Act two of a Greek tragedy

European markets have fallen prey to renewed anxiety that fears over Greece's debt woes are already spreading to Portugal and Spain.

Portugal has already shown signs of contagion, with its bond yields rising sharply to 4.78 per cent overnight, while the cost of default insurance for Irish, Portuguese and Spanish debt has also soared to close to the record peaks reached when the financial crisis was at its worst.

The deterioration comes as the International Monetary Fund has warned that fears over Greece's debt situation could spread to other vulnerable countries in the eurozone, ushering in a new phase of the financial crisis.

"In the near term, the main risk is that – if left unchecked – market concerns about sovereign liquidity and solvency in Greece could turn into a full-blown sovereign debt crisis, leading to some contagion," the IMF warned in its latest World Economic Outlook released overnight.

Another IMF report released earlier this week nominated Portugal, and to a lesser extent Spain and Italy, as the countries most likely to suffer contagion effects from Greece's debt problems. It also noted that European banks held large chunks of Greek debt.

Signs of market nervousness were even evident in the strongest eurozone economy, with Germany failing to sell all of its $US4 billion of 30-year bonds at auction.

But Greece's debt bore the brunt of the market lashing, with yields on the country's 10-year bonds climbing an astonishing 42 basis points to 8.28 per cent, just as a 20 member delegation of officials from the European Union, the IMF and the European Central Bank arrived in Athens to discuss the terms of the country's $US60 billion rescue package.

There is huge resistance within Greece to accepting additional austerity measures that the IMF is likely to impose as a condition of its loan, prompting speculation that a schism has emerged in Prime Minister George Papandreou's Socialist Party, with the hard-left faction stridently opposing the IMF discussions.

The country's public transport will grind to a halt later today, and many banks and government offices will be closed due to a 24-hour strike by the public sector trade union, ADEDY to protest against further austerity measures.

At the same time there are reports that estimates of Greece's budget deficit will be revised upwards to 13.7 per cent of GDP this year, rather than the current figure of 12.9 per cent. This would put huge pressure on Greece to agree to further tax rises and spending cuts to improve its finances.

The joint European Union and IMF rescue package is expected to provide Greece with up to $60 billion of emergency funding this year. Of this, the eurozone countries would provide $40 billion at an interest rate of around 5 per cent, while the IMF would lend $20 billion, charging around 3 per cent interest.

The problem for Greek bond holders is that a condition of the IMF loan is that the fund becomes a preferred creditor of Greece, meaning that it is repaid before all other lenders. It is uncertain whether the other eurozone countries will also claim preferred creditor status for their loans.

There is also mounting concern that the EU/IMF rescue package might involve some form of Greek debt restructuring, which could involve existing lenders to Greece taking some losses on their loans, or accepting delays in repayment.

Meanwhile, time is running out for Greece to get the EU/IMF funding package in place in time to refinance $11.4 billion bond that matures on May 19.

The Greece finance minister, George Papaconstantinou has estimated that the talks over the conditions of the rescue package would likely last two weeks, and that a joint text could be agreed by May 15. He estimated that funds from eurozone countries could then start arriving in one to three weeks.

Meanwhile, while France has moved towards making its $8 billion financing package in place, there are still question marks over whether the German parliament will approve its $11.4 billion contribution to the rescue package.