IMF says U.S. should hike debt limit to avert global shock

Failure by U.S. lawmakers to agree soon on a deal to raise the government's borrowing limit could deliver a severe shock to a still fragile recovery and global markets, the International Monetary Fund warned on Wednesday.

In an annual review of U.S. economic conditions, the IMF said the key challenge the country faces is finding a way to stabilize its debts by mid-decade without derailing growth, which is likely to remain modest for some time.

And of course, the federal debt ceiling should be raised expeditiously to avoid a severe shock to the economy and world financial markets, the IMF said in a statement.

The U.S. Treasury already has hit the existing $14.3 trillion legal limit on the nation's debt and has warned the debt ceiling needs to be raised by August 2 to avoid a default on the nation's obligations.

The IMF said a failure to raise the ceiling in time could lead to a downgrade in the United States' coveted AAA debt rating and send interest rates soaring. These risks would also have significant global repercussions, given the central role of U.S. Treasury bonds in world financial markets, it said.

The Obama administration and Congress are locked in tense negotiations to try to reach a deal on budget cuts that would give lawmakers political cover to raise the debt ceiling.

The IMF said the goal should be to stabilize the nation's debt ratio -- which it said now was unsustainable -- by mid-decade and gradually ratchet it down after that.

We see early political agreement on a comprehensive medium-term consolidation plan based on realistic macroeconomic assumptions as a cornerstone of a credible and cyclically appropriate fiscal adjustment strategy, the IMF said.

It said the Federal Reserve's policy of keeping interest rates near zero likely will be appropriate for some time in view of modest U.S. growth prospects.

But it added the U.S. central bank must also be ready to respond decisively if inflation expectations appear likely to become unhinged.

(Editing by James Dalgleish)