The United States and Japan received sharp warnings from the IMF and ratings agencies that they must tackle their huge budget deficits to avoid investors dumping their bonds, which would create a sovereign debt crisis and push up their borrowing costs.
Rating agency Standard & Poor's on Thursday cut Japan's long-term debt rating for the first time since 2002, and a day after a U.S. agency raised its 2011 budget deficit forecast by 40 percent.
In the United States, Moody's Investors Service warned said while the risk to the United States' coveted top triple-A rating was small, it was rising.
The International Monetary Fund had harsh words for both the United States and Japan, saying they urgently need to act to cut their deficits.
As a political battle heated up in Washington over the budget, the U.S. Treasury took steps to prevent the government from hitting a legal limit on its debt. Republicans are demanding spending cuts as the price of their support for raising the $14.294 trillion debt ceiling.
President Barack Obama this week announced a five-year freeze in annual domestic spending, which the White House estimates will save more than $400 billion over the next decade, but an International Monetary Fund official said on Thursday that more is needed.
Carlo Cottarelli, director of the IMF's Fiscal Affairs Department, said Washington must be more specific in detailing plans that go further.
One Republican warned that the United States faced the risk of a currency crisis if it did not get its debt under control. "We're getting closer to that all the time," said Texas Representative Ron Paul, who has long advocated a return to a requirement that the dollar be backed by gold.
In Europe, market pressures have forced many governments to adopt austerity budgets to bring down soaring borrowing costs, and the European Union is now locked in debate over whether a 440 billion euro bailout fund for its members is too small.
In a report on global debt, the International Monetary Fund patted Europe on the back for its efforts while declaring the United States and Japan as the budget-cutting laggards.
"In advanced economies where fiscal sustainability has not been a market concern, credible plans going well beyond 2011 need to be put in place urgently to lock in benevolent market sentiment," the IMF said.
"Renewed market pressures in some advanced economies demand that these countries underline their commitment to their deficit targets and devise contingency plans to ensure that adjustment goals are met," it added.
The fund said large European countries will all tighten their budgets this year broadly in line with earlier plans, with Spain making the deepest cuts.
The IMF's Cottarelli told reporters that markets were overestimating the risk of default or debt restructuring in Europe, following bailouts of Greece and Ireland.
But the IMF's report said Europe needed a more comprehensive approach to crisis management to avoid spillovers and to "break the fiscal-financial spiral." The IMF said earlier this week that Europe's debt crisis posed one of the gravest risks to the global recovery.
While Europe was cutting its deficits, the IMF said new tax cuts in the United States and increased spending in Japan had set back progress in rich nations more generally.
Cottarelli said Japan needed to raise more revenue and he renewed a call for Tokyo to increase its value added tax.
As for the United States, the fund said Washington would need to make up for the delay by cutting more deeply in 2012. A deeper adjustment by the United States is needed for it to meet an ambitious G20 target of halving its budget deficit by 2013.
A White House official said Obama would lay out "a number of tough steps to tackle our fiscal situation" in a budget proposal next month. At the same time, top White House economist Austan Goolsbee said the government had to be careful not to undermine a fragile economic recovery.
S&P's decision to downgrade Japan's long term debt a notch to AA-minus led to a sell-off in the yen and government bonds.
Prices for U.S. Treasuries were unmoved on the Moody's report, which broke late on Thursday. However, some traders said the report could still seep into markets and pull bonds down on Friday.
"When you have punishing news like this from Moody's and other rating agencies, it will clearly leave a negative impression on Treasuries," said Todd Schoenberger, managing director at LandColt Trading Inc. in Wilmington, Delaware.
Alan Wilde, head of fixed income and currency at Baring Asset Management in London, noted the quandary that investors face.
"We have been underweight Japanese government bonds for several years .... but the outlook is hardly better anywhere else," Wilde said. "There is already speculation that the United States may be next in the credit ratings agencies' sights."
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