PARIS/FRANKFURT Plans to tackle the euro zone debt crisis have stalled with Paris and Berlin at odds over how to increase the firepower of the region's bailout fund, French President Nicolas Sarkozy said on Wednesday.
Sarkozy told French lawmakers the dispute was holding up negotiations and flew to Frankfurt to talk with German Chancellor Angela Merkel in an attempt to break the deadlock ahead of a make-or-break European leaders' summit on Sunday.
The two leaders left that meeting without speaking to waiting reporters.
Asked if a deal had been reached, Jean-Claude Juncker, chairman of the Eurogroup of euro zone finance ministers who attended the evening meeting, replied: "We're still in meetings Saturday, Sunday."
Sarkozy was expected to return to Paris where his wife, the singer and former supermodel Carla Bruni, was at a maternity clinic and believed to be close to giving birth to their first child together.
A French presidency source earlier said the French and German leaders were meeting other euro zone policy chiefs and International Monetary Fund head Christine Lagarde on the sidelines of an event mark the end of Jean-Claude Trichet's presidency of the European Central Bank.
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 ECB, but both the central bank and the German government have opposed this.
"In Germany, the coalition is divided on this issue. It is not just Angela Merkel whom we need to convince," Sarkozy told the parliamentarians at a lunch meeting, according to Charles de Courson, one of the legislators present.
His comments fueled doubts about whether euro zone leaders will agree a clear and convincing plan when they meet on Sunday.
Failure to do so would further undermine financial markets' already shattered confidence in the currency bloc and its ability to get on top of a two-year-long debt crisis, which threatens the long-term viability of the single currency.
One senior EU official, who is involved in coming up with solutions to the crisis, said the only "circuit-breaker" now was for the ECB to make an explicit commitment to go on buying distressed euro zone debt for "as long as it takes," something Trichet has said should not happen.
However, Barroso appeared to back such intervention, saying in Frankfurt: "The decisive intervention of the ECB in secondary bond markets was and still is a critical element in securing financial stability in the euro area."
Uncertainty over the euro zone's future intensified as Moody's issued a double-notch downgrade of Spain's credit rating a day after the agency warned France its triple-A rating could come under pressure.
In Greece, parliament gave initial approval to a new round of belt-tightening measures needed to avert a default which could reverberate throughout the wider euro zone.
Greek police clashed with black-clad demonstrators outside parliament as workers began their biggest strike in years in protest at cuts demanded of their country in return for help.
Merkel warned late on Tuesday that leaders would not solve the debt crisis at a single meeting and reiterated that past errors would not be solved in "one stroke."
"If the euro fails, Europe fails but we will not allow that," she said in Frankfurt.
Finland's Prime Minister Jyrki Katainen added his voice to what appeared to be efforts to lower expectations, telling public broadcaster YLE he did not believe Sunday's summit would resolve the euro zone 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," he said in comments broadcast on Wednesday.
"We're trying the whole time," said EU Economic and Monetary Affairs Commissioner Olli Rehn after the Merkel-Sarkozy meeting, when asked about the chances of reaching a deal at the weekend summit.
Nevertheless, the hope remains that leaders will agree new steps to reduce Greece's debt, strengthen the capital of banks with exposure to troubled euro zone sovereigns and leverage the euro zone's rescue fund to prevent contagion to bigger economies.
"You know the French position and we are sticking to it. We think that clearly the best solution is that the fund has a banking license with the central bank, but everyone knows about the reticence of the central bank," French Finance Minister Francois Baroin told reporters in Frankfurt.
"Everyone also knows about the Germans' reticence. But for us that remains ... the most effective solution."
A senior German government source said Berlin remained resolutely opposed to the ECB backstopping the rescue fund.
BANK OR INSURER?
Euro zone officials have told Reuters that an alternative model, whereby the EFSF could underwrite a portion of newly issued euro zone debt, is also on the table.
By guaranteeing the first 20-30 percent of any losses, the EFSF could stretch three to five times further. With about 300 billion euros of its 440-billion-euro capacity still available, the fund could be expanded to more than 1 trillion euros, and give markets pause for thought.
However, analysts are unconvinced that a leverage plan involving a guarantee on first losses would succeed, warning that it could create a two-tier structure in some bond markets and would be meaningless without an explicit commitment from the ECB to go on buying at-risk debt.
"On paper this solution has some merits because it is expedient ... but is in fact fraught with complications that are very likely to make it fail," Shahin Vallee, an analyst with Bruegel, a leading think-tank, said in a research paper.
As well as trying to strengthen the rescue fund, euro zone leaders are racing to convince banks to accept "voluntary" writedowns of up to 50 percent on their Greek sovereign holdings. They are also trying to agree on a blueprint for recapitalizing financial institutions at risk from the deepening crisis.
Greece remains mired in recession and its overall debt is forecast to climb to 357 billion euros ($489 billion) this year, or 162 percent of annual economic output -- which few economists believe can be paid back.
A Reuters polls of economists predicted European leaders would probably ask private investors to shoulder losses of around 50 percent on holdings of Greek government debt, the top end of a range suggested by officials last week.
Moody's cut Spain's bond rating to A1, from Aa2, the third of the major agencies to act in recent weeks and taking it a notch below the ratings of Standard & Poor's and Fitch.
The agency's reasoning may focus minds ahead of Sunday's summit, highlighting the lack of resolution to the bloc's crisis rather than particular Spanish policy shortcomings.
"Since placing the ratings under review in late July 2011, no credible resolution of the current sovereign debt crisis has emerged and it will in any event take time for confidence in the area's political cohesion and growth prospects to be fully restored," Moody's said.
While Europe's leaders rush to stop a larger writedown of Greek debt infecting others in the euro zone, ordinary Greeks are angry at the prospects of several more years of pain as the price of help from international lenders.
"Who are they trying to fool? They won't save us. With these measures the poor become poorer and the rich richer. Well I say: 'No, thank you. I don't want your rescue'," said 50-year public sector worker Akis Papadopoulos.
(Additional reporting by Luke Baker in Brussels, Lefteris Papadimas and Renee Maltezou in Athens, Eva Kuehnen and Edward Taylor in Frankfurt and Elizabeth O'Leary in Madrid; Writing by Mike Peacock, editing by Jon Boyle)