Greek Bailout in Peril

France, Germany Press Athens, Bondholders to Reduce Debt

The Wall Street Journal

… Greece's bailout loans from the euro zone and the International Monetary Fund are on hold until a deal is reached…

… concerns in financial markets that Greece's bailout program is in danger of unraveling…

… France and Germany have also failed so far to offer a convincing path back to economic growth…

… European Central Bank's overnight deposit facility reached a high on Friday…

… The chancellor also backed the French president's call for a financial-transaction tax…

By WILLIAM BOSTON , BERND RADOWITZ and ANDREA THOMAS

BERLIN—Germany and France on Monday pressed Greece and its bondholders to agree on a reduction of Athens's debt burden, warning that Greece's bailout loans from the euro zone and the International Monetary Fund are on hold until a deal is reached with private investors.

German Chancellor Angela Merkel and French President Nicolas Sarkozy met in Berlin on Monday to discuss the euro zone's plans to tackle the debt crisis on the bloc's periphery, and to flesh out their proposals for closer coordination of economic and budget policies among the euro's 17 member countries. But their talks were overshadowed by concerns in financial markets that Greece's bailout program is in danger of unraveling, driving the euro to a 16-month low and hitting global stocks on Monday.

Greece's deteriorating economy is threatening the viability of a €130 billion ($165.2 billion) bailout for the country that European leaders agreed to in October. The bailout package, which followed an earlier aid deal for Athens that was agreed on in 2010, relies on Greece negotiating a 50% reduction in much of its outstanding bond debt. It also requires Greece's government to make fresh efforts to cut its budget deficit.

"The second Greece program has to be implemented soon, otherwise it won't be possible to disburse the next tranche" of aid loans, Ms. Merkel told a joint news conference with Mr. Sarkozy after their meeting.

A spokesman for the Greek government declined to comment on Monday.

Many analysts and officials, including at the IMF, fear that Greece will need bigger debt forgiveness from its bondholders if it is to bring its overall debts down to a sustainable level. Germany and France, however, made it clear on Monday that they want to see the October agreement implemented.

At their first meeting of 2012, Ms. Merkel and Mr. Sarkozy, the euro zone's two most powerful leaders, discussed the details of a pact among euro-zone countries to limit government debts and align economic policies in order to prevent a repeat of Greece's debt crisis. Euro-zone leaders agreed in December to create a system of more-credible penalties for running up excessive budget deficits and public debts.

Many economists are critical of the Franco-German plan for enforcing fiscal discipline, arguing that it neglects that deeper economic imbalances within the euro zone that have led to a buildup of excessive private as well as public debt in countries such as Greece, Portugal and Ireland. Analysts said France and Germany have also failed so far to offer a convincing path back to economic growth.

The spreading recession in the euro zone is also making it harder for Greece and other countries with bailout programs to close their fiscal deficits, economists said. Greece's stubbornly high deficit is raising the risk of a full-blown default on its bonds, which economists say could have incalculable consequences for the euro zone as a whole.

European governments remain worried that a bond-market panic could cut off major economies such as Spain and Italy from affordable credit. Meanwhile, European banks are increasingly reluctant to lend one another money, partly out of fear of many banks' heavy exposures to indebted euro-zone governments.

In a sign of that mutual mistrust, banks' use of the European Central Bank's overnight deposit facility reached a high on Friday. Euro-zone banks parked nearly €464 billion in the facility, ECB data released Monday showed. The ECB deposit facility is a safe but low-interest-bearing alternative to lending between banks.

"The situation is very strained, maybe more than ever before in the euro area," said Mr. Sarkozy.

Ms. Merkel said she will discuss the Greek bailout plan with IMF Managing Director Christine Lagarde, who arrives in Berlin on Tuesday for talks with the government of Europe's biggest economy.

Ms. Merkel and Ms. Lagarde are also expected to discuss the planned €200 billion boost to the IMF's resources agreed at last month's European Union summit. While most of that total is meant to come from euro-zone central banks, the agreement envisages €50 billion in contributions from countries outside the euro zone.

Germany's central bank, the Bundesbank, has said it will contribute only if the U.K., which doesn't use the euro, also does so. But the U.K. has rejected calls to contribute extra cash to the IMF.

Monday's Franco-German summit was the first of a series of talks aimed at agreeing on the details of the euro zone's new rules on fiscal and economic policy by the end of March.

The rules are expected to include a requirement that all euro members enact balanced-budget laws in order to bring down their overall public debt progressively—a policy modeled on the so-called debt brake in Germany's constitution.

"We are making good progress on the fiscal pact," Ms. Merkel said. "There is a good chance that we will be able to sign agreements on the debt brake in January, or February at the latest," she said.

Mr. Sarkozy, who faces a challenging two-round presidential election in April and May, was also pushing ahead of the meeting to stress the need for promoting economic growth and jobs, rather than only budget austerity.

Ms. Merkel sought to accommodate her guest, agreeing that the euro zone needs "growth impulses" as well as budget discipline, without specifying how Germany or others can stimulate growth.

The chancellor also backed the French president's call for a financial-transaction tax across the 27-nation EU. She said she would support introducing such a tax for the subset of 17 countries that use the euro if the full EU can't agree on the measure. The U.K., the largest EU country that doesn't use the euro, has rejected such a tax, which the U.K. fears would put London's financial center at a competitive disadvantage.

But passage of any kind of tax proposal on financial transactions is far from certain. The idea was immediately rejected by Ms. Merkel's junior coalition partner, the pro-business Free Democrats, suggesting she is making a promise to Mr. Sarkozy she will never have to keep.

Write to William Boston at william.boston@dowjones.com, Bernd Radowitz at bernd.radowitz@dowjones.com and Andrea Thomas at andrea.thomas@dowjones.com