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BRUSSELS/BERLIN (Reuters) - Euro zone countries continued to grapple with the thorny issue of involving the private sector in tackling Greece's debt pile as they prepared for a meeting to decide support for the country next week.
"The principle of having a euro chiefs' meeting is accepted by the main players, including Germany," said one EU diplomat, adding that it was likely to happen next week despite earlier signals from Berlin that there was no rush to finalize a second package of aid.
First, however, countries have to agree how to involve private sector investors in tackling Greece's debt burden, a key demand of Germany before it signs off more support for Athens and a step the International Monetary Fund said on Wednesday must be taken.
"Comprehensive private sector involvement is appropriate, given the scale of financing needs and the desirability of burden sharing," the IMF said in its latest review of the debt-choked country.
"Greece's debt service capacity may also need to be bolstered by combining appropriate PSI and official support," IMF officials wrote, referring to private-sector involvement.
Ratings agency Fitch cited continued uncertainty about private-sector participation and foot-dragging on giving more aid to Greece, when it downgraded the country further into junk territory.
Euro zone leaders' agreement to meet followed warnings they needed to act quickly after markets were rattled by the failure of finance ministers to reach agreement earlier this week.
Italian central bank chief Mario Draghi, soon to take the helm of the European Central Bank, and Ireland's premier both said a definitive plan was needed and quickly -- echoing a strongly-worded attack from Greece's prime minister earlier in the week.
The spotlight was taken off the euro zone, at least temporarily, after the Federal Reserve Chairman Ben Bernanke said the central bank could resort to more monetary stimulus if a sluggish U.S. economy weakens further.
Ratings agency Fitch had also countered the bleak outlook in Europe following an earlier downgrade of Ireland to junk status by Moody's when it said Italy could keep its credit status by sticking to fiscal targets.
But many remained on edge after a market attack on Italy and concerns that it too could need assistance, something that would overwhelm the euro zone's existing rescue funds.
"Moody's problem is not with Ireland, Ireland's problem is with Europe," Prime Minister Enda Kenny told parliament, as the cost of insuring Irish debt climbed.
"There is no point in having a meeting that won't bring about a conclusion in a comprehensive sense to something that is not going to go away unless it is dealt with."
Should the leaders meet, they will need to pin down how private owners of Greek government bonds can be persuaded to shoulder a portion of the cost of a new package for Greece, a key demand of Germany.
They will weigh up the potential impact on markets if securing such involvement is declared a debt default by ratings agencies, as expected.
But countries had appeared to be subsiding into a bout of internal wrangling and risk creating a no-win situation.
"Markets reacted very badly after euro zone finance ministers could not reach an agreement," an EU diplomat said, referring to a finance ministers' meeting on Monday. "If they cannot agree, we take the fight to the highest level."
Herman Van Rompuy, the presides over meetings of EU leaders, had originally informed ambassadors he wanted to hold a summit on Friday evening.
But Europe's biggest economic power, Germany, which one EU official said was angry about being "backed into a corner", was reluctant, pushing the date of the gathering into next week.
Another concern of leaders are the results of stress tests of European banks.
That could have a further impact on Italy, where bank stocks and the bond market have been hit by growing concerns that the euro zone's third-largest economy could be next in line after Greece, Ireland and Portugal to suffer debt contagion.
Draghi said Italian banks would comfortably pass the tests but echoed Kenny's call for a comprehensive EU response to the spreading debt crisis.
"We have to recognize that management of the financial crisis has not gone smoothly with partial and temporary interventions," he said in a speech.
"We must now bring certainty to the process by which sovereign debt crises are managed, by clearly defining political objectives, the design of instruments and the amount of resources," he said.
There are two main proposals on the table for securing the private sector's involvement in reducing Greece's debt burden.
One would be to buy back Greek bonds at a discount. Another is to swap Greek debt for longer-dated securities with a lower coupon.
However, it remains unclear how a buy-back of Greek bonds would be financed. It could involve using the 440 billion euro European Financial Stability Facility (EFSF).
The ECB remains vehemently opposed to any Greek plan that ratings agencies would be likely to see as a default.
ECB policymaker Jens Weidmann said the EFSF should not be used to buy bonds in the secondary market and it would be unacceptable for the ECB to accept Greek debt as collateral if the country were in default.
"The money of the (EFSF) bailout should not be used for the purchase of government bonds in the secondary market," he told Die Zeit newspaper. "Containment of the crisis should not mean that we undermine our principles. We must draw a red line."
But Germany's finance ministry said funds from the euro zone's rescue mechanism could in theory be used by members of the bloc to buy back their own bonds, suggesting a shift in Berlin's stance.
Additional reporting by Julien Toyer and Luke Baker in Brussels, and by Noah Barkin and Gernot Heller in Berlin; editing/writing by Mike Peacock