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Swift U.S. action on debt needed in global interest: IMF

By Glenn Somerville and Mark Felsenthal

WASHINGTON (Reuters) - The International Monetary Fund on Monday urged the United States to swiftly raise the debt ceiling to ward off risks of a credit downgrade that could damage the global economy.

The IMF appeal was part of a review of U.S. economic prospects in which it concluded a slow-paced recovery can continue with some fiscal tightening while also stressing its concern about getting government debts under control.

"Directors (on the IMF board) highlighted the urgency of raising the federal debt ceiling and agreeing on the specifics of a comprehensive medium-term consolidation program," the global lender said.

Talks between the Obama administration and lawmakers to craft a plan to avoid potential U.S. default seemed to be making scant progress.

Facing an August 2 deadline after which the United States may not be able to issue more debt, both sides have so far refused to compromise on how to lift the $14.3-trillion legal borrowing limit and come to grips with spending and tax issues.

The IMF, which held talks with senior administration officials while preparing its assessment, clearly opted for a broad-based plan over stop-gap measures.

It said some action to rein in debts must start in fiscal 2012, which begins on October 1, or the United States will face a disruptive loss of credibility.

"The strategy should include entitlement reforms, including additional savings in health care, as well as revenue increases, including by reducing tax expenditures," it said.

IMF staff said risks to the U.S. outlook were rising.

Those include the possibility of a sudden increase in interest rates or a sovereign downgrade in U.S. debt -- basically a decision by ratings agencies to rank the United States as less creditworthy -- if agreement to raise the debt ceiling and install a medium-term plan for debt reduction is not soon reached.

"These risks would also have significant global repercussions, given the central role of U.S. Treasury bonds in world financial markets," the IMF said.

At best, it estimated only a soft expansion for the U.S. economy from 2012 onward, likely between 2-3/4 percent and 3 percent that would bring only moderate income gains and slow reduction in heightened unemployment rates.

That was little changed from its most recent official assessment, published in the IMF's June World Economic Outlook, in which it estimated U.S. expansion at 2.5 percent in 2011 and 2.7 percent in 2012.

A co-founder of the influential Economic Cycle Research Institute that tracks recessions and recoveries, noted the political imbroglio over debt was playing into an already soft growth scenario and could make a bad situation worse.

SLOWDOWN COULD TIP TO RECESSION

"You could have a slowdown turn into a recession," said Lakshman Achuthan, the institute's chief executive, noting that the drag on production from the disruption caused by Japan's major earthquake earlier this year already was slowing output.

"And now we have a lot of financial market concerns around the debt ceiling," he added, with no certainty what resolution of any will be reached. "If you have a lot of taxes or a lot of spending cuts in the short term, that is a negative, that is a negative for the economy itself."

An IMF official, briefing reporters by telephone, said that if the United States' AAA debt rating -- regarded as the gold standard for creditworthiness -- was downgraded it could be "extremely damaging" for the U.S. and world economy.

The IMF official said that, since such a downgrade would be precedent-setting, it was impossible to predict with certainty the impact, but it would certainly drive interest rates up.

While underlining the urgency of reaching a debt-reducing agreement, the IMF also cautioned that an "excessively large upfront fiscal adjustment" should be avoided because that would further dampen domestic demand and slow growth.

"With a still-wide output gap and downside risks to the outlook, especially potential spillovers from European financial markets, directors called for a cautious approach to unwinding macroeconomic support," the IMF said.

(Reporting by Glenn Somerville and Mark Felsenthal; Editing by Andrew Hay)

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