UPDATE 2-IMF urges US to remove 'fiscal cliff' uncertainty

Tue Jul 3, 2012 10:29pm IST

* IMF urges U.S. to remove uncertainty of 'fiscal cliff'

* Lagarde: threat of fiscal cliff may hurt growth this year

* IMF cuts 2013 U.S. growth forecast

* IMF says U.S. needs credible fiscal consolidation plan

By Lesley Wroughton

WASHINGTON, July 3 (Reuters) - The International Monetary Fund on Tuesday urged the United States to quickly remove the uncertainty over the path of fiscal policy, which is set to tighten abruptly at the start of next year without congressional action.

IMF Managing Director Christine Lagarde warned that just the threat of the "fiscal cliff" could weaken U.S. economic growth later this year and she called for action to address it sooner rather than later.

She said the potential for a deterioration in the euro zone debt crisis was the other main risk facing the United States.

The U.S. economy is facing $4 trillion worth of expiring tax cuts and automatic government spending reductions, and most analysts do not expect Congress to act to soften the blow until after the congressional and presidential elections in November.

"It is critical to remove the uncertainty created by the 'fiscal cliff' as well as promptly raise the debt ceiling, pursuing a pace of deficit reduction that does not sap the economic recovery," the IMF said in its annual health check of the U.S. economy.

In addition to the looming budget tightening, the United States is expected to hit the $16.4 trillion statutory limit on its debt sometime between the election and the end of the year. If Congress fails to raise it, it would lead to a U.S. default.

Most analysts expect Congress to strike a post-election deal to avoid the "fiscal cliff" and buy time for lawmakers to work on a long-term budget and tax plan. But the uncertain outlook already appears to be weighing on business hiring and investment decisions.

The Fund forecast economic growth in the United States of 2 percent this year and cut its projection for 2013 to 2.25 percent from 2.4 percent.

But it warned that the already modest forecast for next year could prove much too optimistic if Congress fails to relax the fiscal tightening of about 4 percent of gross domestic product contained in current law.

If Congress does not act, the economy could contract early next year and annual growth could come in well below 1 percent, the IMF said.

"We believe that fiscal consolidation is necessary but not just any fiscal consolidation. It has to be sensible and certainly not excessive," Lagarde told a news conference.

The Fund said that over the medium-term both revenue increases and reforms to government entitlement programs would be needed to help curb the growth in U.S. debt.

For now, however, it said the focus should be on fostering stronger growth.

"Continued policy action is needed to boost the recovery," Lagarde said. "We believe that the U.S. authorities do not have a lot of space available - they have limited space actually - to act but they should use it to support the recovery."

The IMF said U.S. monetary policy was appropriately "very accommodative" and emphasized that the Federal Reserve had room for further easing should economic conditions worsen.

The U.S. central bank has held overnight interest rates near zero since December 2008 and has bought $2.3 trillion in bonds in a further effort to lower borrowing costs. Last month it extended a program to reweight its bond holdings toward longer-dated securities to push long-term interest rates lower.

The Fed has said it is prepared to do more to spur a stronger recovery if needed and a raft of weak data has kept speculation alive that it might soon launch another round of bond purchases to lift the economy.