UPDATE 2-U.S. debt standoff could "damage" world economy-ECB head

Thu Oct 10, 2013 2:00pm EDT

NEW YORK Oct 10 (Reuters) - A prolonged U.S. debt standoff could hurt the global economy, European Central Bank President Mario Draghi said on Thursday.

The rest of the world believes the United States will resolve a deadlock that has left the federal government largely shut down and threatens to cause a default as October wears on, he said. Nevertheless, he noted, there could be a showdown among U.S. lawmakers that lasts weeks or even months.

"In that case, it's probably safe to say that this could cause severe damage to the U.S. economy and to the world," Draghi said at the Economic Club of New York ahead of attending weekend meetings of the International Monetary Fund and World Bank in Washington.

The U.S. federal government has been partially shut down since Oct. 1, when Congress failed to reach an agreement on funding for the new fiscal year due to a standoff over healthcare reforms.

In addition, the U.S. government is expected to hit its borrowing limit by Oct. 17, and a divided Congress might prove unable to raise that ceiling. That, in turn, raises the specter of a default.

In contrast, the euro zone economy is showing progress in recovering from a sovereign debt crisis that has lasted more than three years, Draghi said.

But he cautioned that the monetary union's path to further economic gains will be bumpy.

"The pace of recovery is going to be subdued, uneven and to some extent fragile, being exposed to many risks," he said.

The ECB, as expected, left its benchmark interest rate unchanged on Oct. 2 at a record low 50 basis points, a level it has held at since May. After lifting rates in 2011, the bank reversed course and started to lower them in November of that year.

Not only has the sovereign debt market stabilized, Draghi said, but banks are also finding better prospects for raising capital than in recent years.

That has been a major result of raising transparency, he said, which has been a major goal for the ECB and key to restoring the health of the monetary union's banking system.

"Transparency is the key thing. By and large people outside Europe are convinced that if there is no more transparency, it is very unlikely they can actually invest in the banking system," Draghi said.

The ECB takes over supervision of the region's banks in about a year. A resolution mechanism to deal with problem lenders is expected to follow in 2015.

An asset quality review followed by stress tests will occur before the supervision starts to ensure banks are in good health. The central bank is also working to create a single mechanism to wind down failing banks.

"We've seen in the last month and a half, we have seen several banks capable of raising capital. So, the market prospects are way better than they were on the occasion (of) the last stress test two years ago," Draghi said.

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