Fresh EU Tension Shows Limits of IMF Relief

The International Monetary Fund accord on new resources fails to relieve European debt crisis.


How much relief does $430 billion buy? When it comes to Europe’s ongoing debt crisis, the answer is, not much. Christine Lagarde had hoped to ease tensions in the euro zone last month when she persuaded members of the International Monetary Fund to stump up $430 billion in new IMF resources, part of a so-called firewall to prevent a worsening of the crisis.

But the ink had barely dried on the accord when a poor showing by Nicolas Sarkozy in the first round of France’s presidential elections and the collapse of the Dutch government signaled mounting public opposition to Europe’s austerity-first strategy of containing the debt crisis. Market tensions rose further after Spain acknowledged its economy had slipped back into recession in the first quarter and Standard & Poor’s lowered Spain’s credit rating by two notches, to BBB+.

The news pushed yields on Spanish bonds above 6 percent, threatening the same kind of debt spiral that forced Greece to seek a bailout from the European Union. “We fear that things are likely to get worse before they get better,” says Martin van Vliet, a senior euro zone economist at ING Group in Amsterdam.

The problem, Fund officials say privately, is that any intervention in Spain could stretch IMF resources to the limit. Spain’s borrowing needs approach $200 billion a year, and bailout deals so far have provided three years’ worth of funding. Any Spanish deal, moreover, could easily spark a run on Italian debt. Instead, Fund officials urged the EU to use its bailout facilities to help recapitalize Spanish banks. They also urged EU countries to accelerate pro-growth reforms.

As Poul Thomsen, a senior Fund official who helped design the EU-IMF bailout programs for Greece, Ireland and Portugal, put it at an IMF seminar, “If these programs only become about fiscal consolidation and financial deleveraging, they will obviously fail.”

Europe has no quick fixes to jump-start growth, though. Germany, the only country that could act as an economic locomotive, rejects any talk of stimulus. The labor and product market reforms that crisis countries are pursuing to boost their competitiveness and restore growth will take years to pay off. Portugal, for instance, is likely to need a second bailout by September because budget cuts are deepening the country’s recession, according to a report by Morgan Stanley analysts Daniele Antonucci and Paolo Batori.


Natacha Valla, chief economist at Goldman Sachs France, says that concerns about European debt sustainability and the health of banks that hold big chunks of that debt will persist for years and that markets are likely to be roiled by repeated waves of risk aversion.