Greece steps back from prospect of debt default

Posted June 17, 2011, at 10:02 p.m.

ATHENS, Greece — Greece appeared to step back from the prospect of a devastating debt default Friday after its prime minister quelled chaotic political infighting and Germany softened a contentious demand on the participation of the private in a new European bailout.

After two days of dissent inside his Socialist party that threatened to bring down his government, Prime Minister George Papandreou named his main internal rival as finance minister. The move is expected to solidify the support from lawmakers Papandreou needs to pass a 28 billion euro ($39.5 billion) package of steep tax hikes and budget cuts so despised inside Greece that riots exploded outside parliament this week.

European donors and the International Monetary Fund require Greece to pass the austerity measures before releasing the next 12 billion euro ($17 billion) loan from a 110 billion euro package agreed on last year to keep Greece afloat until it it can get its struggling economy back on track.

A Greek default could set off an unpredictable chain reaction that would badly hurt European banks, roil markets and make it harder for other indebted countries to cope with their debts, hiking borrowing costs for eurozone countries.

Apparently, frightened by the prospect of a near-term default, Germany on Friday calmed fears that it planned to force losses on banks and other private investors as part of a second bailout. In recent weeks, German Chancellor Angela Merkel had backed her finance minister’s calls for banks and other private bondholders to give Greece an extra seven years to repay its bonds. Rating agencies as well as the European Central Bank, however, warned that such a moved would likely count as a “credit event,” a partial default by Greece that could spread panic on financial markets and hurt Greek banks.

“It is about a voluntary participation of the private sector,” Merkel said after meeting French President Nicolas Sarkozy in Berlin.

Instead, Merkel backed a softer form of private sector involvement, in which banks would be asked to buy Greek bonds as old ones expired.

Markets welcomed the developments in Athens and Berlin. Yields on Greek 10-year bonds dropped more than a percentage point to the still sky-high level of just under 17 percent, while the Athens Stock Market closed up 3.8 percent at 1,254.02.

“As of last night, there were two main obstacles to sealing a package for Greece: disagreement among European policymakers, and Greek politics,” said Nicola Mai, an analyst at JPMorgan. “Following a meeting between Merkel and Sarkozy this morning, the first of these two obstacles appears to have been lifted.”

Moving from his post as defense minister, new Finance Minister Evangelos Venizelos faces the immediate task of controlling budget overruns and setbacks in cost-cutting reforms, as well as pushing ahead with a massive privatization drive worth 50 billion euros ($70.5 billion).

At the same time, he will have to negotiate the vital second bailout package with Greece’s frustrated international creditors.

“The country must be saved and it will be saved,” Venizelos said. “I am leaving defense today to go to the real war.”

Papandreou’s new government now must win a confidence vote in Parliament, where his Socialists have a majority of five seats. The vote is likely to come at midnight on Tuesday.

Socialist dissenters have given no indication they will vote against the government, but one rebel said he would not back new austerity measures without “major changes.”

If the government clears that hurdle, Greece appears headed for a second bailout, worth several tens of billions of euros. But the country still faces years of trying economic times if it is going to get on top of its 350 billion euro debt.

Papandreou had tried to face down a political crisis by negotiating with the conservatives to form a coalition government earlier this week, but the talks quickly collapsed.

Venizelos, a 57-year-old constitutional law professor, is considered Papandreou’s main internal Socialist rival. A veteran of several ministries, he handled the run-up to Greece’s hosting of the Olympic Games in 2004 as culture minister, and has also held the justice, development and transport portfolios in the past.

He insisted there would be “no deviation” from fiscal targets laid out in the next 2011-2015 austherity program, but said there was still room for “marginal changes aimed at greater social fairness.”

He replaces George Papaconstantinou, who became broadly unpopular as he imposed budget cuts and tax hikes as part of last year’s €110 billion international bailout deal.

Papaconstantinou retains a ministerial position.

Government portfolios were also redistributed to address demands for faster reform from Greece’s debt monitors at the European Union and IMF. A new ministry for administrative reform was created to help scale back the country’s bloated public sector. The government has also promised to slash its bloated public service by 150,000 people by 2015 and effectively end government jobs for life.

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