Germany signaled for the first time on Tuesday that it may accept European financial aid for Greece as a last resort, but only if the IMF is involved and euro zone partners accept tougher budget discipline rules.

A senior German official spelled out Berlin's conditions for any aid mechanism ahead of an EU summit starting on Thursday:

* Greece would have to be unable to access credit markets;

* The International Monetary Fund would have to make a substantial contribution to any rescue;

* European Union states would have to agree to negotiate additional instruments to enforce budget discipline, beyond existing rules that failed to prevent Athens running up huge debts and deficits that have shaken the euro zone.

A source in Chancellor Angela Merkel's conservative bloc quoted her as telling lawmakers Germany would only agree to a rescue model combining bilateral and IMF assistance. There would be no decision at this week's summit but a special EU summit would be called to decide if an emergency arose.

The condition for action, as a last resort, is that Greece's financing on the capital markets is exhausted, the senior official said.

There are first signs from various capitals that people could envisage financial co-assistance by the IMF, he said.

European diplomats said France and Germany, co-founders of the single currency, were working on a joint position on Greece for the summit, including a possible role for the IMF, which Paris has hitherto rejected as anathema inside the euro family.

One source said Paris and Berlin had not yet reached a common position and the talks were very sensitive.

European Central Bank President Jean-Claude Trichet and Eurogroup chairman Jean-Claude Juncker have said involving the Washington-based lender would send a damaging message that the euro zone was incapable of handling its own problems. Some senior French policymakers have said it would be a severe political setback for European integration.

The message from Berlin is crystal clear really, which is that Greece still needs to continue not just with consolidation but to test the markets out and if necessary use the IMF, said Julian Callow, Chief European Economist at Barclays Capital.

The implication is that Germany will support Greece only if the IMF channel does not deliver, he said.

Greece needs to refinance some 16 billion euros in maturing debt between April 20 and May 23 and is hoping that a public display of an EU emergency support mechanism, which would not need to be activated, will be enough to force down the cost.

The crisis over Greece's debt, expected to hit 120 percent of national output this year, and its budget deficit, which reached 12.9 percent of GDP last year, has shaken confidence in the euro single currency.

REASONABLE PRICE?

Credit ratings agency Fitch said it doubted EU leaders would offer Greece aid at the summit but failure to reach a deal would not trigger a downgrade as long as the IMF option was open.

As long as the market is prepared to make the money available to the Greek government at any reasonable price -- current rates are reasonable given circumstances although not desirable -- we would have no immediate reason to change the rating, Chris Pryce, a director at Fitch Ratings, told Reuters.

That could leave Greece raising funds at market rates of more than 300 basis points over benchmark German bonds, adding an estimated 500 million euros a year to its debt service bill despite Athens' pleas for help to reduce its borrowing costs.

France and Spain called for a special meeting of leaders of the 16 nations that share the euro zone ahead of the regular two-day EU summit which opens on Thursday afternoon. The Eurogroup has held only one such summit previously, at the height of the global financial crisis in October 2008.

Merkel faces massive public opposition to any bailout ahead of a regional election in May in which her center-right coalition's upper house majority is at stake.

Greek Finance Minister George Papaconstantinou said he expected a positive outcome and was encouraged by comments from EU institutions on ways to support Greece's efforts to cut its giant deficit and public debt.

There must be a political mechanism to ensure the stability of the euro zone and support the efforts made by every country, he said, adding that data for the first two months of 2010 show Greek revenues rose and spending fell sharply.

The risk premium that investors charge for holding Greek debt rather than German bonds narrowed to 324 basis points from around 344 at Monday's settlement close on hopes of a deal, although it was still above last week's levels.

Diplomats said European Council President Herman Van Rompuy, who will chair Thursday's summit, was working for a compromise that would satisfy Merkel and prevent the bloc's divisions over Greece spilling into the open again and destabilizing markets.

The nominee for vice-president of the European Central Bank, Vitor Constancio, pointed to a possible solution, telling a European Parliament hearing that giving Greece credit would not be an illegal bailout if the loans were not subsidized.

Papaconstantinou stressed that Greece was not bankrupt and was not going to the EU summit as a beggar.

We want to play by euro zone rules. Greece has full access to financial markets as it proved with its recent 10-year bond sale. Obviously, we would like the spreads to fall but I believe this will gradually happen as the stability programme is implemented, he said.

Germany International Monetary Fund