Dublin, which signed up to an €85bn EU/IMF bailout in late 2010, aims to return to long-term debt markets later this year to help it prepare for the ending of official funding next year and meet borrowing needs of up to €20bn in 2014.

The IMF said Ireland would need a “substantial improvement” in market conditions to achieve a planned return to bond markets to avoid a new bailout when the current one expires at the end of next year.

Growing market turmoil is increasing the importance of addressing the huge burden of €63bn of debt taken on to bail out the country’s banks, the IMF said in its quarterly report on Ireland.

“Tackling the issues remaining from Ireland’s deep banking crisis in a proactive manner has become critical, and such efforts would be most effective as part of a broader European plan to stabilise the euro area,” the report said.

One avenue would be for Europe to soften the terms of Ireland’s bank bailout by replacing €30bn of high-interest IOUs given mainly to the former Anglo Irish Bank with another instrument that would lengthen their maturity and cut their interest rate.

The Government has been lobbying its European partners for months, but has yet to secure any concession.

“Extending the term of the promissory notes and the associated Eurosystem funding, and placing banks’ legacy assets in a vehicle that does not rely on market funding, would much enhance the prospects... for the Irish sovereign to return to the market.”

The fund also backed Government calls for direct financing of European financial institutions by Europe’s bailout funds. The idea has so far been rejected by European leaders, who last week insisted that the Spanish government backstop a €100bn bailout of the country’s banks.

“Temporary European equity participation in state-owned banks would greatly reinforce these benefits, by weakening bank-sovereign linkages, immediately enhancing debt sustainability, and improving prospects to attract private owners,” the IMF said.

The IMF repeated its call for more effort to stimulate growth, warning significant additional fiscal adjustment in a low growth environment would risk a “pernicious cycle of rising unemployment, higher arrears and loan losses”.

Ireland’s performance has been held up by European leaders as a glowing example of how their plans to fight the eurozone debt crisis are working and the IMF said that Dublin’s policy implementation remained strong.

The fund cut its GDP forecast for next year to 1.9% from 2.0% and downgraded its average GDP growth forecast for 2013-2017 to 2.6% from 2.8% on weaker exports and higher unemployment.

The national debt will peak at 121% of GDP next year if growth targets are hit, but could surge to 133% if it remained at the 0.5% forecast this year.

Ireland’s plans to return to issuing treasury bills in the second half of 2012 remain “feasible” but risks have grown recently, the report said.

Reuters