Greece and euro zone paymaster Germany tried to fend off talk on Thursday that Athens needed help with debt repayments via a buyback with European funding that could face stiff opposition in national parliaments.
A German paper said euro zone nations were mulling a plan to enable Greece and Ireland to write off some of their debt burden using the European Financial Stability Facility, set up after the Greek bailout as a safety net for others who hit trouble.
The Financial Times Deutschland said euro zone finance ministers, who met on Monday, discussed a plan for the bloc's rescue fund to buy bonds from these states or give them favorable loans for repurchasing debt.
It was not clear under the plan whether bondholders would be paid the face value of the debt or not, leaving open the crucial question of whether investors faced a haircut.
It is also unclear whether European parliaments would accept changes in rules binding the 440 billion euros fund, whose real lending capacity is much lower because of its complex loan guarantee system.
German Chancellor Angela Merkel's conservatives looked set to oppose any attempt to use the EFSF to buy up Greek debt, which would have to be approved by national parliaments first, said a senior lawmaker from her Christian Democratic Union.
I do not see a quick willingness for a purchase of state debt by the EFSF, Hans Michelbach told Reuters.
With Ireland already tapping the fund and Portugal and possibly Spain potentially needing it, Europe is discussing how to beef it up without raising the headline sum, which would also be difficult to sell to the German parliament and public.
The head of the EFSF, Germany's Klaus Regling, denied that Greece needed more funding at the moment.
GERMAN POLITICS CRUCIAL
A Barclays Capital research note said it was very likely that euro area governments will decide to upsize the EFSF to its statutory lending limit of 440 billion euros.
Barclays said changing the EFSF rules to permit buying government bonds outright was unlikely because parliaments would have to vote on it. But EFSF loans to governments to buy back bonds were more likely to gather support, including from the European Central Bank which would be relieved of such a role.
The Greek and German governments have repeatedly denied reports that plans were afoot to prepare for a Greek debt rescheduling or restructuring and did so again on Thursday.
Germany's Deputy Finance Minister Steffen Kampeter told Reuters that talk about a restructuring of Greece's sovereign debt was a fantasy based on rumors and not facts.
But giving Greece and Ireland funds to buy back their own debts would not necessarily construe a restructuring.
Analysts believe Germany's denial is rooted in domestic political considerations, with Chancellor Angela Merkel facing seven state elections this year.
The key danger for the market is internal German politics where Merkel faces a key state election in Baden Wuertemberg just days after the EU summit (in late March) and given the resistance of the population to bailouts this could lead to procrastination, wrote RBS in a research note.
Merkel's conservatives risk losing the state after 60 years while her Free Democrat (FDP) coalition partners are faring so badly in polls that their leader, deputy chancellor and foreign minister Guido Westerwelle, faces calls to step down.
The FDP sees itself as the champion of German taxpayers and will resist any additional burden being placed on them.
But Merkel's government is being warned by at least some of its select group of Wise Men economic advisors to prepare for the worst, such as a Greek debt rescheduling.
Officials in Germany's finance ministry are working on contingency plans to handle the fallout in case Greece defaults or needs to restructure its debt, analyzing what it could mean for German banks and euro zone stability, sources with direct knowledge of the matter said on Wednesday.
Economist Peter Bofinger, a left-leaning member of this group of five, told Handelsblatt daily the European Union should create a Marshall Plan for the most indebted euro countries.
Lars Feld, who takes up a wise man post in March, told the paper he did not believe Greece will manage without a cut in its debt and Germany should take measure so that the guarantees it will provide do not violate a new debt brake fiscal law.
This law, which came into effect at the beginning of 2011, stipulates that Germany has to cut its structural deficit to 0.35 percent of gross domestic product by 2016.
(Additional reporting by Dave Graham, Annika Breidthardt, George Georgiopoulos in Athens and Nigel Stephenson in London, editing by Mike Peacock)