Barroso challenges Merkel on Greek aid

Jose Manuel Barroso told a German newspaper that European Union leaders must decide at a summit on Thursday and Friday on a support mechanism for Greece or risk harm to their common currency, noting the euro's stability was in Germany's interest.

We need a decision at this summit on how to deal with Greece, otherwise the heightened uncertainty will go on and on, Barroso told business daily Handelsblatt.

We can't carry on as we are, as this would threaten the stability of the euro zone and encourage speculation, he said.

However, a spokesman for Merkel repeated on Monday that the issue of aid for Greece was not on the summit agenda.

Underscoring Barroso's warning, the euro slipped to a three-week low against the dollar on Monday as investors fretted over the uncertain prospect of support for Greece.

The risk premium on Greek debt jumped to its highest level since March 1 and the cost of insuring Greek debt against default also rose.

Greece's central bank meanwhile disclosed that the country's final 2009 budget deficit was 12.9 percent of national output, even higher than the Socialist government announced when it doubled the previous administration's estimate to 12.7 percent on taking office last October.

The Bank of Greece said the economy had fallen into a vicious circle, with gross domestic product seen shrinking by 2 percent this year after a similar slump last year, and the only way out was the drastic reduction of the deficit and debt.

The 16-nation euro zone remains divided over whether and how to provide financial help to Athens, whose struggles to cope with soaring debt and deficits have plunged the currency bloc into the deepest crisis of its 11-year existence.

COLLISION COURSE?

Barroso's comments appeared to put him on a collision course with Merkel, who faces massive opposition at home to any bailout ahead of a key regional election in May in which her center-right coalition's upper house majority is at stake.

Merkel repeated on Sunday that Greece, which has imposed draconian austerity measures to cut its budget gap, did not need money for now, something Prime Minister George Papandreou confirmed in a telephone call with the German leader.

That's why I'd urge us not to stir up turbulence in the markets by raising false expectations for Thursday's council meeting, she told Deutschlandfunk radio.

An FT/Harris poll in Monday's Financial Times showed 62 percent of Germans oppose their government helping Greece with its budget deficit, while only 20 percent are in favor.

One-third of Germans think Greece should be asked to leave the euro, while 40 percent believe Germany would be better off outside the currency bloc.

A plurality of Spaniards supports EU aid to Greece while opinion is evenly divided in France and Italy, whose governments have strongly advocated helping Athens, partly because they fear a market rout of Greece might ultimately turn against them.

Any financial support for Athens would likely be challenged in the German Constitutional Court, which set strict conditions barring transfers to other euro states when it approved European monetary union in the 1990s.

Given the daunting political and legal hurdles, Merkel aides have suggested Greece may have to go to the International Monetary Fund rather than the euro zone if it needs help.

Her spokesman appeared to hint at a possible joint euro zone/IMF mechanism, telling a Berlin briefing: In case of such an emergency arising ... financial co-assistance from the IMF is, for the chancellor and the government, definitely a point for discussion.

Private economists say clarity is needed quickly to make Greek borrowing costs more manageable.

Unless there is a major change of heart in Berlin, it seems increasingly likely that Greece could be forced to turn to the IMF for assistance, said Ben May, an economist at Capital Economics. After all, the only way that bond yields will return to more normal levels is if Greece gets some kind of explicit assistance.

Barroso appealed to Berlin's interests as the biggest economy in the single currency area, which is its number one export market.

Securing the stability of the currency union is in Germany's interest, he told Handelsblatt. I'm sure Germany will make a constructive contribution to resolving the current crisis.

Other euro zone states backed Barroso's call for an agreement this week. Italy's foreign minister called for a compromise before the summit and his Austrian counterpart said the summit should decide on a support plan for Greece.

The new head of Greece's PDMA debt agency last week revised down the amount that Athens need to borrow by the end of May to 16 billion euros. Petros Christodoulou said 23 billion euros of Greek debt falls due from April 19 to May 23, but the government has a positive cash balance of around 7 billion euros.

The risk premium on Greek debt rose to more than 350 basis points over benchmark German bonds on Monday, meaning Athens would have to pay more than 6.6 percent to borrow on capital markets -- more than twice what Germany pays.

(Writing by Paul Taylor, editing by Patrick Graham/Ruth Pitchford)