The stumbling global economic recovery and deepening euro zone sovereign debt crisis pose a heightened risk to financial markets in advanced economies, the International Monetary Fund said Wednesday, calling for swift government action.
Political strife across many of the world's largest economic players, including the United States and European Union, have prompted private financial markets to "question their ability" to take action to boost economic expansion, while also enacting much-needed fiscal reforms.
"Risks are elevated, and time is running out to tackle vulnerabilities that threaten the global financial system and the ongoing economic recovery," the IMF said in a release.
The IMF sees the debt situation in the euro zone as particularly worrisome as several countries are struggling with levels of public debt that significantly surpass their total economic output. Greece, in fact, needs billions of euros to avoid defaulting on its debt, a move that the IMF says could reverberate across the 17-member currency bloc.
Indeed, according to the IMF's calculations, the sovereign debt crisis has already cost the European banking sector more than $270 billion since 2010, not including the capital needs of banks. French banks, which are seen as having particularly high exposure to sovereign debt, have seen their shares pummeled in the stock market. For example, banking-giant BNP Paribas has plunged 47% since the beginning of 2011.
Additionally, the IMF notes banks in certain economies have lost access to funding in the private markets, although the report didn't specify exactly which banks are affected. When banks lose access to private funding, they need to go through government channels, which is more costly, and shifts private-sector risk into the public sphere.
"The risk of more severe deleveraging, credit contraction, and economic drag unless adequate actions are taken to deal with the sources of sovereign risk," the report said.
If the banking-sector takes a hit, the IMF notes, it may "reignite" a dangerous feedback loop that damages the real economy, and further pressuring the financial sector.
Officials across global governments need to make "coherent policy solutions" to address the risks, the IMF urged. In particular, the IMF called on European, American and Japanese governments to continue making fiscal reforms of the medium term.
A failure by the U.S. government to tackle its fiscal challenges, the report says, can cause "many adverse global economic and fiscal repercussions."