The global economy is at risk of sliding into a "lost decade" unless joint action is taken to remove threats to growth, Christine Lagarde, the IMF managing director, said yesterday.
The warning came as the euro-zone debt crisis - the centre of the global economic tumult - threatened to engulf Italy further. The country's borrowing costs surged higher yesterday despite a commitment by Silvio Berlusconi to resign as prime minister. Yields on 10-year notes hit 7.4 per cent, a euro-era high, as stock markets across Europe tumbled.
Advanced economies had to take steps to restore confidence and lift growth, said Ms Lagarde. In turn, China had to rebalance its economy, she said.
"If we do not act, and act together, we could enter a downward spiral of uncertainty, financial instability and a collapse in global demand," said Ms Lagarde during a speech in Beijing. "Ultimately, we could face a lost decade of low growth and high unemployment."
Insufficient action by policymakers meant Japan lurched into a lost decade marked by soaring debt and stagnant growth during the 1990s.
Ms Lagarde's warning that the world economy could face a similar fate follows unfolding political turmoil in the euro zone.
Mr Berlusconi on Tuesday said he would resign as prime minister as soon as parliament passed urgent reforms, in votes expected this month.
In Greece, another troubled economy, the prime minister, George Papandreou, is still locked in talks about forming an interim government after he promised to step down.
Earlier rallies in European markets were halted yesterday as investors worried about the prospect of political vacuums in the economies most exposed to the euro-zone debt crisis. The Stoxx Europe 600 was down 1.9 per cent at 235.93 in mid-afternoon training yesterday.
The spread between the yields on 10-year Italian bonds and German bunds of the same maturity moved to new euro-zone highs above 500 basis points. Adding further pressure to Italy's funding challenge, the clearing house LCH Clearnet raised margin calls on Italian bonds, making them more expensive to trade.
Optimism that with Mr Berlusconi's exit Italy would be able to get to grips with its debt problems were perhaps a little premature, Tim Fox, the chief economist of Emirates NBD, wrote in a research note yesterday.
"Italy is a notoriously difficult country to govern at the best of times and facing considerable economic and social problems it might not be very much easier for a technocratic government, which may now step in, to do much better," he wrote.
Ms Lagarde said fast action was needed to restore debt sustainability in Greece, recapitalise European banks, strengthen the firewall against financial contagion and lay the foundations for robust economic governance in the euro zone.
In China, policymakers also needed to act, she said. The country needed to reduce its reliance on an export-led growth model and, instead, stimulate domestic consumption. Beijing also needed to allow its currency to strengthen, she said.
The US has long argued that China's weaker currency makes its exports artificially cheap and, in turn, hamper efforts to create US jobs.
Governments in the wider Asia region had to be ready to take action, Ms Lagarde said.
"If the global economic environment deteriorates further, it makes sense to change course quickly and deploy a range of measures to cushion economic activity," she said.
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