E.Europe must strengthen financial systems -IMF

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Policymakers in emerging Europe will need to strengthen their financial systems and make labor and capital markets more flexible to reduce volatility as their economies converge with the west, the IMF said on Monday.

In its inaugural "Regional Economic Outlook" the International Monetery Fund (IMF) said that despite relatively high external vulnerabilities, emerging Europe has so far remained largely unscathed by the global financial turbulence sparked by the sub-prime mortgage crisis in the United States.

The report said the limited reliance on interbank markets and complex financial products has helped shield the region during the crisis, though risks have risen, especially for those countries that have been funding large current account imbalances with foreign bank borrowing.

"In this regard, the financial turbulence may herald a healthy correction to past exuberance, bringing risk spreads closer to fundamentals, improving credit discipline, and helping to reduce external imbalances in emerging countries," it said.

"In the emerging economies, inflationary pressures and external vulnerabilities will then warrant further interest rate increases in the central scenario.

"In those cases where monetary policy tools are ineffective or unavailable, the tightening will need to be achieved through fiscal restraint. Strong banking supervision will be critical throughout emerging Europe," the report said.

The IMF pointed toward the "blistering pace of credit growth and the rapid increase in private indebtedness" in many emerging European economies as one of the prime challenges faced in the context of converging with the richer west.

It said the region could benefit from sustained development of financial systems "in terms of efficiency, risk diversification, and resilience in coping with possibly volatile external capital flows".

The report said that the integration process of countries which have already joined the European Union could speed up the process of financial development, while those outside the EU should focus on "reinforcing the foundations of financial development". (Reporting by Alan Crosby; Editing by Gerrard Raven)

Keywords: IMF EAST/REPORT

[PRAGUE/Reuters/Finance.cz]