Germany has put a Greek restructuring back on the table, demanding in a letter to its EU partners that private bond holders make a major contribution to a looming debt relief deal for the struggling euro zone member.
The letter by German Finance Minister Wolfgang Schaeuble explicitly urges the bloc to go beyond the softer Vienna Initiative approach to private sector involvement that euro zone governments have been mulling ahead of a crucial summit later this month.
Dated June 6 and addressed to the heads of the European Central Bank, International Monetary Fund and Schaeuble's euro area counterparts, it demands a quantified and substantial contribution from bondholders to Greek support efforts.
Such a result can best be reached through a bond swap leading to a prolongation of the outstanding Greek sovereign bonds by seven years, at the same time giving Greece the necessary time to fully implement the necessary reforms and regain market confidence, the letter, a copy of which was obtained by Reuters, reads.
Such a swap would amount to a restructuring of Greece's privately held debt, even if it was done on a voluntary basis, and ratings agencies have warned that they would classify it as a default.
The ECB, after rejecting all talk of restructuring for months, has over the past week backed the idea of a voluntary rollover of Greece's privately held debt.
It is unclear whether the central bank could accept the solution advocated by Schaeuble, which stops short of an outright haircut -- a term used to describe a forced reduction in the value of a bond's principal -- but goes beyond some of the softer rollover solutions the bloc has been discussing.
The cost of ensuring Greek debt against default rose on Wednesday as investors fretted about the possibility of a restructuring.
But the euro held near one-month highs against the dollar, supported by expectations of an ECB rate hike next month, and the spreads between Greek 10-year bonds and German benchmarks were steady at 13 percentage points.
Schaeuble's letter was sent two weeks before a crucial June 23-24 summit of EU leaders, where a new bailout package for Greece is expected to be agreed.
The 110 billion euro aid-for-austerity deal that Greece sealed last year has failed to restore confidence in the country's finances and a new one is now in the works which could total 80-100 billion euros and cover Athens' funding needs through 2014.
Whether and how to involve the banks, hedge funds and other private holders of Greek debt in the new package has been hotly debated for weeks, with some officials worrying such a step could unleash contagion that envelops new countries like Spain, with disastrous consequences for the currency bloc.
In a report on Tuesday, the European Commission expressed concerns that Spain's growth forecasts were overly optimistic and urged new reforms to help the country meet its deficit targets. Madrid brushed off the suggestions.
Berlin has been leading calls for broader burden sharing involving private debt holders, in part to satisfy a public and parliamentarians at home who are deeply opposed to more bailouts that rely solely on taxpayers -- like those given to Greece, Ireland and most recently Portugal.
What Schaeuble is saying here probably goes beyond the solutions we've been hearing about in recent weeks, said Silvio Peruzzo, an economist at RBS in London. We know there are some parties in Chancellor Angela Merkel's coalition who are keen for a substantial involvement of the private sector.
OBAMA PRESSES GERMANY
During a visit to Washington by Merkel on Tuesday, U.S. President Barack Obama urged European countries and bondholders to prevent a disastrous default by Greece and stressed the importance of German leadership on the issue -- a thinly veiled message that he expects Berlin to help Greece.
Obama's political standing has suffered from stubbornly high U.S. unemployment and ballooning debt levels, and he can ill afford a dramatic worsening of the euro zone's debt crisis, which could aggravate economic problems at home.
A German government spokesman said on Wednesday that Merkel had been informed about Schaeuble's letter before it was sent. And a spokesman for the finance ministry said private bond holders still held enough Greek debt to make a big contribution to a solution for the country.
Beyond domestic considerations, Berlin may also be worried that if private creditors do not participate in the new bailout, the share of debt owned by official creditors -- euro zone governments, the ECB and IMF -- will rise to the point where a future restructuring of the private sector accomplishes little in terms of returning Greece to a sustainable debt path.
Greece's debt burden stands close to 340 billion euros -- or roughly 150 percent of its gross domestic product (GDP).
The bond swap idea mooted by Schaeuble would not reduce that burden and could well increase it if private holders were offered incentives -- such as higher coupons -- to exchange their debt.
But it would give Athens more years to return to growth, deliver on its economic reform program and make headway with a 50 billion euro privatization drive.
By giving Greece that extra time, European officials may hope to avoid the harder restructuring, involving substantial haircuts, that many economists still believe is inevitable.
(Writing by Noah Barkin, editing by Mike Peacock)