IMF urges repeal of 'ill-designed' sweeping federal budget cuts

WASHINGTON (Reuters) - The International Monetary Fund on Friday urged the United States to repeal sweeping federal budget cuts that will be a severe drag on economic growth this year.

In its annual check of the health of the U.S. economy, the IMF forecast economic growth would be a sluggish 1.9 percent this year. The IMF reckons growth would be as much as 1.75 percentage points higher if not for a rush to cut the government's budget deficit.

The IMF cut its outlook for economic growth in 2014 to 2.7 percent, below its 3 percent forecast published in April.

Washington enacted across-the-board federal government spending cuts, known as sequestration, in March because Congress could not agree on an alternative.

"The deficit reduction in 2013 has been excessively rapid and ill-designed," the IMF said. "These cuts should be replaced with a back-loaded mix of entitlement savings and new revenues, along the lines of the (U.S.) administration's budget proposal."

The IMF warned the sequester cuts to education, science and infrastructure spending could reduce U.S. potential growth in the medium-term.

Economists believe the expiration of payroll tax cuts and the increase in taxes on richer Americans in January are also holding back America's recovery from the 2007-09 recession.

The Fund said gross general government debt is set to peak at 110 percent of GDP and then start declining in 2015. But U.S. government finances are on an unsustainable path due to an aging population and higher spending on health care, the IMF said.

As in previous reports, it urged the United States to adopt a comprehensive plan that would lower future deficits by raising more revenues and slowing the growth in spending on government-funded health care and pensions, known in America as "entitlements."

KEEP EASING FOR NOW

The Fund recommended the U.S. Federal Reserve keep up its massive asset purchases at least through the end of the year to support the U.S. recovery, but should also prepare for a pull-back in the future.

The Fed is currently buying $85 billion per month of Treasuries and mortgage-backed securities in an effort to hold interest rates at very low levels and spur employment growth.

Speculation over when the Fed might start to pare back its bond buying has roiled financial markets recently. Fed Chairman Ben Bernanke last month stoked market speculation when he said a decision to pare the Fed's current pace of asset purchases may happen at one of the Fed's "next few meetings" if the economy looked set to maintain momentum.

Recent outflows from bond funds and the rise in volatility offer a worrying glimpse of how markets are likely to behave as the Fed works to scale back its enormous monetary stimulus of the U.S. economy.

The IMF said unwinding the easy-money policies are likely to present challenges. It also said the long period of low interest rates could have unintended consequences in the future, sowing the seeds of future financial vulnerabilities.

(Reporting by Anna Yukhananov and Jason Lange; Editing by Andrea Ricci)