Athens on 'political suicide mission' to pass cuts after €12bn loan deal

Fears that the Greek debt crisis could generate another banking meltdown and global economic crash persisted yesterday despite a short-term fix by the EU and IMF.

The European Union agreed terms with the International Monetary Fund to release a €12bn (£10.5bn) tranche of loans to prevent Greece becoming the first developed economy to default since the 1950s. But the loans are conditional on an increasingly fragile Greek government pushing through new spending cuts and tax rises against street and parliamentary opposition in the next two weeks.

The Greek Prime Minister, George Papandreou, was trying to put together a new government last night, after his efforts to pass an austerity package sparked street protests and brought his Socialist-led administration to the brink of collapse. Mr Papandreou, who is reshuffling his cabinet, admitted to "mistakes and weaknesses" by his government, but vowed to tackle the crisis.

"We've had an economic crisis that's turned into a political crisis," said Vagelis Agapitos, an economist. He said the new cabinet would be on a "political suicide mission to do the right thing, to pass tough measures and to pass them on time and implement them".

Fears that the rolling Greek crisis might end in a Lehman Brothers-type default, which would destabilise not just the euro and Europe but the world economy, generated a sudden international willingness to compromise.

The IMF softened its objections to paying its share of €12bn of loans to allow Greece to meet the latest instalments of its debts to international creditors. After negotiations with the EU, the IMF dropped its refusal to pay the money until a longer-term €120bn, EU-led rescue programme was agreed.

Germany was also reported to have eased its demands that any further, bailout must include pain for Greece's creditors – ie the banks – as well as new European and international loans.

However, it all depends, in theory at least, on Mr Papandreou pushing a painful austerity programme through the Greek parliament. The EU economic affairs commissioner, Olli Rehn, said that eurozone finance ministers were likely to approve the new €12bn payment – part of a €110bn package of loans for Greece agreed last year – when they meet in Luxembourg on Sunday. "It means that the funding of the Greek sovereign debt can now be ensured until September, while we take the decisions for the medium-term, beyond September, in July," he said.

However, Mr Rehn made it clear that the money would be withheld – in effect forcing Athens into default – if the Greek parliament failed to approve by the end of June the much contested, new austerity measures forced on Mr Papandreou by the EU in May.

International markets remained fearful that what Mr Rehn called an "accident scenario" – a Greek sovereign default – may have been deferred rather than avoided. Eurozone officials continue to bicker, so the general feeling is the crisis is taking a turn for the worse, said Omer Esiner, chief market analyst at Commonwealth Foreign Exchange.

International markets fear that large banks, especially French and German, will be forced to write off part of their multibillion-euro loans to Greece. This generates fears about the safety of Portuguese and Irish loans and has pushed up the cost of borrowing for Spain.

The ratings agency Moody's lowered the credit rating of the three largest French banks – all heavily exposed to Greece – this week. As a worst-case scenario, there are fears that a Greek default could have a cascade effect on other banks and markets.

The French President, Nicolas Sarkozy, will fly to Berlin today for talks with Angela Merkel. Franco-German differences on how best to help Greece lie at the heart of the eurozone's difficulties. Chancellor Merkel insists that, as part of any long-term solution, banks must "buy back" some of their own loans to allow Athens a longer period to pay. Paris fears that a forced "hair-cut" could destabilise its own banking industry and the world economy. It insists that any contribution by banks to solving the crisis must be voluntary. There were reports that Ms Merkel might be prepared to offer a compromise.

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