WASHINGTON, March 15 (Reuters) - Belgium's recovery from a deep economic recession is likely to be slow and fragile, the International Monetary Fund said on Monday, warning that the banking sector, in particular, needed to be closely watched.
In its review of Belgium's economy, the IMF said it was important that government liquidity support for banks was withdrawn only gradually to avoid a credit squeeze, which would slow the recovery further.
Overall, the IMF said the Belgian economy had suffered a severe contraction due to the global financial crisis and unemployment was heading upwards again after fours years of continuous declines in unemployment.
"The near-term outlook is clouded by a sluggish rebound in both domestic and external demand, rising unemployment, and growing public debt," the IMF said.
The IMF underscored the need for Belgium to map out a "credible" medium-term adjustment to put the country's public finances back on solid ground and address problems of an aging population.
It supported the government's plan for a balanced budget by 2015 and welcomed efforts to take additional actions, if needed, to reach the deficit target for 2011 and beyond.
"Early action is crucial to restore fiscal sustainability, further reinforce financial stability, and intensify labor and product market reforms to boost competitiveness and growth prospects," the IMF added.
An IMF staff document suggested the government introduce a cap on total expenditure growth for each level of government and the social security administration.
Turning to Belgian banks, the IMF said the banking sector had stabilized thanks to massive liquidity support by the government, but banks remain vulnerable to possible spillovers from mature and emerging European markets.
Therefore, the IMF said it was important that the governments withdrawal of support for banks is gradual to avoid market reactions and a credit squeeze.
IMF staff estimates, based on the results of a cross-country analysis, that Belgium has a relatively high probability of experiencing a creditless recovery.
In particular, Belgian banks are highly exposed to France, the U.S., Britain and the Netherlands. Non-performing loans have increased rapidly from countries like Ireland and Spain, which suffered major recessions during the crisis.
"The risk of a creditless recovery is a cause for concern although this is mitigated by the public support and ongoing bank restructuring. Hence, credit to the economy should be closely monitored," the IMF added.