(Adds holdout creditors organizing new negotiating committees)
BUENOS AIRES, July 8 (Reuters) - Argentina said on Tuesday it would meet with a mediator for the second time this week in the country's dispute with "holdout" investors, lifting market hopes for a deal needed to avoid another painful debt default.
With the economy already in recession, President Cristina Fernandez's cash-strapped government has until July 30 to reach an agreement with hedge funds who refused to participate in the country's earlier debt restructuring and have been suing for full repayment of sovereign bonds which Argentina defaulted on in 2002.
On Argentina's local over-the-counter market, benchmark Discount bonds rose 1.60 percent to 88.65 while Par bonds were up 1.32 percent to 49.90. Traders cited optimism over the talks as the reason for the climb.
Argentina's cabinet chief Jorge Capitanich did not say whether the holdout funds led by Elliott Management Corp and Aurelius Capital Management would participate in Friday's meeting. There was no immediate comment from the funds.
Other holdout investors with over $6 billion worth of unrestructured Argentine debt have started organizing negotiating committees, encouraged by Buenos Aires' stated desire to settle with 100 percent of its creditors.
The government has said that settling with funds led by Elliott would carry the risk of opening Argentina to a slew of suits from other holdouts.
On Monday, Argentina's Economy Minister Axel Kicillof spent four hours discussing the case in New York with the mediator, Daniel Pollack, who was appointed by U.S. District Judge Thomas Griesa to find common ground in the years-long dispute.
"It was agreed to continue this meeting on Friday," Capitanich said. "It has been an intense dialogue."
Kicillof flew back to Buenos Aires on Tuesday and described the session with Pollack as "an important advance".
"We will go back on Friday," Kicillof told reporters.
In the last few months Kiciloff has settled long-standing disputes with the Paris Club of creditor nations and Spanish oil major Repsol in a bid to lure investors back to Argentina.
But his stance toward the holdouts was anything but conciliatory on Tuesday. "They are trying to extort a sovereign country," he said in a statement on the presidential website.
Without a deal this month, a court ruling by Judge Griesa would prevent the country from making coupon payments to creditors who accepted a large writedown on their debt holdings after 2002. That would put Argentina in default.
PAYMENT IN LIMBO
More than 92 percent of creditors accepted less than 30 cents on the dollar in restructurings worked out in 2005 and 2010. The holdouts shunned those terms and sued for full repayment plus interest, but they say they are willing to negotiate with the government.
Judge Griesa blocked a June 30 coupon payment that Argentina tried to make on the restructured bonds, triggering the start of a 30-day grace period ending July 30.
Argentina is being pushed into talks after refusing for years to negotiate with the holdouts, portraying them as "vultures" circling the corpse of the country's 2002 default as most bought the bonds in the secondary market at a discount.
Fernandez's government says Griesa overstepped his powers by blocking the coupon payment.
Argentina published a two-page legal notice in the New York Times on Tuesday, saying it "duly deposited the amounts of interest due on the New Debt Securities issued within the framework of the 2005 and 2010 Sovereign Exchange Offers."
It said that Bank of New York Mellon, the trustee bank, is required to distribute those funds to bondholders, calling BONY Mellon's failure to do so a "violation of its obligations".
BONY Mellon had no comment on the legal notices from the government. A source with direct knowledge of the situation said the bank will file a motion to Judge Griesa on Thursday seeking guidance on what it should do with the money. (Additional reporting by Jorge Otaola and Richard Lough in Buenos Aires and Daniel Bases in New York; Editing by Andrew Hay)