Merkel rules out Greek default

Merkel Commission 6 Oct_picnik.jpg

Chancellor Angela Merkel has ruled out letting Greece default on its debt, in the latest sign Berlin is softening its stance towards Athens ahead of an eagerly awaited report on its reform progress from the "troika" of international lenders.

The German leader signalled that she would be taking a more conciliatory approach towards Greece by visiting the country last week for the first time since the eurozone crisis erupted there three years ago.

And over the weekend, comments by several conservative allies of the chancellor provided further evidence that the government has embarked on a delicate policy pirouette.

Finance Minister Wolfgang Schäuble, one of Greece's harshest critics, told a meeting of business leaders in Singapore over the weekend that the country would not go bankrupt – an acknowledgement that Athens will get the €31.5 billion aid tranche it needs next month to avert a default.

Merkel told a news conference with Panama's president yesterday (15 October) that she was in total agreement with Schäuble, and explicitly ruled out any steps – including a Greek insolvency or eurozone exit – that might unleash "uncontrollable developments" in the single currency bloc.

The change in tone, which helped push down Greek bond yields to their lowest levels in over a year, reflects a reassessment by Merkel of the costs and benefits of her tough public stance towards the eurozone's most vulnerable member.

The hard line served two main purposes: it ensured that reform pressure on Greek Prime Minister Antonis Samaras remained high, and it convinced sceptical conservative allies of Merkel in parliament to support her.

Now the calculation has changed. With a US election less than a month away and a German vote due one year from now, reducing the risk of turmoil has become the top priority, even if it complicates Merkel's domestic dance.

She now looks set to grant Samaras the two extra years he is seeking to hit deficit reduction targets. This will be a tough sell at home, in part because it would tear a new hole in Greece's funding plan.

But it is seen as workable as long as Merkel can avoid going to parliament to seek approval for additional loans, on top of those set out in the country's second bailout package.

"There is a recognition, not just in Germany, that we need to avoid going back to national parliaments for Greece," a senior German official told Reuters, requesting anonymity.

Bundling aid for Greece, Spain 'an illusion'

Ideas under consideration range from front-loading the loans in the second bailout, to using left-over EU budget funds to plug a Greek hole that sources say could total as much as €30 billion.

Governments and the European Central Bank have ruled out accepting losses on their existing loans to Greece – a solution favoured by the International Monetary Fund (IMF) to fill the Greek gap.

Merkel also seems to have cooled on the idea, floated by some German officials, of bundling aid for Greece, Spain and Cyprus together in one final package towards the end of this year.

"It's an illusion to think we can align these three countries in one package," a second senior German official said. "Things just don't work that way in Europe."

Working in Merkel's favour is the support of the main opposition party, the Social Democrats (SPD), for a softer stance on Greece.

Her SPD challenger in the 2013 election, Peer Steinbrück, has come out in favour of giving Greece more time to make savings, reducing the domestic risks for Merkel of that course.

The IMF has expressed frustration with Europe's piecemeal response to its debt crisis and warned that a recent respite in borrowing costs for debt-laden countries such as Spain may prove short-lived unless eurozone leaders come up with a comprehensive and credible plan.

In its financial stability report last week (10 October), the IMF said that without swift policy action, including the triggering of the European Central Bank's bond-buying programme,

the premium that investors demand to hold Spanish and Italian debt instead of safer German bonds would nearly double.

Standard & Poor's cut its rating on Spain on 10 October to a level just above junk territory, and Moody's may soon follow.

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