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Greek Debt Talks Risk Derailing EU Summit

European Union leaders gather for their first summit of 2012 as a deteriorating economy and the struggle to complete a Greek debt writeoff risk sidetracking efforts to stamp out the financial crisis.

EU chiefs arrived in Brussels today to put the finishing touches on a German-led deficit-control treaty and to endorse the statutes of a 500 billion-euro ($656 billion) rescue fund to be set up this year. European finance officials yesterday discussed a deal that Greece and its private creditors expect to complete in the coming days after bondholders signaled they would accept government demands for a bigger cut in their debt holdings.

Efforts to hold the 17-nation euro area together with bolstered fiscal rules and a stronger firewall are colliding with stalled progress in Greece, where the crisis began in 2009. To prevent a financial collapse, Greek bondholders have been pushed to cede more ground after agreeing in October to take a 50 percent cut in the face value of more than 200 billion euros of debt.

“The fact we’re still at the beginning of 2012 talking about Greece is a sign this problem hasn’t been dealt with,” U.K. Chancellor of the Exchequer George Osborne said at the World Economic Forum in Davos, Switzerland.

No Longer Enough

The summit follows warnings at the gathering that ended yesterday in Davos that it’s time to end the region’s debt crisis and that measures aimed at simply containing the turmoil are no longer enough. The euro economy is set to contract by 0.5 percent this year, according to the median of 19 economist forecasts compiled by Bloomberg.

The European Central Bank’s unlimited three-year loans to banks have helped buoy sentiment among investors in the euro area. Italian 10-year bonds gained for a third week, while Spanish two-year yields dropped to the lowest since November 2010. The euro gained against the U.S. dollar every day last week, climbing 2.2 percent on the week. The European currency was down 0.7 percent at $1.3123 at 12:26 p.m. in Brussels.

“We can say -- with caution -- that we see elements of financial stability in France, in Europe and in the world,” French President Nicolas Sarkozy said in a nationally televised interview in Paris yesterday. “Europe is no longer at the edge of the cliff.”

Debt Sales

That optimism will be tested this week as European nations including Italy, Belgium and Spain sell about 22 billion euros of debt securities. Italian borrowing costs fell as the nation sold 7.5 billion euros of debt today, near the maximum for the auction. Belgium sells as much as 3 billion euros of bills tomorrow, with Spain, Portugal, Germany and France issuing 13 different maturities during the week.

A draft of the summit statement showed that EU leaders will pledge to retarget unspent subsidies and consider boosting the lending of the bloc’s project-financing arm. No figures are given in the draft, which was obtained by Bloomberg News.

Attention before the Brussels summit turned to negotiations between the interim government of Greek Prime Minister Lucas Papademos and creditors. The two sides were “close” to an agreement outlined by Luxembourg Prime Minister Jean-Claude Juncker, the Institute of International Finance, negotiating on behalf of private creditors, said in a Jan. 28 statement after three days of talks in Athens.

Creditors are prepared to accept an average coupon of as low as 3.6 percent on new 30-year bonds, said a person familiar with the talks, who declined to be identified because a final deal hasn’t been struck yet. As recently as Jan. 23, creditors wanted an average coupon of about 4.25 percent, two people familiar with the talks said then. That offer equated to a loss of about 69 percent on the net-present value of Greek debt.

‘Last Minute’

The initial debt-swap agreement with creditors three months ago sought to scale back Greece’s debt to 120 percent of gross domestic product by 2020. The anticipated agreement on private sector involvement, or PSI, will open the way to a 130 billion- euro second bailout from Greece’s European partners and the International Monetary Fund for the country, which faces a 14.5 billion-euro bond payment on March 20.

“A deal on PSI will be reached at the last minute,” Niall Ferguson, a professor of economic history at Harvard University, said in a Davos interview. “The trouble for Europe is the crisis won’t be over as the Greek position remains unsustainable. Any PSI deal will bring only temporary respite.”

Greece now requires 145 billion euros for the second bailout, 15 billion euros more than was agreed in October, Der Spiegel reported Jan. 28, citing an unidentified official from the troika in Greece.

As a possible condition of the bailout, European policy makers are discussing plans to directly intervene in Greek budget decisions as the country struggles to cut its deficit, according to two euro-region government officials. Leaders are mulling responses to states that are “off-track,” German Finance Ministry spokesman Martin Kotthaus said in Berlin today.

U.K. Refusal

Patience with Greece “is really coming close to the limit,” Philipp Roesler, chief of Germany’s Free Democratic Party, the junior coalition partner, told Bild newspaper. “Time is running out. There can only be additional help if the Greek government carries out the necessary reforms.”

Another objective at the summit will be to complete a fiscal compact, which was negotiated in December in talks that exposed a rift in the EU after the U.K. refused to participate. The rules aim to provide stricter sanctions and closer cooperation on national budgets.

The latest draft, dated Jan. 27 and obtained by Bloomberg, requires governments to set up a “correction mechanism” to be triggered “automatically” when deficits stray from targets. The treaty caps structural deficits at 0.5 of GDP, allowing deviations in case of “exceptional circumstances” such as a “severe economic downturn,” according to the draft.

A call by Poland, the biggest country with aspirations to join the single currency, to take part in euro-area decision- making looms as the main obstacle to the deal, two officials said. Poland’s plea to take part in euro summits is opposed by a group led by France, which aims to turn the 17-nation monetary union into an exclusive policymaking club.

Future Action

“We will not express an acceptance of the present form in which the compact has been drafted, a compact that excludes or endangers the community-based method,” Polish Prime Minister Donald Tusk told reporters in Brussels today.

Over the weekend, senior officials worked to clear away lesser snags to the treaty, including the role of national parliaments and the ratification threshold. A draft last week foresaw the treaty taking effect after ratification by 12 of the 17 euro countries.

EU leaders plan to endorse the statutes of the permanent bailout fund, the European Stability Mechanism, to be signed in early February and sent to national parliaments to ratify. The ESM is scheduled to go into operation this year.

Leaders are unlikely to address mounting pressure to raise the ceiling on rescue lending from 500 billion euros once the permanent fund goes on line, the officials said.

To contact the reporter on this story: Patrick Donahue in Brussels at pdonahue1@bloomberg.net

To contact the editor responsible for this story: James Hertling at jhertling@bloomberg.net

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