DUBLIN (Reuters) - The International Monetary Fund on Friday urged Europe to help Ireland refinance its crippling bank bailout and consider taking equity in state-owned banks to help Dublin return to bond markets and avoid a second bailout next year.
Dublin, which signed up to an 85 billion euro (68.98 billion pounds) 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 20 billion euros in 2014.
The IMF, one of the country's "Trokia" of lenders along with European Union institutions, 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 63 billion euros 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 stabilize the euro area," the report said.
One avenue would be for Europe to soften the terms of Ireland's bank bailout by replacing 30 billion euros 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 IMF said.
The fund also backed Irish government calls for direct financing of European financial institutions by Europe's bail-out funds. The idea has so far been rejected by European leaders, who last week insisted that the Spanish government backstop a 100 billion euro 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 that 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 euro zone debt crisis are working and the IMF said once more that Dublin's policy implementation remained strong.
However with weaker exports and a larger than expected decline in consumption weighing on Ireland's economy.
The fund cut its GDP forecast for next year to 1.9 percent from 2.0 percent and downgraded its average GDP growth forecast for 2013-2017 to 2.6 percent from 2.8 percent on weaker exports and higher unemployment.
The national debt will peak at 121 percent of GDP next year if the growth targets are hit, but could surge to 133 percent if it remained at the 0.5 percent forecast this year.
Ireland's plans to return to issuing treasury bills in the second half of 2012 remain "feasible" but risks have growth in recently, the report said. Ireland's government debt agency said last week it expected to return to short-term debt markets during the summer.
(Reporting by Conor Humphries; Editing by Jeremy Gaunt)