Brussels - European Union leaders piled pressure
on Italy on Sunday to speed up economic reforms to avoid a Greece-style meltdown
as they began a crucial two-leg summit called to rescue the euro zone from a
deepening sovereign debt crisis.
The aim is to agree by Wednesday on reducing Greece’s debt burden,
strengthening European banks, improving economic governance in the euro area and
maximising the firepower of the EFSF rescue fund to prevent contagion engulfing
Before the 27 leaders began talks on a comprehensive plan to stem
the crisis, German Chancellor Angela Merkel and French President Nicolas Sarkozy
held a private meeting with Italian Prime Minister Silvio Berlusconi, officials
Diplomats said they wanted to maximise pressure on Rome to
implement structural labour market and pension reforms to boost Italy’s economic
growth potential and reassure investors worried about its huge debt ratio,
second only to Greece’s.
A German government source said Merkel and Sarkozy underlined “the
urgent necessity of credible and concrete reform steps in euro area states”,
without which any collective EU measures would be insufficient.
Merkel warned in a speech on Saturday that if Italy’s debt remained
at 120% of gross domestic product “then it won’t matter how high the
protective wall is because it won’t help win back the markets’ confidence”.
Arriving for Sunday’s sessions of the full EU and the 17-nation
euro zone, the leader of Europe’s most powerful economy played down expectations
of a breakthrough, telling reporters decisions would only be taken on Wednesday.
Before then, Merkel must secure parliamentary support from her
fractious centre-right coalition in Berlin for unpopular steps to try to save
the euro zone.
European Council President Herman Van Rompuy, chairing the summit,
painted a sombre picture of the economic challenges facing Europe in his opening
remarks, citing “slowing growth, rising unemployment, pressure on the banks and
risks on the sovereign bonds”.
“Our meetings of today and Wednesday are important steps, perhaps
the most important ones in the series to overcome the financial crisis, even if
further steps will be needed,” he said.
Finance ministers made progress at preparatory sessions on Friday
and Saturday, agreeing to release an €8bn lifeline loan for Greece and
to seek a far bigger write-down on Greek debt by private bondholders.
They also agreed in principle on a framework for recapitalising
European banks, which banking regulators said would cost just over €100bn, to help them withstand losses on sovereign bonds, although some details
remain in dispute.
Sarkozy, who disagreed sharply with Merkel over strategy last week,
pressing to put the European Central Bank in the front line of crisis-fighting,
said after meeting her again on Saturday he hoped for a breakthrough in the
middle of the week.
“Between now and Wednesday a solution must be found, a structural
solution, an ambitious solution, a definitive solution,” Sarkozy said. “There’s
no other choice.”
Asked whether he was confident of a deal, he replied: “Yes,
otherwise I wouldn’t be here.”
The key outstanding issues were how to make Greece’s debt burden
manageable and scale up the euro zone rescue fund to shield Italy and Spain, the
euro area’s third and fourth largest economies, from bond market turmoil that
forced Greece, Ireland and Portugal into EU-IMF bailouts.
Markets are concerned that Greek debt, forecast to reach 160% of GDP this year, will have to be restructured, but investors do not
know what kind of damage they will have to take on their Greek portfolios.
The size of the losses private bond holders would have to suffer
was the first issue that will be discussed on Sunday.
A debt sustainability study by international lenders showed that
only losses of 50-60% for the private sector would make Greek debt
sustainable in the long term.
This is much more than a 21% net present value loss agreed
with investors on July 21 and some officials question whether it can be achieved
voluntarily, or only through a forced default that would trigger wider market
Euro zone officials now argue the recession in Greece is much
deeper than expected, the country is behind on privatisation and fiscal targets
and market conditions have deteriorated in the past three months.
To have enough money to support Italy and Spain, if needed, the
euro zone wants to boost the firepower of its bailout fund, the €440bn European Financial Stability Facility.
But public opinion in many countries is strongly against more
bailouts, and further commitments to the EFSF could drag down some countries’
credit ratings, worsening the crisis.
How to raise the potential of the fund without new cash was
probably the most contentious point to be discussed on Sunday, but not expected
to be resolved until Wednesday.
France and several other countries would like the bailout fund to
be turned into a bank so that it can get access to limitless financing from the
European Central Bank. But Germany and the ECB itself are adamantly against
The most likely solution seems to be that the EFSF would guarantee
a percentage of new borrowing of Spain and Italy in a bid to improve market
sentiment towards those countries.
Such a solution might help ring-fence Greece, Ireland and Portugal,
but some analysts say it could have perverse effects, creating a two-tier bond
market in which secondary bond prices would be depressed, and removing the
incentive for Italy to take politically unpopular action to cut its debt.
Another possibility under discussion is to create a special purpose
vehicle that would enable non-euro zone countries and sovereign wealth funds to
invest in government bonds, but EU officials are reluctant to give countries
like China a seat at the euro zone table.
Unless European banks get more capital to cover potential losses on
these bonds, other banks will be reluctant to lend to them on the interbank
market, triggering a liquidity crunch, now prevented only by stepped-up ECB
The European Banking Authority told European Union finance
ministers on Saturday that if all such bank assets were valued at market prices,
EU banks would need €100-110bn of new capital to have a 9%
core tier 1 capital ratio, an EU source familiar with the discussions said.
Ministers agreed to give banks until June 2012 to achieve this
capital ratio, first using their own funds or from private investors, and if
that fails, by using public money from governments or as a last resort the EFSF.
With Italy, Spain and Portugal unhappy about the burden being
placed on their banks, EU leaders were to discuss the issue on Sunday, but the
source said it was unlikely an overall sum for recapitalisation would be