LONDON - The country's economy will shrink sharply in 2009 before edging into growth in 2010, and the government should make clear plans to reduce borrowing when recovery comes, the International Monetary Fund said on Thursday.

In its annual health-check on the British economy, the IMF said the country had succeeded in averting financial meltdown, but now needed to focus on ensuring public borrowing did not get out of control during its deepest recession for decades.

Market conditions so far suggest the UK is getting the benefit of the doubt. But this benefit of the doubt will not last forever, said Ajai Chopra, the IMF's mission chief for Britain.

The IMF forecast Britain's economy will shrink 4.2 percent this year before recovering to grow 0.2 percent in 2010, unchanged from forecasts released earlier this month.

The economic outlook is highly uncertain. Recent indicators suggest that economic activity has begun to stabilise. However, the recovery is likely to be slow and subdued as banks and households go through a difficult balance sheet adjustment, the IMF said.

The global economic watchdog's forecasts are gloomier than government projections of 3.25-3.75 percent contraction in 2009 followed by 1.0-1.5 percent growth in 2010, and it identified rocketing government debt as a major vulnerability.

Borrowing was likely to equal around 13 percent of GDP in 2009 and 2010, with total debt approaching 100 percent of GDP over the next five years.

The success of the current policy package depends on continued trust in the sustainability of the fiscal position. A strong commitment to reverse the sharp deterioration of the public finances once the economic recovery has been established, ... will be essential, the IMF said.

Credibility would be enhanced by specifying concrete expenditure and revenue measures to achieve the desired adjustment, it added.
With a national election less than a year away, MPs s are loath to say what cuts and tax rises they would have to implement to pay back debt, and all main parties have accused each other of misleading the public about their plans.

BOE POLICY APPROPRIATE

The IMF said the Bank of England's monetary policy -- which has seen interest rates slashed to 0.5 percent -- was appropriate, but that it was too soon to judge the effectiveness of its 125 billion pound quantitative easing policy.

It also called for the BoE to buy a wider range of private sector assets, which currently amount to less than 3 percent of its total purchases, as the majority of funds have been spent on buying British government debt.

Given economic weakness, the IMF said it expected inflation to stay low for an extended period.

The IMF also welcomed recent government proposals for financial regulation reform, but warned that the government may have to dig into its coffers to help banks out again as the recession threatened asset quality and capital buffers.

These lingering uncertainties are restraining lending growth, the IMF said.

Authorities should encourage banks to strengthen their capital base and explore options to improve capital structures. The authorities should also continue their contingency planning, and ... should be prepared to provide further public capital, if needed, it said.

(Additional reporting by Christina Fincher; Editing by Toby Chopra)

United kingdom International Monetary Fund