World Economy

Euro-zone leaders are expected Thursday to sign off on a new aid plan for Greece that would cut the nation’s debt burden and increase the flexibility of the region’s rescue fund in a bid to keep the debt crisis from spreading, news reports said.

A draft plan expected to be published at the conclusion of Thursday’s closely-watched summit of euro-zone leaders would see the European Financial Stability Facility, or EFSF, charge loan rates as low as 3.5%, Dow Jones Newswires reported, citing a draft copy of conclusions. The plan would also reduce debt burdens for Ireland and Portugal.

The maturities of EFSF loans would be extended to at least 15 years from an average of 7.5 years, the report said, and the EFSF could be used to recapitalize banks through loans to euro-zone governments, including governments that haven’t sought a bailout. Financial firms will be given a menu of options on how to help finance Greek debt, the report said, including debt exchanges, rollovers and buybacks.

The Wall Street Journal reported that discussions were also under way to allow the EFSF to provide precautionary credit lines, loans to governments and debt buybacks in the secondary market.

The news boosted stocks and lifted the euro, which has seen choppy trading as headlines flowed from Brussels. The 17-nation shared currency changed hands at $1.4304, up from $1.4230 in late North American trading on Wednesday.

Hopes for a comprehensive agreement at the summit were boosted early Thursday morning after German Chancellor Angela Merkel and French President Nicolas Sarkozy agreed to a “common position” after seven hours of discussions in Berlin.

Click to Play

Greek taxi drivers clash with police

Protesting taxi drivers clash with riot police outside the transport ministry after government talks fail. Video courtesy Reuters.

Germany and France are Europe’s two largest economies, but any deal will need the approval of all 17 euro-zone leaders.

Market jitters were triggered after Luxembourg Prime Minister Jean-Claude Juncker told reporters in Brussels ahead of the closely-watched summit that leaders were attempting to avoid a “selective default,” but that a new bailout plan could potentially trigger such a designation by ratings agencies.

Merkel’s spokesman said the leaders discussed the situation with European Central Bank President Jean-Claude Trichet and European Council President Herman Van Rompuy. Trichet has repeatedly warned that any default would result in Greek bonds becoming ineligible to be used as collateral for ECB funding, potentially starving Greek banks of financing unless national governments come up with a funding solution.

The agreement between France and Germany comes amid mounting pressure on Merkel, as leader of Europe’s largest economy, to reach agreement on a second bailout for Greece and take steps to prevent the further spread of the region‘s long-running debt crisis . Read more on Thursday’s euro-zone summit.

Merkel last weekend had said she might not attend the summit unless a comprehensive deal was on the table.

Rising bond yields for Spain and Italy have triggered alarm in world markets and among world leaders that the euro-zone crisis could run out of control, threatening global growth.

U.S. President Barack Obama had a telephone conversation with Merkel earlier this week to discuss the situation. European Commission President Jose Manuel Barroso on Wednesday warned that a failure to respond to the crisis would produce “negative consequences [that] will be felt in all corners of Europe and beyond.”

Italy, Spain also in focus

Although Greece is at the top of the agenda, “any decision taken today must be made with one eye on Italy and Spain,” said Gary Jenkins, head of fixed-income research at Evolution Securities in London. “It was always likely that the contagion would spread to these countries at some stage and, because of the size of their debt, that they would be the line in the sand that could not be crossed.”

Germany, in the face of growing taxpayer resentment over bailouts, has previously insisted that private bondholders must share some of the cost of a new Greek bailout and has previously resisted calls to use the euro zone’s rescue mechanism, the European Financial Stability Facility, to purchase government bonds or fund buybacks of government debt.

France and the European Central Bank have resisted calls for private-sector participation, saying such an approach could cause the crisis to spread by spooking bondholders.

While the ECB has maintained that Greece and other debt-strapped countries should focus on austerity measures, many economists have viewed some form of debt restructuring for Greece — and potentially fellow bailout recipients Ireland and Portugal — as inevitable.

Greece’s economy has contracted sharply, sparking civil unrest and doubts about the government’s ability to press ahead with further austerity measures. The government last month barely won passage of a fresh round of austerity and privatization measures deemed a prerequisite for a delayed tranche of aid under last year’s bailout and for a new bailout package.

News reports Thursday morning said the negotiations saw France drop calls for a bank tax that had been estimated to raise as much as €50 billion over five years that would have been used to finance buybacks of Greek government bonds.

Markets are likely to remain in a wait-and-see mode as an agreement between France and Germany must still convince the other 15 euro-zone leaders, analysts noted.

“The markets will be keen to know how the EU intends to tackle the issues beyond Greece, in particular how the role of the EFSF will change,” said Gavan Nolan, director of credit research at Markit in London, in emailed comments. “Until the details are clear they will be wary; memories of past disappointments are still fresh