The International Monetary Fund said that despite bailouts for Greece, Ireland and Portugal, Europe''s debt crisis may yet spread to core euro zone countries and emerging Eastern Europe.
The stark 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.
IMF''s latest economic report on Europe said that "Contagion to the core euro area, and then onward to emerging Europe, remains a tangible downside risk."
A Reuters'' poll of investors and economists showed an overwhelmingly majority believe Greece will restructure its debt, possibly as soon as later this year. Most fund managers expect Athens to pay back less than half of what it owes.
The IMF said it stood ready to provide more aid to Greece if requested, but the country that triggered Europe''s sovereign debt crisis in 2009 still had plenty of untapped potential to raise extra cash itself though privatizations.
Finance ministers of the 17 country single currency area are set to approve a EUR 78 billion rescue plan for Portugal 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 EUR 327 billion debt and will have to restructure, forcing losses on investors with severe consequences in the euro zone and beyond.
Asked whether there could be new aid package to help Greece work through its fiscal recovery program, Mr Antonio Borges, the IMF''s European department director, said the fund was open to the possibility. He added that "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."
The semiannual 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.
Mr Borges said that the program 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.
French finance minister Mr Christine Lagarde reiterated that Greece would not need to restructure its debt. He said that "What I rule out is restructuring. There is no question about it."
Speaking on the same program, British finance minister Mr George Osborne said Britain should not be involved in future discussions on a further Greek bailout since it was not part of the original euro zone package and is not a euro zone member.
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 in Greece 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%.
By contrast, Portuguese and Irish yields eased after the Finnish deal on aid to Lisbon removed one political uncertainty. The euro skeptical 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.
Reuters'' polls showed that among 28 mainly sell side economists and 15 fund managers only three said a restructuring could be avoided. Nearly 60% of fund managers expecting a restructuring said it would eventually mean a haircut, in which bondholders are forced to take a loss. The median expectation was for a 55% 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%. Officials from Greece, the European Commission and ECB have repeatedly rejected any talk of debt restructuring.
German finance minister Mr 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 program.
Signs of disquiet have begun to emerge from the EU IMF ECB troika mission, government sources in Athens said. They added that "They are forming an opinion that there are difficulties. 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 EUR 12 billion tranche of its EUR 110 billion EU IMF bailout. Without it, Greece could effectively default.
Ireland and Greece are already dependent on EUR 52.5 billion of IMF aid while Portugal is awaiting a EUR 26 billion 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 12th 2011.