The International Monetary Fund has set off a political earthquake in Europe, warning that Greece may need a full moratorium on debt payments for 30 years and perhaps even long-term subsidies to claw its way out of depression.

"The dramatic deterioration in debt sustainability points to the need for debt relief on a scale that would need to go well beyond what has been under consideration to date," said the IMF in a confidential report.

Greek public debt will spiral to 200 per cent of GDP over the next two years, compared with 177 per cent in an earlier report on debt sustainability issued just two weeks ago.

The findings are explosive. The document amounts to a warning that the IMF will not take part in any the Economic and Monetary Union-led rescue package for Greece unless Germany and the EMU creditor powers finally agree to sweeping debt relief.


This vastly complicates the rescue deal agreed by eurozone leaders in marathon talks over the weekend since Germany insists the bailout cannot go ahead unless the IMF is involved.

The creditors were aware of the IMF's report as early as Monday, yet chose to sweep it under the carpet. Extracts were leaked to Reuters yesterday, forcing the matter into the open.

The EMU summit statement vaguely mentions "possible longer grace and payment periods", but only at later date, and only if Greece is deemed to have complied with all the demands. Germany has ruled out a debt "haircut", claiming it would violate Article 125 of the Lisbon Treaty.

The IMF said there is no conceivable chance Greece will be able to tap private capital markets in the foreseeable future, leaving the country dependent on rescue funding.

It claimed that capital controls and the shutdown of the Greek banking system had changed the picture for debt dynamics, an implicit criticism of both the Greek Government and the eurozone authorities for letting the political dispute get out of hand.

The decision by the European Central Bank to force the closure of the Greek banks two weeks ago by freezing emergency liquidity assistance (ELA), appears to have cost European taxpayers very large sums of money.

The IMF said the Europeans would either have to offer a "deep upfront haircut" or slash the debt burden by stretching maturities and presumably by lowering interest costs.

"There would have to be a very dramatic extension with grace periods of, say, 30 years on the entire stock of European debt," it said.


Debt forgiveness alone would not be enough. There would also have to be "new assistance", and perhaps "explicit annual transfers to the Greek budget".