While the finance ministers of the countries that use the euro as their currency adopted a tough stance on how much rescue money they would pump into the Greek economy, the head of the group that represents the country's private creditors — banks and other investment firms — warned that the future of Europe was being threatened if a voluntary debt reduction deal over Greece was not agreed.
Charles Dallara, the managing director of the Institute of International Finance, warned that Europe was putting "decade of progress at risk" over the management of Greek debt-reduction talks, which stalled over the weekend.
"European stability is at stake as well," Dallara said in Zurich in a press conference.
On the front line of Europe's sovereign debt crisis, Athens is trying to get its private creditors to swap their Greek government bonds for new ones with half their face value, thereby slicing some €100 billion ($130 billion) off its debt. The new bonds would also push the repayment deadlines 20 to 30 years into the future.
However, the main stumbling block over the past few weeks to securing this deal has been the interest rate these new bonds would carry. A high interest rate could buffer losses for investors, but would also require the eurozone and the International Monetary Fund to put up more than the €130 billion ($169 billion) in rescue loans they promised in October.
Dallara said the private creditors, which include banks, insurance companies and hedge funds, were acting in good faith and that the proposal made last week was in the spirit of last October's agreement. At that time, Europe's leaders said Greece should look to reduce the value of its private sector debts by 50 per cent, or €100 billion ($130 billion).
In the early hours of Tuesday, eurozone politicians drew a firm line on the Greek debt restructuring.
Jean-Claude Juncker, the Luxembourg prime minister who chaired a meeting of finance ministers on efforts to fight the crisis, said the average interest rate over the lifetime of the new Greek bonds must be "clearly below 4 per cent," with an average rate of less than 3.5 per cent for the period until 2020. That is far below the 4 per cent demanded by the Institute of International Finance, which has been leading negotiations for the private bondholders.
The European ministers' tough stance on the interest rates underlines how the eurozone and the IMF are unwilling to increase new rescue loans above the promised €130 billion, even though Greece's economic situation has deteriorated. After already granting Greece a €110 billion bailout in May 2010, the eurozone and the IMF are threatening to withhold further funding for the country, which has repeatedly failed to hit budget and reform targets required in return for the financial aid.
The interest rate caps will also seriously test the willingness of private bondholders to agree to a debt deal voluntarily.
Dallara said talks would continue over the coming days, adding that he was confident there would be "large-scale" participation by the private sector if a "voluntary" deal is clinched.
However, he refused to put a deadline on the discussions.
Given the complexity of the negotiations and the legal consequences that would ensue, many analysts think a deal has to be agreed soon if Greece is to meet a vital bond repayment deadline in March.
If it can't pay its bond, Greece would be in default of its debts, a scenario that could lead to renewed panic in financial markets and potentially derailing a feeble global economic recovery.
Dallara said Europe must keep the support of the private sector, given the massive amounts of debt that have to be refinanced from France to Portugal.
He added that there wasn't a country that didn't need investment from the private sector.
"Investors need to feel confident in their investments ... in sovereign debt," he said.
Before Dallara's latest comments, German Finance Minister Wolfgang Schaeuble said the current impasse was a normal part of difficult negotiations.
"We continue the negotiations (with investors) as happily, but also as little susceptible to blackmail as possible," he told reporters in Brussels. "That exists in every bazaar — a final offer — one shouldn't let oneself be overly impressed by that."
The alternative to a voluntary deal would be to force losses on to investors — a move that the eurozone has so far been unwilling to make. Some officials fear that a forced default could trigger panic on financial markets and hurt bigger countries like Italy, Spain or even France.
But several ministers indicated that they might be willing to accept a forced default if it puts Athens in a position where it can eventually repay its remaining debt — including the rescue loans from the eurozone and the IMF. The eurozone has said that Greece's debt is sustainable if it falls to some 120 per cent of gross domestic product by 2020. Without a restructuring it would reach close to 200 per cent by the end of the year.
Even Olli Rehn, the EU's Monetary Affairs Commissioner, said that forcing some holdouts to accept a restructuring that has the support of the majority of bondholders would be acceptable.
"That is possible within the framework of achieving a voluntary agreement on private sector involvement," Rehn said, referring to so-called collective action clauses that Greece could write into its old bond contracts to allow majority decision making. The Commission has so far always been opposed to any forced losses for investors.
But ministers also put the pressure on Greece to reach a manageable debt level by bolstering its reform and austerity measures.
"Greece and the banks have to do more in order to reach a sustainable debt level," Dutch Finance Minister Jan Kees de Jager told reporters as he arrived for a second day of meetings with his European counterparts. "We have to await the discussions about that because a sustainable debt level is absolutely a precondition for the next (rescue) program."
Schaeuble also insisted that firm support for new austerity measures from all major Greek parties — including after elections expected in April — was a precondition for a new bailout.
Pan Pylas in Zurich and Nicholas Paphitis in Athens, Greece, contributed to this story.