Decaying political support for budget cuts in Europe is threatening global financial stability and could undermine a recovery that is already weakening, the International Monetary Fund warned in a trio of reports Friday.
Nations throughout the continent have put in place government spending plans that reduce record high deficits and have made other changes to invigorate their economies. But growth has been slow to return, and the cuts to social programs and public payrolls are proving increasingly unpopular — and politically difficult to sustain.
The implications have become most clear in Greece, where the government is trying to enforce an austerity plan that the IMF says is needed to restore growth — and which must be followed for the country to receive an upcoming disbursement of emergency funds.
The IMF studies released on Friday also cautioned that the lack of political progress on deficit reduction in the United States and Japan was weighing on a world economy characterized by strong growth in developing nations like China and continued weakness in the developed world.
That weakness has become more pronounced in recent months, with the U.S. recovery slowing and Europe saddled with a still vulnerable banking system and several countries near insolvent.
“We have entered into a new phase of the crisis that I would term the political phase, where hard political decisions need to be made because the window for substantial policy action is closing. Time is of the essence,” said IMF financial counsellor Jose Vinals at a press conference in Brazil.
On Friday, Greek Prime Minister George Papandreou struggled to cling to power as he worked to put together a new cabinet and persuade a restive country to stand behind a new round of spending cuts and other concessions needed for the release of emergency loans from the International Monetary Fund.
Papandreou announced that he had replaced finance minister George Papaconstantinou — the public face of the government’s austerity push — with defense minister Evangelos Venizelors.
As Papandreou continued his cabinet reshuffle, there was some positive news for Greece from Germany. Chancellor Angela Merkel and French President Nicolas Sarkozy announced that Germany and France had reached a compromise regarding the bailout package they are preparing. Germany backed away from a provision that would have required private investors to be involved, saying their participation would now be voluntary. Sarkozy called the decision a “breakthrough.”
European stock markets, which had been declining since the chaos began in Greece, turned positive and the euro strengthened against the dollar.
But defections among Papandreou supporters left his governing coalition with a shrinking majority in the Greek Parliament. A call for a vote of confidence in his new government was expected this weekend.
The possibility that Papandreou will fail — and be unable to commit the country to an austerity program negotiated with the IMF and European officials — is considered one of the chief risks pushing Greece toward a default on its bond payments and what the Obama administration and others consider potentially calamitous economic fallout.
European Union and IMF officials played down the worst-case scenario.
Olli Rehn, the European Union’s economic commissioner, said Thursday that a crucial $17 billion loan disbursement to Greece from the E.U. and the IMF would be made by early July, in time to prevent the nation from running out of cash to pay its creditors. Release of the funding, part of the $160 billion bailout for Greece that was approved last year, was being held up by deadlocked talks over the size and shape of a second massive bailout that the country now needs as its financial straits worsen.
Rehn said an agreement on the release of the $17 billion will be reached this weekend by finance ministers from the 17 nations that share the euro. The funds, he said, would no longer be linked to a broader agreement on a second bailout.
He said he expected the IMF to agree to the plan. “We will avoid the default scenario and pave the way for an agreement,” Rehn said in a statement.
The IMF said that although it anticipates a “positive outcome” to the talks this weekend, disbursement of the next round of bailout money remained contingent on Greece agreeing to the billions of dollars in spending cuts, tax increases and public asset sales recently negotiated by Papandreou.
“We stand ready to continue our support for Greece subject to adoption of the economic policy reforms agreed with the Greek authorities,” IMF spokeswoman Caroline Atkinson said.
Those reforms are to be imposed on a society beleaguered by 16 percent unemployment and a recession made deeper by the very austerity programs insisted upon by European nations and the IMF as a condition of the bailout. According to IMF data, public-sector spending in Greece dropped nearly 9 percent in 2010 and is expected to fall by the same amount this year, drawing billions of dollars from the economy even before the newest round of cuts is imposed.
Reaction on the street has been intensifying, with tens of thousands of protesters blocking Athens’s main Syntagma Square on Wednesday to pressure Parliament to reject the latest plan.
Even if that plan is approved and the next round of emergency money is disbursed, it will tide the country over only until fall, at the latest, and will do little to assure investors that Greece is on a sound long-term footing. Greece at present is not selling long-term bonds, relying instead on the emergency bailout loans. However, the interest rate demanded by investors buying Greek bonds on the secondary market has risen to more than 20 percent, a sign of how far the country is from being able to borrow money on its own.
“There is very little way that Greece can pay back the debt” it accumulated during years in which its entry into the euro-zone currency union allowed it to borrow money at rates not much different than Germany, said Jonathan Tepper, partner at Variant Perception, an economic research group in London. The government bonds issued by Germany, an economic powerhouse, are considered among the world’s safest investments and, accordingly, carry low interest rates.
The situation has drastically changed for Greece and other European countries, with Ireland and Portugal also under emergency IMF programs and borrowing costs rising in Spain, Italy and Belgium because of concern they may eventually have trouble repaying their loans.
“The fact that the situation has deteriorated in Greece has made the situation more acute,” said Gavan Nolan, a research analyst at Markit Group in London. “The E.U. and the IMF look set to delay the day of reckoning, giving them more time. But it throws the ball back into the court of the Greek government. Can they pass the austerity measures? That’s the key.”
European officials have been working for 18 months to avoid a Greek default and make sure all of the country’s bondholders are repaid.
Papaconstantinou, who handled negotiations with the European Union and IMF as the Greek finance minister last year, was clear about the stakes. “At this very difficult moment, there is only one goal for all of us: stability, to keep the country and its economy on its feet, to continue without interruption the financing of the country and its lenders,” Papaconstantinou told reporters hours before he was moved to the Environment Ministry Friday.
Faiola reported from London.