, the European Financial Stability Facility.

Shinohara directed Japan’s currency policy as the vice finance minister of international affairs from July 2007 to July 2009.

The IMF official said Japan’s plan to buy bonds to fund the bailout of Ireland was a “very welcome development.” The purchases “aren’t a bad investment” for Japan because it would involve AAA-rated bonds and offer higher yields relative to German bunds, he said.

Finance Minister Yoshihiko Noda said on Jan. 11 that Japan will use existing euro assets in its foreign-exchange reserves to buy more than 20 percent of the bonds to be issued later this month by the European Financial Stability Facility.

Yuan Undervalued
Japan’s government is considering more purchases of the European bailout bonds in coming months to help boost confidence in the euro area, according to the two officials, who spoke on condition of anonymity because the government’s plans aren’t public.

In real effective exchange-rate terms, the value of the yen is “broadly in line with medium-term fundamentals and close to its long-run historical average,” Shinohara said.

The weighted average of the yen’s exchange rate against other currencies was 104.25 in November after rising to 105.17 in October, the highest since February 2009, according to the Bank of Japan.

Shinohara also said China should allow the yuan, also known as the renminbi, to appreciate faster to rebalance its economy.

“We continue to view the renminbi as substantially below the level consistent with medium-term fundamentals,” Shinohara said. “However, the exchange rate should not be viewed in isolation and a broad range of policies will be needed if China is to successfully rebalance its economy,” he said, adding that too rapid an appreciation of the currency is undesirable.

To contact the reporters on this story: Keiko Ujikane in Tokyo at kujikane@bloomberg.net Tatsuo Ito in Tokyo at Tito2@bloomberg.net