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IMF's Lagarde proposes 'rainy day fund' to help struggling eurozone countries

The eurozone should create a common "rainy day fund" to help struggling member countries during times of economic hardship, International Monetary Fund Managing Director Christine Lagarde said March 26.

In a speech hosted by the German Institute for Economic Research in Berlin, Lagarde outlined proposals that would see countries in the currency union each contribute 0.35% of GDP annually to a fund that could be tapped by nations with economic troubles.

This would take some pressure off the European Central Bank, which Lagarde suggested had shouldered too heavy a burden during the global financial crisis of 2008/2009 and Europe's ensuing sovereign debt crisis. The ECB was forced to adopt ultraloose monetary policy and played a significant part helping to resolve debt crises in countries on Europe's geographical periphery, besides becoming the main regulator for the eurozone's largest banks.

Lagarde, who was herself involved in resolving the sovereign debt crisis, first as France's finance minister and then as IMF head from July 2011, said that spending cuts and tax hikes by many countries in the eurozone between 2011 and 2013 exacerbated weaknesses and contributed to a double-dip recession.

"To avoid a painful repeat of this experience, we believe that the euro area needs a 'central fiscal capacity,'" she said. This could reassure investors that the bloc has better tools to stop the next crisis from spreading, she said.

Shortfalls offset

The proposals would see countries contributing annually to build up assets in good economic times, and struggling countries receiving transfers to help offset budget shortfalls during downturns.

Such transfers would depend on a member country's compliance with EU fiscal rules, and countries benefiting from the scheme during bad times would have to pay a premium at other times — much like a car insurance premium tends to increase following an accident.

"By itself, the capacity may not be enough to solve the next crisis, but it would certainly help," Lagarde said.

Lagarde also recognized that such a plan would be politically difficult to achieve, but she said she hoped policymakers could come together in the next six months or so for a "meeting of minds" to outline the general principles and timeframe for implementation. The current upturn in the European economy provides a window of opportunity for the bloc to build up the backstop, she said.

The central fiscal capacity would serve as another tool to promote financial stability within the eurozone along with the capital markets union, which is designed to facilitate cross-border financing, and the banking union, which could see the creation of a pan-European deposit insurance scheme.

But banks themselves have more to do, Lagarde stressed.

"In return for a common deposit scheme, banks which have high levels of nonperforming loans should commit to aggressively cleaning up their balance sheets," she said, adding that they should put in place a timetable for action.