Greece expected to default even after a second IMF/EU bailout

Greece could still default on its debts "within months", according to economists, even as the European Union works on a second bailout of the protest-hit nation.

Athens was offered hope of salvation on Friday when the German Chancellor, Angela Merkel, softened her stance on Greece's debt, agreeing with French president Nicolas Sarkozy that a swift resolution was necessary. Crisis meetings in Luxembourg and Brussels this week are expected to thrash out the terms of this ¤90bn-to-¤120bn (£80bn-to-£105bn) bailout, barely a year after the first ¤110bn rescue.

However, Ben May, a European economist at Capital Economics, warned: "Weaknesses and divisions with the ruling party [Pasok] have been exposed, casting doubt over its will and ability to take the further measures that will be required of it. We think there will be a default, whether involuntarily or with the consent of Europe, in the coming months."

A dramatic week in Athens culminated in a cabinet reshuffle on Friday, which included replacing the Finance Minister, George Papaconstantinou, with the former defence minister, Evangelos Venizelos. Considered a tough-talking socialist party "big beast", he has also been made co-Deputy Prime Minister.

On Wednesday night, following some of the most violent anti-austerity protests in the capital so far when 20,000 people took the streets, the socialist Prime Minister, George Papandreou, made a surprise offer to form a coalition government with the main opposition party, the right-wing New Democracy.

This followed Mr Papandreou's failure to gain parliamentary agreement to ¤28bn of new cuts required by the International Monetary Fund and the European Union as a condition of July's tranche of the original ¤110bn bailout. It is expected that the IMF will still approve this ¤12bn tranche today, despite its concerns over public spending.

The resignation of two socialist MPs on Thursday and a planned confidence vote in the new government in two days time has led some economists to question Greece's political will to continue implementing the painful measures in the long-term.

Although Pasok should have enough votes to survive the confidence vote this week, it is likely to do so by the slimest of majorities. Robert Farago, the head of asset allocation at Schroders Private Banking, said: "The basic situation has not changed, but the last few days have increased the odds of a bad outcome happening sooner. We are very worried."

These fears hit world markets, with the MSCI World plunging to a three-month trough on Thursday.