Europe's leaders prepare to prop up Greece

BRUSSELS - European Union leaders were laying the groundwork yesterday for a precedent-setting aid package for Greece to try to shield the euro from the wrath of markets.

Germany and France set the stage for a Brussels summit by working on options such as loan guarantees as long as Prime Minister George Papandreou overcomes street protests and makes deeper cuts to the EU's biggest budget deficit.

"I am having several discussions at the moment so that we can come up with an answer that will satisfy the markets," Luxembourg Prime Minister Jean-Claude Juncker, who heads the panel of euro-region finance chiefs, told Luxemburger Wort newspaper.

European stocks and bonds rallied alongside Greek markets on expectations that EU chiefs will stand by the country, raising the risk of a sell-off if the 27-nation bloc fails to send a convincing signal of support.

"Markets could try to test such a commitment," said Carsten Brzeski, an economist at ING Group in Brussels.

"Markets would probably be enthusiastic at first glance, but at second glance there might be people trying to check how strong this commitment was."

The meeting, which will include European Central Bank president Jean-Claude Trichet, was to take place overnight and finish this morning.

Called by EU President Herman Van Rompuy to sketch out a 10-year economic strategy, the summit has turned into a crisis-management exercise that will test Europe's ability to run a common currency with 16 separate national fiscal policies.

For that reason, EU officials have resisted putting Greece in the hands of the International Monetary Fund, concerned that recourse to outside assistance would expose Europe's inability to get its own house in order.

Investors might view an IMF package "as a sign that the European institutions had failed", Ben May, an economist at Capital Economics in London, said in a research note.

"This could cast doubt on the long-term future of the euro zone."

Greece, representing 2.7 per cent of the euro region's US$13 trillion ($18.6 trillion) economy, posted a budget deficit of 12.7 per cent of gross domestic product in 2009, the highest in the euro's history and more than four times the EU's 3 per cent limit.

Papandreou's government needs to sell €53 billion ($104.6 billion) of debt this year, the equivalent of about 20 per cent of GDP. Greece's credit rating was cut by Standard & Poor's, Moody's Investors Service and Fitch Ratings in December.

The euro's slide to a nine-month low of US$1.3586 on February 5 forced Greece to the top of the EU agenda out of concern that speculators might take aim at Spain and Portugal, which are also struggling to cut their deficits.

The EU needed to act to calm exaggerated fears in the markets, a French official said.

Greek bonds yesterday staged the biggest gains since at least 1998, with the yield on the 10-year security falling as much as 55 basis points.

Greece said spending cuts started to take hold in January, narrowing the central government's cash shortfall to €818 million in January from €1.3 billion a year earlier.

Belt-tightening measures "will be implemented in every detail", Papandreou said in Paris yesterday.

Whether from individual countries or the EU as a whole, a financial lifeline for Greece would open a new chapter in the euro experiment by breaking with the orthodoxy that each country has to steer its own economy.

DEFICIT WOES
* Greece posted a budget deficit of 12.7 per cent of gross domestic product in 2009.
* This was the highest in the euro zone's 11-year history and more than four times the EU's 3 per cent limit.
* Greece's credit rating was cut by Standard & Poor's, Moody's Investors Service and Fitch Ratings.

- BLOOMBERG