London: A two-speed global economy has left Europe and the west vulnerable to a weak recovery and emerging economies facing severe overheating, the International Monetary Fund said in a report on the G20 finance ministers' meeting last weekend. Europe's fina ncial sector remains fragile and could suffer further shocks while countries like Brazil and China are grappling with rising demand and soaring inflation from jumps in commodity prices. The situation is made worse by a flight of capital from west to east as investors desert advanced economies in favour of strongly growing emerging economies, the IMF report said.
It said: "In line with the two-speed recovery, downside risks remain elevated in advanced economies, while overheating risks are growing in emerging economies. Intensification and broadening of financial sector strains resulting from sovereign and banking sector risks in the euro area periphery is a significant risk to the recovery in the region and possibly beyond."
The report, written by the IMF's economic staff, urges emerging economies to allow their currencies to rise. Europe's politicians must react by repairing their financial systems which remain weak.
In a direct snub to the recently departed head of the German central bank, Axel Weber, the IMF said eurozone countries needed to stand ready to bail out peripheral economies that could fall victim to shocks.
It pointed out that investors are wary of the European banking sector and have demanded increasingly high rates to insure peripheral countries and their banks in recent months.
IMF boss Dominique Strauss-Kahn has bemoaned the lack of effort by world leaders in tackling global imbalances. He believes without radical reforms emerging economies will continue to thrive simply be selling their goods to highly indebted advanced economies.
The report said world growth was higher than expected last year and should continue in 2011 although at a slower pace. Without a common policy to tackle imbalances there was risk of economic shocks from banking collapses or sovereign defaults in the west and asset bubbles in developing countries.
It said emerging economies could use inflows of capital to underwrite wide-ranging reforms, but a sudden influx of money could also have negative effects.
It warned: "Capital flows can threaten macro stability and financial stability, by leading to excessive credit growth and localised asset bubbles. In response to these concerns, countries should fully utilise macroeconomic and prudential tools."
Learning from the mistakes of countries like Britain before the crash, emerging countries should restrain lending with higher capital ratios and restrictions on consumer credit.