PARIS Whatever the outcome of sexual assault charges against its managing director, the International Monetary Fund may take a more distant and tougher line on sovereign debtors in Europe under new leadership.
Dominique Strauss-Kahn has softened the IMF's image as a stickler for fiscal orthodoxy and deregulation since 2007, and committed the global lender deeply to rescuing heavily indebted European countries -- not the Fund's traditional clientele.
The French Socialist had been widely expected to return home by July to run for his party's nomination in next year's presidential election before he was arrested on an Air France plane and indicted over an incident at a New York hotel.
His lawyer has said he will plead not guilty and the IMF said it remained "fully functioning and operational," but it is hard to imagine Strauss-Kahn staying in office for long while defending himself in a sex assault case.
The next head of the IMF may well not be a European, given strong pressure from emerging countries such as China, India and Brazil for their increased economic weight and priorities to be reflected in the Washington-based fund.
Complicating matters, Strauss-Kahn's deputy, John Lipsky of the United States, announced on Thursday he would step down when his term ends in August. So the global financial institution faces a potential leadership vacuum at a crucial time.
"The chances are the successor won't be a European, and will want to rebalance the IMF's priorities away from its massive commitment in Europe," said Jean Pisani-Ferry, director of the Bruegel economic think-tank.
MOST COMMITTED EUROPEAN
Strauss-Kahn negotiated an increase in representation for the emerging nations at the IMF. He has campaigned for stricter financial regulation, created new credit lines to help states before they get into trouble and built an unprecedented partnership with the European Union in euro zone bailouts.
When the global finance crisis struck in 2007-8, he campaigned for bold stimulus spending to avoid another Great Depression and reinvented the IMF as a more socially conscious financial fire brigade, seeking to avoid what he saw as errors committed in Latin America and Asia in the 1980s and 1990s.
For example, when IMF and European Commission officials negotiated a rescue program for Latvia in 2009, the IMF pushed for a fairer sharing of the tax burden in the Baltic state, because of concern that its flat income tax unfairly penalized the poor.
"He has been the IMF chief most committed to European integration and most actively involved in the European debate," Pisani-Ferry said. "He strongly believes that Europe has to follow the logic of monetary union and build a political union."
Strauss-Kahn has repeatedly urged the EU to take a bolder, more comprehensive approach to its debt challenge, warning that its piecemeal approach to crisis management was behind the curve and was not working.
In private, he has made clear his support for issuing common euro zone bonds -- vehemently opposed by Germany -- to reduce the prohibitive borrowing costs of weaker peripheral European states, in return for stronger EU-supervised economic reforms.
The IMF has pledged one-third of all the emergency loans made available to Greece, Ireland and now Portugal, in addition to providing funds to EU newcomers Hungary, Latvia and Romania and a backup flexible credit line for Poland.
The Fund has committed nearly 100 billion euros ($142.9 billion) to these programs. Yet at key points in the sovereign debt crisis, the IMF has deferred to the Europeans rather than insist on its traditional policy recipes, experts say.
It dropped calls for Latvia to devalue its currency and for private bondholders in Irish banks to share huge losses with taxpayers, and it has continued to support loan disbursements for Greece as Athens has fallen short of its fiscal targets.
A key test will come next month when Greece is due to get the next 12 billion euro tranche of aid, crucial to meet a 13.7 billion euro debt redemption due in June.
IMF and EU inspectors now in Athens have found new holes in Greece's books, with recession and tax evasion opening a big revenue shortfall set to blow the country further off course.
With Strauss-Kahn sidelined, the Fund may be less inclined to keep on bankrolling Greece without significant policy changes. It may also be more inclined to challenge the view of the European Commission and the European Central Bank that Athens remains solvent and does not need a debt restructuring.
A Greek official told Reuters that Strauss-Kahn's arrest "might definitely cause some delays in the short term" but would not change the IMF's policy on Greece.
That could cause some jitters in euro markets, increasing the steep premium that Greek bond yields offer over German ones, and raising the cost of buying protection against default.
Any such market moves would be more pronounced if it became clear that decisions about the next tranche of loans to Greece might be held up.
David Buik, senior partner at London-based inter-dealer broker BGC Partners, said Strauss-Kahn's arrest could have a short-term negative effect on the euro but added that the IMF's economic restructuring work may not be impeded much.
"It may rattle the market's cage a little bit and the euro may come off a cent or two, but organizations such as the IMF have got a pretty deep infrastructure in place," said Buik.
However, the euro has remained resilient through the crisis due to the European Central Bank's commitment to monetary tightening to combat inflation.
(Additional reporting by Swaha Pattanaik and Sudip Kar-Gupta in London; editing by Mark Trevelyan)