October 20, 2011 / 12:30 PM / in 6 years

Merkel resists pressure for euro zone big bang

* French ramped up pressure for big deal at EU summit

* Merkel unlikely to change cautious approach

* Progress seen on banks, Greek haircut; EFSF tricky

By Madeline Chambers

BERLIN, Oct 20 (Reuters) - Exhausted by two years of crisis, Europe and its trading partners are hoping Chancellor Angela Merkel will ditch her customary caution and sign up to a “big bang” solution at Sunday’s EU summit -- but she is unlikely to deliver.

The German leader, accused by her critics of worsening the euro zone’s debt debacle with her hesitant approach, has tried to dampen expectations of the meeting.

“Government debts were built up over decades and that’s why they won’t be removed in one summit,” she warned this week, saying the meeting would be just one of several important steps.

French President Nicolas Sarkozy, however, has heaped pressure on Merkel by declaring that Europe’s fate would be determined in the days to come.

Share markets and the euro fell on Thursday due to doubts about the leaders’ ability to come up with a comprehensive plan to solve the debt crisis at Sunday’s meeting, the latest in a series billed as crucial for the euro zone’s future.

“It is again the week of all weeks, the summit of all summits. It is again crunch time in Brussels on Sunday,” wrote Carsten Brzeski, senior economist at ING.

EU leaders are set to tackle three questions -- bank recapitalisation, a bigger writedown of Greek debt and a possible leveraging of the European Financial Stability Facility (EFSF) bailout fund to boost its effectiveness.

France and Germany are at odds on how the fund could be leveraged.

Sarkozy’s tough words, however, are unlikely to outweigh domestic pressure on Merkel, leader of Europe’s biggest economy and the biggest contributor to the EFSF, not to sign a blank cheque for struggling euro zone members.

“I don’t think they can meet expectations. The summit will fall well, well short of the kind of big bang needed to reassure the markets,” said Simon Tilford, chief economist at the Centre for European Reform in London.

Tilford fears markets will react badly next week. “By the time the Germans finally budge, it’ll be too late,” he said.

The summit’s timing is crucial. It is only a matter of weeks before Greece may go bankrupt, which could cause billions in losses for European banks, especially in France.

On top of that, credit rating agencies have compounded fears about the crisis spreading. Moody’s this week downgraded Spain’s debt rating and cast doubt on France’s triple A credit rating.

WAIT-AND-SEE

Merkel’s wait-and-see, tactical approach to politics helped her gain and hold on to power, and she is unlikely to change her style now. She struggled to contain a rebellion within her centre-right coalition last month in a parliamentary vote on the EFSF bailout fund and her popularity has slid in opinion polls along with that of her party.

Most of all, she cannot afford to deepen discontent by signing off on a deal that would burden German taxpayers more.

Given domestic disgruntlement about the cost of the bailouts, Merkel is unlikely to pay much attention to critics at home and around the world who accuse her of exacerbating the crisis.

“We should have written down Greek debt a year-and-a-half ago,” said Sigmar Gabriel, leader of the opposition Social Democrats. “Now everything is much, much more expensive.”

Many analysts agree Merkel has been part of the problem.

“The trouble is that the longer they delay a comprehensive solution, the more difficult it becomes politically because the costs are rising exponentially,” said Tilford, arguing that a fundamental problem has been Berlin’s narrow analysis of the causes of the crisis.

The slow progress can also be put down to lack of chemistry between the energetic, shoot-from-the-hip Sarkozy and the dour, pragmatic Merkel.

Their regular talks have repeatedly exposed rifts on economic policy which they have tried to paper over with vague declarations such as plans for a European economic government.

On Sunday, Merkel, Sarkozy and the other EU leaders will have to come up with more than platitudes to calm markets.

Leaders are likely to agree to ask private investors to shoulder greater losses on holdings of Greek government debt than the 21 percent already agreed. They will probably also insist that banks must recapitalise and meet a 9 percent core capital target to make sure they are strong enough to absorb losses on sovereign debt and weather possible recession.

Boosting the firepower of the EFSF probably poses the biggest problem for Merkel.

Trying to reassure voters that leveraging up the fund would not involve more taxpayers’ money, Merkel and Finance Minister Wolfgang Schaeuble have ruled out boosting it beyond 440 billion euros, with 211 billion euros from Germany.

The scale of the deadlock on the EFSF became apparent on Wednesday when Sarkozy rushed to Frankfurt to talk to Merkel as his wife was giving birth. It seems little progress was made.

Germany is still dead set against France’s favoured solution of turning the EFSF into a bank which could then access funding from the European Central Bank.

In any case, Merkel’s hands are tied on the EFSF.

A Constitutional Court ruling last month gave a bigger say to German lawmakers in euro zone bailouts. Parliament’s budget committee now has to approve changes to the EFSF’s guidelines.

An agreement on Sunday may not even be a done deal if Germany’s budget committee has not approved it. This could even stall the talks as Merkel may feel obliged to consult the committee, on standby to meet at short notice, first.

There are, though, signs that Merkel has realised the scale of the problem. In an apparent response to stinging criticism from former Chancellor Helmut Kohl, once her mentor, Merkel has started to talk up the benefits of the euro and the EU.

“The pressure is increasing but the Germans are putting energy into it now,” said Ulrike Guerot, a senior fellow at the European Council on Foreign Relations.

She pointed to contingency plans for a possible Greek bankruptcy, including bank recapitalisation steps. “There is no big bang. We will not wake up overnight and have it fixed. But things are moving now.”

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