Greece and its creditors were back at the drawing board on all terms of a planned bond swap on Wednesday in a last-ditch bid to overcome an impasse in talks and stave off a painful default.
Talks broke down last week over the interest rate Greece will offer on new bonds and a plan to enforce investor losses. Both sticking points were on the table when negotiations resumed in the late afternoon in Athens between the two sides.
All variables are being considered, said a Greek government official, who requested anonymity, calling the interest rate on the new bonds Greece will offer in the swap the most visible aspect of the talks.
After the temporary pause in the negotiations last week, the parties have reconsidered and are back, the official added.
Athens needs a deal with the private sector within days to avoid going bankrupt when 14.5 billion euros (12 billion pounds) of bond redemptions fall due in late March.
Greece's foreign lenders have warned no further aid will be released until the bond swap deal is done, and investors fear a disorderly default could provoke a shock to the financial system that would tip the global economy into recession.
With analysts warning the costs of failure are too high for either side to leave without agreement, earlier worries of a prolonged stalemate have given way to hopes of a deal by the end of the week or early next week.
In the end, something is likely to be agreed partly because no side is going to want to see a disorderly default, said Ben May, European economist at London-based Capital Economics.
A lot of what's been going on is manoeuvring from both sides to get a better deal. There's likely to be an element of brinkmanship taking place from both sides in order to get the best terms.
One source close to the talks said logic dictated that a deal will come together one way or the other and a banking source close to negotiations said it was imperative a deal is reached by early next week at the latest.
Greek officials were cautious about predicting the outcome of the talks, and Finance Minister Evangelos Venizelos told parliament the talks were at a delicate stage.
The only thing I can say at this stage is that we're optimistic, said another Greek government official who declined to be named.
The talks between Prime Minister Lucas Papademos and Charles Dallara, head of the International Institute of Finance representing the private creditors began just after 1600 GMT.
Greece has ratcheted up pressure on hedge funds and other holders of Greek debt ahead of the talks by threatening to consider legislation that forces creditors to take losses if not enough bondholders signed up to the deal.
A law on so-called collective action clauses forcing holdouts to accept losses could be drafted if Greece deems the participation rate unsatisfactory, Greek officials said.
A debt swap is necessary to clinch a new rescue package for Greece but it will push Athens into temporary default irrespective of the size of investor losses, a senior analyst at Fitch Ratings told Reuters on Wednesday. He said the terms of the agreement will influence the rating of the new bonds.
We would mark it appropriately with a default rating, which we would probably maintain for a short period before we put the replacement bonds on a new rating that we have not decided on yet, Fitch's lead analyst for Greece, Paul Rawkins, said.
Still, hedge funds holding Greek bonds that mature in March may have the strongest hand.
The Greek government wants to swap out that maturing debt for new, lower-yielding bonds and a small cash payment as part of a programme in which bondholders would voluntarily write down 100 billion euros from Greece's debt of over 350 billion euros.
But some hedge funds in London and New York that snapped up chunks of Greece's next big maturing bond, the March 20 2012 issue, for around 40 cents on the euro, are balking.
A team of European Union, International Monetary Fund and European Central Bank officials are already combing through Greece's books as part of efforts to finalise the new, 130 billion euro rescue package the country needs to stay afloat.
The bailout, together with structural reforms, aim to reduce Greece's debt to a more manageable 120 percent of gross domestic product in 2020 from about 160 percent now.
The debt swap deal would see creditors voluntarily giving up 50 percent of the nominal value of the bonds they hold.
The real loss, known as net present value, is estimated at between 60 and 70 percent depending on the coupon, maturity and discount rate. The hit on individual banks would also depend on the price at which they bought Greek bonds.
The main stumbling block in the negotiations has been the low coupon, or interest payment, offered on the new bonds.
Bloomberg News quoted a U.S. hedge fund manager as saying that Greece was nearing a deal that would give creditors cash and securities with a market value of about 32 cents per euro of government debt.
Bruce Richards, CEO of New York-based Marathon Asset Management LP which is a member of a Greek creditors' committee, told Bloomberg he was highly confident the deal will get done.
No one was immediately available at Marathon to confirm the comments.
The talks come against a backdrop of rising anger among ordinary Greeks, who have been hit hard by the tax increases and spending cuts which were part of a first bailout agreed in 2010.
They now fear more austerity and wage cuts with the second bailout and thousands marched to parliament on Tuesday in an anti-austerity protest, waving banners reading EU, IMF out!.
Greece has entered its fifth consecutive year of austerity-fuelled recession, with unemployment at record highs and nearly one in two youth out of work.
A 48-hour strike by journalists on Tuesday and Wednesday, part of a broader protest by workers in Athens, was also timed to coincide with the arrival of a technical mission from the troika of foreign lenders this week.
(Additional reporting by George Georgiopoulos, Karolina Tagaris and Angeliki Koutantou, Writing by Deepa Babington)