Second Greek bailout in reach, funding gap narrows

BRUSSELS Mon Feb 20, 2012 6:07pm EST

1 of 7. (L to R) Greece's Finance Minister Evangelos Venizelos, Greece's Prime Minister Lucas Papademos and Germany's Finance Minister Wolfgang Schaeuble attend a Eurogroup meeting at the European Union council headquarters in Brussels February 20, 2012.

Credit: Reuters/Yves Herman

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BRUSSELS (Reuters) - Euro zone finance ministers inched towards approving a second bailout for debt-laden Greece on Monday that would resolve Athens' immediate repayment needs but seems unlikely to revive the nation's shattered economy.

Agreement on a 130-billion-euro rescue package with strict conditions would draw a line under months of uncertainty that has shaken the currency bloc, and avert an imminent bankruptcy.

After seven hours of talks, senior officials said ministers had found ways to cut Greece's debt to between 123 and 124 percent of gross domestic product by 2020, but were pressing for more. Negotiators for private bondholders had offered to accept a bigger loss to help plug the funding gap.

A report prepared for ministers by EU, European Central Bank and IMF experts, obtained exclusively by Reuters, said Greece would need extra relief to cut its debts to the official target of 120 percent of GDP by 2020.

If Athens did not follow through on economic reforms and savings, its debt could hit 160 percent by that date.

"Given the risks, the Greek program may thus remain accident-prone, with questions about sustainability hanging over it," the 9-page confidential report said.

The euro zone sources said national central banks could restructure Greek bonds held in their investment portfolios in the same way as private investors, cutting Athens' debt by another 3.5 percentage points.

If the ECB were to forego profits on its Greek holdings, that would raise another 5.5 percentage points of GDP, the report showed. However, the sources said some euro zone countries were reluctant to pursue this option.

Diplomats and economists say a deal may only delay a deeper default by a few months. A turnaround could take as much as a decade, a bleak prospect that brought thousands of Greeks onto the streets to protest against austerity measures on Sunday.

EU sources said the minister needed to agree new measures to find some 6 billion euros to make the financing work, given the ever-worsening state of the Greek economy.

An accord will enable Greece to launch a bond swap with private investors to help reduce and restructure Athens' vast debts, put it on a more stable financial footing and keep it inside the 17-country euro zone.

A senior euro zone source said the finance ministers were negotiating for private sector creditors to take a loss of at least 53.5 percent on the nominal value of Greek bonds under the debt swap, up from a previously agreed 50 percent loss.

Earlier in the day, French Finance Minister Francois Baroin said all the elements were in place to reach an agreement and Greek Finance Minister Evangelos Venizelos said he expected a deal.

"We expect today the long period of uncertainty - which was in the interest of neither the Greek economy nor the euro zone as a whole - to end," Venizelos said in a statement.

Dutch Finance Minister Jan Kees de Jager, the most outspoken of Greece's creditors, said the Netherlands could not approve the rescue package until Greece had met all its obligations. But the chairman of the Eurogroup, Jean-Claude Juncker, said Athens had met all the prior conditions demanded of it.

Finland, another stern creditor, signed a side-deal with Greece for Greek banks to provide collateral in cash and highly rated assets in return for Finnish loan guarantees, removing one long-running obstacle.

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DOUBTS OVER COMMITMENT

Skeptics question whether a new Greek government will stick to the deeply unpopular program after elections due in April, and believe Athens could again fall behind in implementation, prompting exasperated lenders to pull the plug once the euro zone has stronger financial firewalls in place.

Several thousand Greeks demonstrated on Sunday against the austerity measures to reduce the country's debt, although the numbers were much lower than protests a week earlier which saw building in Athens torched and looted.

While there are doubts in Germany and other countries that Greece will be able to meet its commitments, including implementing 3.3 billion euros of spending cuts and tax increases, officials said they were closing in on a deal.

Greek Prime Minister Lucas Papademos, International Monetary Fund Managing Director Christine Lagarde and ECB President Mario Draghi were all attending the Brussels talks in a sign they were likely to be decisive.

European shares hit a seven-month high and the euro rose on Monday as expectations of an agreement boosted investor appetite for riskier assets.

Under one crucial element of the deal, Greece will have around 100 billion euros of debt written off via a restructuring involving private-sector holders of Greek government bonds.

Banks and insurers will swap bonds they hold for longer-dated securities that pay a lower coupon, resulting in a real 70 percent reduction in the value of the assets.

The bond exchange is expected to launch on March 8 and complete three days later, Athens said on Saturday. That means a 14.5-billion-euro bond repayment due on March 20 would be restructured, allowing Greece to avoid default.

The vast majority of the funds in the 130-billion-euro program will be used to finance the bond swap and ensure Greece's banking system remains stable: 30 billion euros will go to "sweeteners" to get the private sector to sign up to the swap, 23 billion will go to recapitalize Greek banks.

A further 35 billion will allow Greece to finance the buying back of the bonds, and 5.7 billion will go to paying off the interest accrued on the bonds being traded in.

Those numbers could change during Monday night's talks given the scramble to meet the overall objective of reducing Greece's debts from 160 percent of GDP to around 120 by 2020.

MEETING THE TARGET

The debt sustainability report delivered to ministers last week showed that without further measures, Greek debt would only fall to 129 percent by 2020.

The IMF has said if the ratio cannot be cut to near 120 percent, it may not be able to help finance the bailout.

A number of measures, including restructuring the accrued interest portion, reducing the "sweeteners" and having euro zone central banks take part in the debt swap are being considered to move the figure closer to 120 percent.

There are also discussions about marginally lowering the interest rate on 110 billion euros of bilateral loans already made to Greece in May 2010, the first package of support.

The biggest difference would be made by involvement of the ECB and national euro zone central banks.

A deal would provide immediate relief to Athens and financial markets but no one is pretending it will end Greece's problems. Figures last week showed its economy shrank 7 percent year-on-year in the last quarter of 2011, much more than expected, with further cuts likely to make matters worse.

The troika of European Commission, ECB and IMF, responsible for monitoring Greece's reform progress, carries out quarterly reviews and could decide Athens is not meeting its commitments at any one of them.

(Additional reporting by Julien Toyer, Annika Breidthardt, Robin Emmott in Brussels, Daniel Flynn in Paris, Terri Kinnunen in Helsinki,; writing by Mike Peacock and Paul Taylor.)

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