IMF: $650 billion isn't enough for the European bailout fund

European finance ministers agreed to move up the launch of a permanent bailout fund by a year, but the fund is still too small, according to the IMF.

Eurozone finance ministers have agreed to install a new, permanent bailout fund a year earlier than planned, a sign that the continent still struggles to find the right cure for its sovereign debt crisis. 

At a meeting in Brussels last night, the Eurogroup decided to launch the European Stability Mechanism (ESM) and provide it with a volume of €500 billion ($650 billion). 

Criticism came quickly. The International Monetary Fund (IMF) said the fund should be boosted to €750 billion ($976 billion). Europe needs “higher firewalls,” said IMF Managing Director Christine Lagarde in a speech at the German Council on Foreign Relations in Berlin on Monday.

The German government promptly rejected the suggestion. Chancellor Angela Merkel said her country was doing everything needed to save the euro, but that a boosting of the rescue fund is unnecessary at this point of time. Germany supplies €22 billion ($28.5 billion) in cash and €168 billion ($218.5 billion) in guarantees to the ESM. Germany has shouldered the largest share of this bailout funding so far.

The backdrop to the current argument is the ongoing debate about the priorities in solving the euro debt crisis. Germany insists on budgetary discipline as the main tool. Before Ms. Merkel commits to spending more money on bailing out ailing economies, she wants to see implementation of the fiscal union she pushed through at the last EU summit in December that would give Brussels more control over individual countries' budgets. By March, member states are supposed to have ratified the union, subscribing to the German idea of austerity. 

Critics of Merkel’s position say that thrift is not the answer, nor does Europe have time until March. Mrs. Lagarde, who on Sunday met with Merkel and Finance Minister Wolfgang Schäuble, was clearly not satisfied by the outcome of that meeting.

"The longer we wait, the worse it will get,” Lagarde said in her speech on Monday. "We must all understand that this is a defining moment. It is not about saving any one country or region. It is about saving the world from a downward economic spiral."

The IMF warned on Tuesday that the euro area would fall into a "mild recession" this year. The eurozone's economy is expected to shrink by .5 percent, according to the IMF's revised forecast released today. 

Lagarde appealed to Germany to fulfill its leadership role. She urged the chancellor to accept financial risk-sharing in the eurozone – possibly in the shape of so-called eurobonds – and an increased engagement of the European Central Bank (ECB) to provide capital to indebted economies as well as to private banks.

“It’s a bit of a gamble,” says Christian Dreger, an analyst at the German Institute for Economic Research in Berlin. “The German government tries to force its European partners into fiscal discipline as long as it can. But rather sooner than later it will have to give in and think about growth programs. In the meantime though, Germany profits from the crisis – its bonds are in high demand.”

At their Brussels meeting the EU finance ministers also discussed the stalled negotiations on a debt swap deal between the Greek government and its private creditors. Talks in Athens about the amount of Greek sovereign debt private lenders would have to write off and about the interest rate lenders would get on new bonds ended on Sunday without a result.

The finance ministers backed Greece, which is asking for an interest rate of about 3.5 percent, while the investors ask for at least 4 percent. The aim of the deal is to reduce the Greek sovereign debts of €350 billion ($454 billion) by about €100 billion ($130 billion). But negotiations have been going on for seven months now and if an agreement is not reached within days, a Greek default seems inevitable.

Some observers think the country should prepare for that event anyway. “Even if the haircut for Greece was 100 percent, it would not solve the problem,” says Robert Halver, analyst at Baader Bank in Frankfurt. “Greece does not have a viable business plan. Let them leave the euro, restructure, and come back reinvigorated in 10 years time.”