Eurozone rescue plans shrouded in doubt

Brussels - A split between the International Monetary Fund and the European Union over Greece's debt mountain threatens to delay a vital next aid payment to Athens in another blow to European efforts to stem the debt crisis.

An admission by French President Nicolas Sarkozy on Wednesday that Berlin and Paris were divided over how to make the eurozone bailout fund stronger had already dented hopes that Sunday’s EU summit would bring substantial progress.

Now, EU officials say the IMF rates Brussels’ projections for Greece’s debt as too optimistic and wants to delay approval of the next aid tranche, further complicating the picture.

The fund wants to wait until after this weekend’s summit to see if discussions produce a clearer picture although the baseline advice remains that the tranche should be paid soon.

Without an €8bn loan payment from the EU and IMF next month Greece faces default, possibly dragging the larger economies of Spain and Italy into the mire and sending shockwaves through the banking system.

Seeking a comprehensive plan, eurozone leaders are striving to agree new steps to reduce Greece’s debt, strengthen the capital of banks with exposure to troubled eurozone sovereigns and leverage the eurozone’s rescue fund to stem contagion to bigger economies.

But progress appears to be glacial.

Sarkozy flew to Frankfurt on Wednesday for emergency talks with German Chancellor Angela Merkel, the head of the IMF and other key eurozone officials. French media reported he missed the birth of his daughter in the process.

France has argued the most effective way of leveraging the European Financial Stability Facility (EFSF) is to turn it into a bank which could then access funding from the European Central Bank, but both the ECB and Berlin oppose this.

Failure to reach a deal at Sunday’s summit of European leaders would further undermine market confidence in the currency bloc and its ability to solve a two-year-long debt crisis, which threatens the viability of the single currency.

Markets caught up with the downbeat tone from policymakers. European shares fell having risen this week on hopes of comprehensive action from eurozone leaders.

Since France’s finance minister pledged a decisive outcome to the October 23 summit last Saturday, expectations have been downplayed with Germany and others saying it will only be another step along the road to solving the debt crisis.

“I don’t believe that such solutions could be made on Sunday that would ... fix everything. But I’m certain that there will be decisions that point to the right direction,” Finnish Prime Minister Jyrki Katainen said in comments broadcast late on Wednesday.

Canada’s Finance Minister Jim Flaherty said the “two-steps-forward one-step-back” approach was disconcerting.

Showing it is far from out of the woods, Spain sold €3.9bn of bonds but paid high borrowing costs after a run of credit-rating downgrades.

Without more firepower, the EFSF will not have the means to defend Spain and Italy from market attack.

Guidelines for the bailout fund obtained by Reuters confirmed it will be able to buy bonds on the secondary market once a request from a country is approved by ECB and eurozone finance officials.

A draft statement for Sunday’s summit showed eurozone countries will make rules to limit budget deficits and public debt part of national legislation by the end of next year.

But there was no indication in the statement of progress on the main areas of dispute.

Forced bank losses?

Adding to the uncertainty, EU officials said there was growing acceptance among key eurozone member states that further private sector involvement in reducing Greece’s debt burden may have to be forced, not voluntary, something that has been ruled out up to now.

“Let’s be serious, everybody knows that a 50% haircut, as Germany is asking for, is not a voluntary moves,” one EU official said.

In July, private sector investors agreed to contribute €50bn to reducing Greece’s debt via a debt buyback and swap agreement, which equated to a 21% writedown. That is now seen as insufficient to make Athens’ debts sustainable.

Greece remains mired in recession and its overall debt is forecast to climb to €357bn this year, or 162% of annual economic output - which few economists believe can be paid back.

The Financial Times reported that plans to strengthen the banking system, another key plank of the discussions, would fall short of market expectations.

Latest official estimates put the banks capital shortfall at less than €100bn, the FT said, compared with a recent IMF report putting the funding hole at €200bn and analysts’ estimates of €275bn or more.

Germany’s banks are likely to face only a mid-single digit billion euro capital shortfall when bolstering their capital buffers, political and regulatory sources familiar with the situation said. They are expected to be able to raise the cash needed without additional backing from taxpayers.

With a senior German government source saying Berlin remained resolutely opposed to the ECB backstopping the rescue fund, eurozone officials have told Reuters that an alternative model, whereby the EFSF could underwrite a portion of newly issued eurozone debt, is also on the table.

By guaranteeing the first 20-30% of any losses, the €440bn EFSF could be stretched three to five times further.

Analysts are unconvinced that a leverage plan involving a guarantee on first losses would be meaningless without an explicit commitment from the ECB to go on buying at-risk debt, something it has been reluctant to do.

While Europe’s leaders rush to stop a larger writedown of Greek debt infecting others in the eurozone, ordinary Greeks are raging at the prospects of several more years of pain as the price of help from international lenders.

Greek protesters marched on parliament, raising the prospect of more violence in strikes against austerity measures parliament is poised to approve to try to stave off bankruptcy.

Running battles between black-clad demonstrators and riot police on Wednesday left streets in central Athens covered with smouldering rubbish and lumps of masonry hacked off buildings.