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Phillip Inman in Tokyo, Thursday 11th October 2012 19:13
Spain defied renewed pressure to accept an international bailout on Thursday, a stance that could last for several more weeks or even months despite the humiliation of having its credit rating cut to near junk status.
As the head of the International Monetary Fund called on governments to co-operate to heal a fractured global economy, credit rating agency Standard and Poor's said recession was limiting Spain's policy options and any delay in seeking a rescue risked a further downgrade. Moody's said it may soon follow suit.
Prime minister Mariano Rajoy, however, struck a defiant tone when he said that tough labour reforms and the rebuilding of its tarnished banking sector meant the IMF's dire forecast for Spain's economy would not be realised.
"If we follow that strategy … we'll see that the reality turns out to be better than the forecasts," he said.
Rajoy's position was strengthened as Spain's key 10-year bond yield remained unchanged on Thursday despite the S&P move. He is thought to want to wait at least until after regional elections on 21 October to ask for aid and even later if the European Central Bank's bond buying keeps borrowing costs down.
He is supported by the German chancellor, Angela Merkel, who does not want to explain another bailout to her voters.
Speaking at its annual meeting in Tokyo, IMF chief Christine Lagarde warned that only with greater co-operation and courage could governments hope to prevent a repeat of the financial crisis.
After banking regulators told her some parts of the financial system were as unsafe as before the collapse of Lehman Brothers in 2008, she said policymakers needed to take immediate action to resolve issues hanging over from the crisis.
"There are threats on the horizon, threats that can be addressed, should be addressed but are not necessarily addressed," she said.
Europe has come under fire for its failure to end the eurozone debt crisis. Leaders in the US and Asia have become frustrated at delays in agreeing measures to bolster Greece, Spain and Portugal.
Lagarde said: "We expect action and we expect courageous and co-operative action on the part of our members."
The IMF has expressed frustration with Europe's piecemeal response to its debt crisis and warned that a recent respite in borrowing costs for debt-laden countries such as Spain may prove short-lived unless eurozone leaders come up with a comprehensive and credible plan.
The IMF itself came under fire after it admitted in its World Economic Outlook report that officials had underestimated the effects of austerity measures on economic growth. The report found that for every £1 of spending cuts the economy shrank by about £1.30, compared with the previous estimate of 50p.
The IMF was a strong supporter of the austerity measures adopted by western countries including Britain in the aftermath of the financial crisis, but it has U-turned in recent months and urged governments to plan their reforms over longer periods to lessen the impact on growth.
Lagarde said on Thursday that struggling countries should have more time to meet budget cuts. "It is sometimes better to have a bit more time," she said. "That is what we advocated for Portugal, this is what we advocated for Spain and this is what we are advocating for Greece."
Lagarde also said, however, that she backed the IMF's chief economist, Olivier Blanchard, who argued it was necessary to pursue government spending cuts or risk a backlash from international money markets and a rise in borrowing costs.
The chancellor, George Osborne, is expected to admit next month in his autumn statement that he has missed at least one of his deficit reduction targets. He has already announced an extension of the government's rolling five-year austerity programme to 2018.
Oxfam warned that the IMF's focus on the eurozone should not be at the expense of the world's poorest. "It's imperative that the poorest countries are not overlooked at this meeting. Europe's crisis needs to be fixed because the fallout is seriously threatening developing countries.