Greece's private sector creditors warned on Monday that the Athens government must urgently break a deadlock in debt swap talks triggered by unreasonable demands from international lenders if is to avoid a disorderly default.
Barely a month after an injection of bailout funds helped to avert bankruptcy, Greece is back at the centre of the euro zone crisis as fears of a default and a subsequent euro zone exit overshadow a mass credit downgrade of euro zone countries.
Cash-strapped Athens needs a deal with the private sector within days to avoid going bankrupt when 14.5 billion euros of bond redemptions fall due in late March.
But talks with its creditor banks broke down on Friday over the interest rate on new bonds Greece will offer and a plan to enforce investor losses. Negotiations were suspended until Wednesday, and Athens sent senior officials to Washington to consult with the International Monetary Fund.
With a growing number of experts -- including a senior Standard & Poor's official -- warning a Greek default was on the cards, the country's creditors expressed alarm.
There is an urgent need for agreement to inject an element of stability, Charles Dallara, head of the Institute of International Finance who represents Greece's private creditors, told Reuters. He said banks were very surprised at completely unreasonable interest rates offered to them.
Greece put a brave face on the standoff.
There is a little pause in these discussions, Greek Prime Minister Lucas Papademos told CNBC television.
But I am confident that they will continue and we will reach an agreement that is mutually acceptable in time.
He expressed optimism that talks on both the debt swap and the latest bailout would be completed in two to three weeks.
But Athens is quickly running out of time on the bond swap front. A deal must be sealed before senior inspectors from the EU, IMF and ECB troika arrive in Athens at the end of the week to agree details of a second, 130-billion-euro bailout.
Furthermore, an agreement in principle is needed by the end of this week if it is to be finalised in time for the March bond redemptions, Dallara said.
Banking sources say Athens is not the problem in the talks, pointing the finger at terms insisted on by the so-called troika of EU, ECB and IMF lenders keeping Greece afloat with aid.
In a bid to resolve the impasse, a government source said the head of Greece's debt agency and a senior adviser were travelling on Monday to Washington to meet IMF officials - just a day before a team of technical experts from the troika arrives in the Greek capital.
Underscoring the stakes involved, a senior S&P official told Bloomberg Television that Greece would default very shortly.
Whether there will be a solution at the end of the current rocky negotiations I cannot say, said Moritz Kraemer, the head of the agency's European sovereign ratings unit.
There is a lot of brinksmanship on and a disorderly default will have ramifications on other countries but I believe policymakers will want to avoid that...The game is still on.
Earlier on Monday, Bill Gross, the manager of the world's largest bond fund PIMCO, tweeted that a mass credit downgrade had made investors aware that countries can default -- and that Greece would be the next to do so.
Under the bailout terms agreed in October, Greek privately held debt would be reduced by half so that, together with structural reforms, the overall debt-to-GDP ratio of Greece would fall to 120 percent in 2020 from 160 percent now.
After initial optimism last week that a deal was near, negotiations stalled on Friday over the interest rate Greece must pay on new bonds it offers.
That is essentially the area where the differences are substantial, said Dallara. They are looking at the private sector to accept interest rates that they would not accept (themselves), which is completely unreasonable.
One banking source said official sector creditors had asked for a coupon of less than 4 percent, irking banks for whom it would have meant losses of over 75 percent on the bonds.
A second source involved in the discussions said the troika had pushed for a coupon of 2 to 3 percent that banks deemed unacceptable, below the 4 percent level that Greece and France proposed. Banks considered a 4 to 5 percent coupon sustainable for Greece, the source said.
Without a more palatable offer, the level of participation among private creditors could slip to below the level needed to ensure the deal is considered voluntary, the source said.
They've got to understand that a voluntary exchange has got to be something we can stomach, said a third source close to the talks.
A fourth source said the banks were ready to strike a deal if they reached common ground with the EU, IMF and ECB.
Changing assumptions about the economic outlook was not helping the situation either, Dallara said.
The downgrades were largely expected and traders said pressure on Italian and Spanish bond yields on Monday were offset by the European Central Bank stepping in to buy the bonds.
MORE MONEY NEEDED?
In its fifth year of recession, Greece has repeatedly flirted with bankruptcy in recent months, with only bailout loans from European partners and the IMF agreed on condition of unpopular austerity measures preventing a default.
The latest impasse in talks has prompted fears that Greece may need further financial support to put its debt on a viable footing. Papademos played down speculation that Athens would need additional aid to that agreed in October.
I think the funds that have been pledged at the Euro Summit, combined with the outcome of the private sector involvement process should be sufficient in order to support financially the Greek economy, Papademos said.
Pledging more funds to Greece would be politically tricky for many euro zone countries struggling with economic problems of their own. Germany's foreign minister, on a trip to Athens, warned Greece must show it was honouring its end of the deal.
We don't want only a hint of a temporary recovery supported by banknotes, German Foreign Minister Guido Westerwelle said in an interview to be aired on Greek Skai television later on Monday. We want structural reforms so that Europe does not face a similar situation in the future.
(Additional reporting by Steve Slater, Sophie Sassard and Tommy Wilkes in London, George Georgiopoulos and Karolina Tagaris in Athens,; Writing by Deepa Babington; editing by Stephen Nisbet)