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EU Officials Set to Discuss Greek Plan That Skirts Default Risk

June 18, 2011

June 18 (Bloomberg) -- European finance ministers meet tomorrow to hammer out a new Greek bailout package watertight enough to avoid triggering a default that German Chancellor Angela Merkel said would be uncontrollable.

Officials must figure out how to design a package that will encourage investors to roll over expiring Greek debt after Merkel yesterday ended a standoff with the European Central Bank over restructuring the country’s debt load. Talks will start at 6 p.m. in Luxembourg and continue the next day. EU leaders meet on June 23-24.

“Now comes the tricky part,” said Tullia Bucco, an economist at Unicredit Global Research in Milan. “This proposal is fraught with difficulties in identifying ways to provide banks with incentives to rollover their bonds. Any deterioration in bond conditions via new coupons below market rates would be seen by rating agencies as the trigger of a credit event.”

Stocks, bonds and the euro jumped yesterday after Merkel ended a feud with the ECB that roiled markets. Highlighting the risks still facing the euro region, Greek Prime Minister George Papandreou must win a parliamentary confidence vote next week that could delay Greece’s next round of austerity and Moody’s Investors Service said late yesterday it may cut its Aa2 rating on Italy’s sovereign debt.

Lehman Experience

Merkel said today in Berlin that policy makers must make sure the Greek crisis doesn’t infect the rest of the euro region and spark a new global financial crisis.

“We all lived through Lehman Brothers,” she told a meeting of activists from her ruling Christian Democrat party. “I don’t want another such threat to emanate from Europe. We wouldn’t be able to control an insolvency.”

Luxembourg Prime Minister Jean-Claude Juncker, who chairs tomorrow’s talks, says a new Greek plan will have to be rubberstamped by the ECB.

“If we made a move that would be rejected by the ECB, by the rating agencies and therefore the financial markets, we risk setting the euro area aflame,” La Libre Belgique quoted Juncker as saying in an interview published today.

The risk is that any pact will still be classified as a form of default by rating companies, effectively cutting Greek banks off from emergency ECB funding. Fitch Ratings said June 15 that a rollover would prompt it to cut Greece’s sovereign rating to “restricted default.” The bonds themselves would still avoid default and be left at “a low non-investment grade probably in the region of CCC,” it said.

Collateral Incentive

The debt is currently graded B+ at Fitch. Standard & Poor’s on June 13 cut its rating on Greece by three levels to CCC, branding it with the world’s lowest debt grade.

EU officials have discussed incentives for investors to reinvest the proceeds of their maturing bonds into new debt, according to people familiar with the situation. They include giving investors preferred status, higher coupon payments or collateral as inducements to buy bonds replacing Greek debt maturing between 2012 and 2014, they said.

The yield on Greece’s two-year bond, which topped 30 percent for the first time on June 16, fell 90 basis points to 28.79 percent yesterday. The signs of flexibility from Germany sent the euro up as much as 1 percent to $1.4339.

Spanish Prime Minister Jose Luis Rodriguez Zapatero said in St. Petersburg today that he expects EU leaders to make a “political commitment” to Greece next week.

Merkel said yesterday she was now willing to accept that the so-called Vienna initiative of 2009, which encouraged creditors to roll over expiring bonds, could be a model for private-investor participation in the new aid package.

Greek Reshuffle

That marked a reversal from the position set out by her finance minister, Wolfgang Schaeuble, who had insisted that Greek bond maturities be extended by seven years. The approach met ECB resistance and led to credit-rating company warnings that the move was tantamount to default, stalling efforts to craft an aid package.

Officials will meet two days after Papandreou announced a Cabinet reshuffle that included replacing Finance Minister George Papaconstantinou in a bid to get rebelling allies to back the 78 billion-euro ($112 billion) austerity plan that the EU and IMF have made a condition for new aid.

Papandreou named Evangelos Venizelos, his defense minister and a former rival for leadership of the ruling Socialist party, to replace Papaconstantinou.

Papandreou then called for a vote of confidence in his new government, which will probably be held the evening of June 21 after three days of debate.

Merkel Push

Merkel is nevertheless still pushing for private investors to play a “substantial” role in any new package, without specifying what that would look like.

“Let us try to get together a substantial contribution in this participation of private creditors,” she said today. “But we don’t do this on the street, we don’t do this in press conferences, we do this in serious talks with those making the contribution.”

European estimates put Greece’s 2012-14 financing gap at as much as 170 billion euros. It would be filled by about 45 billion euros of loans, plus 57 billion euros in unspent aid from the 2010 bailout, roughly 30 billion euros in asset- sale proceeds and about 30 billion euros from creditors.

--Editors: John Fraher, Randall Hackley

To contact the reporters on this story: Tony Czuczka in Berlin at

To contact the editors responsible for this story: James Hertling at

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