Europe Considers Wider Greek Write-Down

More Pain for Bondholders Seen as Part of Solution to Athens's Budget Gap

By CHARLES FORELLE, COSTAS PARIS and MARCUS WALKER

 The Wall Street Journal

LUXEMBOURG—The admission by top European officials that Greece's fiscal distress is deepening has increased the chance that a July deal to give Athens more cash could be revised to exact a greater toll on its private-sector creditors. At a two-day closed-door meeting here that ended Tuesday, European finance ministers debated what to do with their sickest patient. No decisions were made, but the notion of bigger losses for creditors was broached, people familiar with the matter said.

The reappraisal is the consequence of an unpleasant reality: Greece is missing its budget-deficit target and will likely need additional rescue money to plug the gap. Demanding more pain from private bondholders could be a way to do that.

If European governments take that step, it risks heightening worries about banks and other indebted economies, further upsetting financial markets. Keeping such contagion under control means governments are also discussing how to build a firewall around Greece, for example by providing more funds to help other countries pay their debts and support their banks.

The clearest public indication that the private-sector-creditor plan could be revised came late Monday night, when Luxembourg Prime Minister Jean-Claude Juncker said the situation in Greece had changed since July 21, when the plan was hatched, and that it could be subject to "technical revisions." Mr. Juncker presides over meetings of euro-zone finance ministers.

Sweden's finance minister, Anders Borg, was blunter on Tuesday: "It's quite obvious that...Greek debt is at a very, very high level and something has to be done with it," Mr. Borg told reporters. "The most important thing is to build firewalls and get the backstops in place." Sweden doesn't use the euro.

As in much of the euro zone's policy making, the outcome will be governed largely by the currency union's major powers, Germany and France. German officials say Berlin is reluctant to unpick the July deal before international inspectors in Athens have established the size of Greece's financial shortfall; their report is expected later this month at the earliest. But, these officials say, if Greece needs more money, Germany is in the camp of those who want banks and other bondholders to make bigger sacrifices than they agreed to in July, in a deal that is now seen in Berlin as having been too favorable for the banks.

France is another matter. Its banks have significant exposure to Greece and other wobbly countries, and Paris has so far objected to any revision of the July deal that could further roil markets. Spain is on France's side: The Spanish finance minister said Tuesday that she views the July deal as immutable.

French President Nicolas Sarkozy is set to visit German Chancellor Angela Merkel in Berlin on Sunday for talks about the issue, in a bid to close the gap between the two countries' positions and to pave the way for a deal once a report from inspectors examining Greece's finances is completed. As the door opened to changes to Greece's bailout, another door appeared to close. Speaking at the European Parliament in Brussels on Tuesday, Jean-Claude Trichet, the European Central Bank's president, rejected speculation that the euro-zone bailout fund could gain extra firepower by borrowing funds from the central bank.

"I'm not in favor of bailout funds being refinanced by the ECB," which would lead to a "confusion of responsibilities," Mr. Trichet said.

So far, Germany also appears not to be in favor. German officials told their counterparts in Luxembourg that the time hasn't come yet to leverage the bailout fund, because the euro zone hasn't worked out the details of the most recent agreement to beef up the fund. The increase in the fund's lending capacity to €440 billion ($580 billion) still hasn't been ratified by all 17 national parliaments in the euro zone. The last hurdle, in Slovakia's parliament, could be one of the trickiest. On Tuesday, leaders of Slovakia's four-party ruling coalition changed the date for a vote on the fund to Oct. 11 from Oct. 25.

Many economists say a larger fund is needed to backstop debt-burdened Italy. But without support from the ECB and Germany, any proposal to leverage the fund faces steep odds.

With that issue on hold, the attention is on Greece. The country said Sunday that its budget deficit this year would be equivalent to 8.5% of gross domestic product, wider than a target set under the original bailout program.

Even that new figure appeared uncertain. After leaving Luxembourg, Finance Minister Evangelos Venizelos told reporters the country could still fall short.

"If the state and the citizens don't comply, we will likely have problems with our 8.5% deficit target," Mr. Venizelos warned, though he called that revised goal "perfectly achievable."

The second bailout plan, assembled in July, does relatively little to cut Greece's debt burden, which is around €350 billion and growing. That plan foresees a debt swap in which holders of €135 billion of Greek sovereign debt maturing between now and 2020 will agree to accept payment up to 30 years later than expected, and to accept an average reduction of about 10% on the principal of their loans. The effect is that Greece is freed from having to make any substantial debt repayments for the next several years—but it faces decades of still-high interest costs.

The interest burden is serious. In each of 2008, 2009 and 2010, Greece spent around €12 billion a year on interest payments. For next year, it has budgeted €18 billion.

Reworking the debt swap could make Greece's fiscal picture much brighter. Forcing bondholders to take bigger losses would provide immediate relief.

Now creditors in the swap receive, on average, 90% of the face value of the bonds they turn in. Assuming the same €135 billion is subject to the swap, at an average interest rate of 5%, each 10-percentage-point increase in the haircut directly saves Greece €675 million in interest payments each year—as well as cutting into its €350 billion debt burden.

Two euro-zone officials involved in the talks said Tuesday that many member states acknowledge that the amount of sacrifice offered by creditors so far is insufficient to ensure the sustainability of Greece's debt burden.

One official said one idea being debated is a new debt exchange, under which existing bonds would be swapped for new debt with even longer maturities and lower interest rates than had been planned when the proposal debuted in July.

—Laurence Norman, Alkman Granitsas, Matina Stevis and Brian Blackstone contributed to this article.

Write to Charles Forelle at charles.forelle@wsj.com, Costas Paris at costas.paris@dowjones.com and Marcus Walker at marcus.walker@wsj.com