A possible global economic slowdown stemming from Europe's sovereign debt problems could affect currency and stock markets and weigh heavily on Japan's growth prospects, an International Monetary Fund official said on Wednesday.
Euro zone countries are working on a "comprehensive" package of measures to try to resolve their year-long debt crisis, with the aim of completing a deal by the end of March. But a lack of consensus over details of the package means negotiations are progressing slowly.
Increased sign of disagreement in Europe could damage confidence in Europe's ability to prevent sovereign debt woes from spreading to other countries, potentially pushing up yields on government debt.
"The Japanese banking system is facing a number of external downside risks, including a possible global economic slowdown stemming from European sovereign debt problems, a possible slowdown in U.S. growth, and a potential reversal of a property boom in emerging markets such as China," said Naoyuki Shinohara, deputy managing director of the IMF.
"Such external shocks could affect equity and foreign exchange markets, and could weigh heavily on Japan's economic growth prospects," Shinohara said at a seminar in Tokyo.
There is a strong chance the lending capacity of the European Financial Stability Facility, the euro zone bailout fund, will be increased. The nominal size is 440 billion euros ($600 billion), but because of a system of guarantees to secure a triple-A credit rating, the special-purpose vehicle has an effective lending capacity of only around 250 billion euros.
However, smaller European countries have protested against a French and German proposal to write limits on government debt into national laws.
Shinohara also said Japan's fiscal condition is unsustainable in the medium to long term, although its large debt is unlikely to make it an immediate target of attacks in financial markets.
But he saw greater downside risks than upside risks for Japan's economy.
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