Spend now to speed growth, Germans told

Christine Lagarde, the head of the International Monetary Fund, yesterday heaped more pressure on Germany over its handling of the eurozone crisis, effectively calling on Berlin to increase state spending in order to restore growth to the rest of the single currency bloc. Her words came as the Greek debt talks seemed on the verge of success.

On the eve of a tense EU summit in Brussels that will finalise a new inter-governmental agreement on fiscal discipline, the intervention by Ms Lagarde is likely to make the already rocky relationship between Angela Merkel's government and the IMF still worse.

And in a fresh blow to the German Chancellor, the European Commission last night rejected a plan by Berlin to force Greece to hand over control of its budget to Brussels. The German plan, which was also viewed with suspicion by British officials, would have seen the establishment of a eurozone budget commissioner who would directly control tax and spending decisions in debt-ridden Greece.

David Cameron travels to Brussels tomorrow for his first meeting with Nicolas Sarkozy since the PM's veto at the EU summit in December. EU officials are pushing for a quick agreement on the new "fiscal compact" in case of a change of government in Paris, following presidential elections in April and May, sees France tear up the treaty proposals.

News came yesterday evening that Greece and its private creditors are very close to a deal that will significantly reduce the country's debt and give it more time to repay the rest of what it owes. After three hours of talks with Prime MinisterLucas Papademos and Evangelos Venizelos, the Finance Minister, yesterday, Charles Dallara and Jean Lemierre, the two creditor representatives, issued a statement saying the two sides were "close to the finalisation of a voluntary (private sector involvement) ... We expect to conclude next week."

It appears the creditors agreed with the proposal that the new bonds to be issued by Greece in place of the old ones should have an interest rate "clearly below 4 per cent". The rate had been the main sticking point in the two-week-long talks as creditors had demanded a higher rate. Mr Dallara, the managing director of the Institute of International Finance (IIF) and Mr Lemierre, the senior adviser to the chairman of Banque BNP Paribas, represented banks, insurance companies and other private holders of some €206bn (£173bn) in Greek bonds.

While the details are not final, it is expected the bondholders will accept a 50 per cent write-down in the value of their holdings, meaning Greece's debt will be reduced by just over €100bn. The maturities in the new bonds will also be longer. A deal with private creditors is also seen as a prerequisite for Greece to get a second, €130bn, bailout from its EU partners and the IMF, although there are other issues before Greece can get that aid.

Addressing the wider picture at the World Economic Forum in Davos, Ms Lagarde said that a wave of co-ordinated austerity from states across the world was likely to "strangle" global growth. "Some countries have to go full-speed ahead to do this fiscal consolidation, but other countries have space and room," she said.

Although she was careful not to name the nations that ought to increase their spending, Ms Lagarde did say that "some of them have in-house domestic rules that have to do with fiscal consolidation and balanced budgets".

In 2009, a "debt brake" was written into German law, making it illegal for the Berlin government to run deficits. Although the law does allow for higher government spending in the event of an economic emergency, Germany has consistently refused appeals for it to increase spending in order to help pull Europe out of a looming recession.

The renowned economist Nouriel Roubini warned in Davos yesterday that the downturn in the West could last 10 years. "Once you have too much debt in the public and private sector, the painful process could last up to a decade," he said.

The German Finance Minister, Wolfgang Schauble, last week rejected the idea that higher state spending would be appropriate now. "You must never do the opposite in the short term. Otherwise you will never regain credibility," he said in Davos. "You must do the same in the short-term and the long-term."