French President Nicolas Sarkozy failed to bridge his differences with German Chancellor Angela Merkel during their meeting in Frankfurt on the sidelines of a farewell event for outgoing European Central Bank (ECB) president Jean-Claude Trichet on October 19.

 

Sarkozy said eurozone leaders will hold a second crisis summit at the latest on October 26 after divisions made solutions impossible for the October 23 meeting.

 

The Franco-German rift on how to boost the European Financial Stability Facility (EFSF) is bound to prolong uncertainty over conflicting plans for a Greek debt writedown.

 

Paris has argued the EFSF must become a bank in order to leverage a higher funding capacity of up to 2 trillion euros through the ECB.

 

This would give it enough power to cushion the blow Greek and European banks will sustain from a deep haircut of Greek debt and assist in their recapitalisation. It would also defend Spain and Italy from further market attacks. 

 

Both Merkel and Trichet, however, opposed the French proposals. 

Instead, Berlin has suggested that the EFSF’s current 440bn euro fund guarantees could be used to stabilise the eurozone bond market by offering partial-loss insurance to investors buying new Spanish or Italian bonds.

 

 

More friction surfaced, though, on October 20 among Greece’s troika (EU-IMF and the ECB) inspectors.

 

According to news agency reports quoting a report of the EU troika inspection in Athens, findings speak of “extremely worrying” government debt dynamics. 

 

Nevertheless, the EU urged the release of the long-delayed sixth aid tranche of 8bn euros “as soon as possible: as soon as the agreed prior actions on fiscal consolidation, privatisation and labour market reform, which were announced by the government, have been legislated”.

 

Since this was a clear reference to an omnibus austerity bill that was due for a parliament vote late on October 20, the leakage of the EU draft was obviously intended to confirm Prime Minister Papandreou’s warning that Greece faced a precarious future. 

 

But the International Monetary Fund (IMF) was reportedly at odds with its European partners, opting to wait until a clearer outlook emerged from the EU summit on October 23 regarding the sustainability of Greek debt.

 

“The IMF will definitely want to see what the Eurogroup and the European Council come up with first,” the fund said. 

 

 

In July, eurozone leaders agreed on a second 109bn bailout with the involvement of private bondholders (PSI), to trim a portion of the debt’s present value by 21 percent. 

 

This is currently under revision for a much deeper haircut of around 50 percent.

 

“Even though the second bailout package would ease the country’s financing needs in the next five years, it could not suffice for the debt dynamics to be described as sustainable,” the draft warned.

“Debt sustainability has effectively deteriorated, given delays in the recovery, in fiscal consolidation and in the privatisation plan, as well as the perspective of bank recapitalisations,” it noted.

 

 

The EU draft admitted that Greece’s economic downturn was significantly stronger than expected, as sustainability had deteriorated in the last few months and said that medium-term growth forecasts might be in need of cutting as well.

 

Output was projected to fall by 5.5 percent in 2011, while another 3.5 percent downturn was expected in 2012.

 

“The 2011 government deficit will most likely be between 8.5 and 9 percent of GDP, or nearly 19bn euros,” well above the targeted ceiling of 7.75 percent of GDP, or 17bn euros, the draft said.

It admitted that the fiscal consolidation effort of Greece had been “very large”, but added that “more measures will be necessary for 2013-2014”. 

 

But in an optimistic note regarding the latest wage and pension cutback proposals, the draft noted: “Additional government measures on income and spending would enable the country to reach its deficit targets in 2012, though not in 2011.”