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Debt crisis could still spread to EU core, warns IMF

Reuters
Thursday 12 May 2011 17:25 BST
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Despite bailouts for Greece, Ireland and Portugal, Europe's debt crisis may yet spread to core euro zone countries and emerging eastern Europe, the International Monetary Fund said today.

The warning came as government sources in Athens said international inspectors checking on Greece's compliance with its EU/IMF rescue package had found problems and were pressing for deeper spending cuts to cover a likely revenue shortfall.

The IMF said it stood ready to provide more aid to Greece if requested, though the country that triggered Europe's sovereign debt crisis in 2009 still had plenty of untapped potential to raise extra cash itself though privatisations.

"Contagion to the core euro area, and then onwards to emerging Europe, remains a tangible downside risk," the global lender's latest economic report on Europe said.

Finance ministers of the 17-nation single currency area are set to approve a 78 billion euro rescue plan for Portugal next Monday after Finland's prime minister-in-waiting clinched a deal to ensure parliamentary approval of the package.

But markets are increasingly concerned that Greece will never be able to repay its €327bn (£285bn) debt pile and will have to restructure, forcing losses on investors with severe consequences in the euro zone and beyond.

Asked whether there could be a new aid package to help Greece work through its fiscal recovery programme, the IMF's European department director, Antonio Borges, said the fund was open to the possibility.

"The Greeks have to take the initiative, and so far they have not approached us. The IMF stands ready (to provide additional support) as a matter of policy," he told reporters.

The semi-annual IMF report said peripheral members of the euro zone needed to make "unrelenting" reform efforts to overcome the debt crisis and prevent it spreading further.

It also urged the European Central Bank to tread carefully on further rises in interest rates after last month's first increase since 2007, saying euro zone monetary policy could "afford to remain relatively accommodative".

Borges said the programme of austerity measures and structural reforms agreed a year ago was "probably the best thing that can happen" to Greece, though there was always the question of whether it was too ambitious.

The Socialist government has implemented harsh cuts in public spending, public sector wages and pensions but struggled to raise revenue due to deep recession and chronic tax evasion. A general strike yesterday highlighted growing resistance to austerity.

Greek sovereign bond yields hit fresh euro-era highs on a belief that euro zone finance ministers will not deliver fresh aid for Athens next week. The yield on two-year Greek bonds rose to an eye-watering 27 percent.

By contrast, Portuguese and Irish yields eased after the Finnish deal on aid to Lisbon removed one political uncertainty.

The eurosceptical True Finns party, which scored big gains in last month's general election by opposing a Portuguese bailout, said it would not take part in talks to form the next Finnish government.

Nearly 60 per cent of fund managers expecting a restructuring said it would eventually mean a "haircut" in which bondholders have to take a loss. The median expectation was for a 55 per cent cut in the face value of bonds.

Among the economists - who for the most part do not have to make buy or sell decisions - nearly half expected an eventual haircut, but by a smaller 40 per cent.

Greek, European Commission and ECB officials have repeatedly rejected any talk of debt restructuring.

German Finance Minister Wolfgang Schaeuble told parliament in Berlin he saw considerable concern about Greece and doubts about its ability to return to capital markets.

Any fresh aid would have to be tied to clear conditions and could only be considered after EU and IMF inspectors, now in Athens, report on Greek compliance with its fiscal adjustment programme, he said.

Signs of disquiet have begun to emerge from the EU/IMF/ECB troika mission, government sources in Athens said.

"They are forming an opinion that there are difficulties," said one senior government official who requested anonymity. "They are concerned there is a high risk revenue targets will not be met and are pressing for more spending cuts."

The inspectors' assessment is vital to next month's decision on whether Athens receives the next 12 billion euro tranche of its 110 billion euro EU/IMF bailout. Without it, Greece could effectively default.

Ireland and Greece are already dependent on €52.5bn of IMF aid while Portugal is awaiting a €26bn three-year lifeline from the Fund.

Banks in the troubled countries are being kept above water by unlimited ECB liquidity, and the IMF said the central bank might need to extend that system again beyond June 12.

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