Eurozone looks at Greek exit as leaders meet

BRUSSELS (Reuters) - European leaders, at odds over how to resolve the deepening crisis in the euro zone on Wednesday, have been advised by senior officials to prepare contingency plans in case Greece quits the single currency area.

Three officials told Reuters the instruction to be ready was agreed on Monday during a teleconference of the Eurogroup Working Group (EWG) - experts who work for the bloc's finance ministers - and the German central bank said losing Greece would be testing but "manageable".

"The EWG agreed that each euro zone country should prepare a contingency plan, individually, for the potential consequences of a Greek exit from the euro," said one euro zone official.

The Greek finance ministry denied there was any such agreement but Belgian Finance Minister Steven Vanackere, asked by reporters ahead of the EU summit, said:

"All the contingency plans (for Greece) come back to the same thing: to be responsible as a government is to foresee even what you hope to avoid."

The news comes at a highly sensitive time with EU leaders gathering to try to breathe life into their struggling economies at a summit over dinner on Wednesday.

Although minds will be focused by the prospect of Greece leaving the currency area, something EU leaders insist they want to avoid, disagreements over a plan for mutual euro zone bond issuance and other measures to alleviate two years of debt turmoil have already been laid bare.

In its monthly report, Germany's Bundesbank said the situation in Greece was "extremely worrying" and it was jeopardizing any further financial aid by threatening not to implement reforms agreed as part of its two bailouts.

It said a euro exit would pose "considerable but manageable" challenges for its European partners, raising pressure on Athens to keep its painful economic reforms on track.

Greek officials have said that without outside funds, the country will run out of money within two months and there remains the threat that if it crashes out of the euro zone, other member states could be targeted by the markets.

For the first time in more than two years of crisis meetings, the leaders of France and Germany have not huddled beforehand to agree positions, marking a significant shift in the Franco-German axis which has traditionally driven European policymaking.

Instead, new French President Francois Hollande met Spanish Prime Minister Mariano Rajoy in Paris to discuss policy, before the pair travelled to Brussels.

Despite fears Greeks could open the departure door if they vote for anti-bailout parties at a June 17 election, Spain, where the economy is in recession and the banking system is in need of restructuring, is at the front line of the crisis, with concerns growing that it too could need bailing out.

After meeting Hollande, Rajoy said he had no intention of seeking outside aid for Spain's banks, although his government said its rescue of problem lender Bankia would cost at least 9 billion euros ($11 billion).

SHIFTING SANDS

Socialist Hollande's election victory has significantly changed the terms of the debate in Europe, with his call for greater emphasis on growth rather than debt-cutting now a rallying cry for other leaders.

That has set up a showdown with conservative German Chancellor Angela Merkel, who supports growth but whose primary objective is budget austerity and structural reform.

At his first EU summit, Hollande has chosen to make a stand on euro bonds - the idea of mutualising euro zone debt - despite consistent German opposition to the idea.

He has support from Italian Prime Minister Mario Monti and European Commission President Jose Manuel Barroso, among others. But Merkel shows no sign of dropping her objections to the proposal, which she has said can only be discussed once there is much closer fiscal union in Europe.

The Netherlands, Finland and some smaller euro zone member states support her. "Euro bonds (are) not something we are in favor of, they would increase our borrowing costs," Dutch Prime Minister Mark Rutte said.

Arriving in Brussels, Merkel showed no sign of budging either. "I will propose that the mobility of labor market be improved," she said. "Secondly, it's about structural reform."

No decisions will be made at Wednesday's summit, which is intended to promote ideas on jobs and growth ahead of another meeting at the end of June.

But it is clear debate will be intense, not just over euro bonds but over how to rescue European banks and whether to give more time to struggling euro zone countries to meet their budget deficit goals.

"We haven't come together to confront each other ... but we have to say what we think - what are the right instruments, the right methods, the right steps, the right initiatives to raise growth," Hollande said.

Having rallied on Tuesday, European stocks dropped 2.2 percent as investors priced in a lack of dramatic policy intervention. The euro tumbled against the dollar to its lowest since August 2010 and Spanish and Italian borrowing costs climbed.

A German two-year debt auction gave a stark illustration of how money is dashing for safe havens. Investors snapped up the 4.5 billion euros of paper on offer even though it came with a zero coupon - offering no return at all.

As well as exploring ways to foster growth, the leaders will assess how to stabilize their banking systems, particularly Spain's which is laden with bad debts from a property boom that bust and still has some way to go before it touches bottom.

One proposal on the table is for the euro zone's rescue funds to be allowed to recapitalize banks directly, rather than having to lend to countries for on-lending to the banks.

But that is another idea with which Germany is uncomfortable.

"The top priority is injecting liquidity into the European financial system to ensure that European banks, all European banks, can be consolidated," Hollande said.

SEARCH FOR GROWTH

With the euro zone registering no growth in the first quarter of the year and threatening to slip back into recession, the formal summit agenda is jobs and growth, with policymakers touting three ideas they hope will provide near-term stimulus:

- 'Project bonds' backed by the EU budget to finance infrastructure projects alongside private sector investment.

- Doubling the paid-in capital of the European Investment Bank, the EU's co-financing arm, to a little over 20 billion euros.

- Redirecting structural funds which tend to flow to poorer countries, to other areas where they might reap more immediate growth rewards.

Even if all three proposals were to be activated quickly economists and analysts say they will not provide a sufficient shot in the arm to the euro zone and the wider EU economy.

(Additional reporting by Luke Baker and Marine Hass in Brussels, Julien Toyer in Madrid and Catherine Bremer in Paris, writing by Mike Peacock, editing by Anna Willard and Giles Elgood)

EU leaders support growth, give few concrete plans

BRUSSELS (AP) — European Union leaders concluded their latest summit early Thursday with few concrete steps to fix the continent's festering financial crisis even as the potential for a messy Greek exit from the euro appears to be rising. Some leaders stressed the importance of planning for just such an event but offered no measures that might help Greece avoid it.

Also left unresolved was what Europe should do to spark economic growth and restore the confidence of investors, who have driven some countries' borrowing costs to unsustainable levels. The fiscal austerity agenda that Germany has promoted as the solution to Europe's problem of too much government debt has been met with rising skepticism in other euro countries.

The leaders of the 27 EU countries agreed to give institutions such as the European Investment Bank the task of drawing up proposals for growth in time for another summit in June. But there was discord over more aggressive actions promoted by some leaders heading into the summit, such as issuing bonds jointly as a way of reducing borrowing costs for heavily indebted nations among the 17 countries that use the euro.

The perception that European leaders lack the political will to tackle the continent's financial and economic problems has left markets on edge for weeks. Recession is spreading. Banks are under pressure. The biggest fear is that if Greece cannot be saved, other larger economies — like Spain or Portugal — might face the same fate.

The euro countries "have to consider all kinds of events," Luxembourg Prime Minister Jean-Claude Juncker told reporters after a European Union summit, but insisted that "the working assumption" was that Greece would remain part of the euro. Leaders gathered in Brussels recognized that Greece had endured significant hardships and promised to release development funds aimed at spurring growth.

But the statement from Juncker, who also chairs meetings of eurozone finance ministers, was a frank admission that Greece could wind up abandoning the euro. The country's fringe political parties, which are threatening to renege on commitments made to secure bailout loans, saw their popularity surge in recent elections. No party has been able to form a government, and the country will vote again June 17.

Many analysts have said that Greece, already in its fifth year of recession, has no hope of recovery if it sticks to the spending cuts and tax hikes it agreed to in order to secure bailout loans.

"We want Greece to remain in the euro area," German Chancellor Angela Merkel said after the meeting. "We expect that they will stick to the commitments that they have entered into."

Political uncertainty in Greece is just one of the fires the Europe needs to put out. Leaders are also worried about rising borrowing costs in Spain and Italy that could force them to seek bailouts, just like Greece, Portugal and Ireland did.

Markets had expected the latest EU summit to disappoint and it did. Europe's stock markets had fallen heavily during trading on Wednesday and the euro hit a near two-year low against the dollar.

Asian stock markets retreated Thursday as the lack of a breakthrough in Europe unnerved traders. Japan's benchmark Nikkei 225 was down 0.5 at 8,514.53 and Hong Kong's Hang Seng slipped 0.6 percent to 18,682.38.

Dariusz Kowalczyk, senior economist at Credit Agricole CIB in Hong Kong, said Thursday: "Europe is not doing enough, and the market may not wait for them."

One of the biggest questions facing Europe is whether it's time to cut Greece some slack. Some European countries seemed ready to ease the pressure, and international organizations have called for the pace of austerity measures to be slowed in some struggling countries.

But Thursday's summit of 27 European Union leaders ended with no apparent concessions. A final statement said Greece had to respect its commitments and trumpeted the money the eurozone and the International Monetary Fund had loaned Greece as a sign of their "solidarity." It did say that funds for economic development would be sent to Greece — though it's unclear how much of an immediate impact on growth they would have.

Juncker insisted early Thursday that he had not asked the euro nations to prepare national contingency plans for a possible chaotic departure of Greece from the currency.

French President Francois Hollande said that to evoke the even the possibility was dangerous — and would send a signal to the markets that the eurozone wasn't standing behind Greece.

The debate reflects the fine line European leaders must walk between pressuring Greece to stick to a program of spending cuts and tax hikes that have exacerbated its economic slowdown and trying to ensure its presence in the eurozone.

Spanish Prime Minister Mariano Rajoy suggested the European Central Bank resume some of its emergency measures, such as buying the bonds of weak countries, which has the impact of lowering countries' borrowing rates. The ECB has suspended the purchases because, as an independent body, it does not want to be seen supporting governments directly. Instead, it has given European banks massive amounts of cheap loans to bolster confidence in the financial system and allow banks to buy up their country's debt.

Leaders on Thursday also addressed the contentious issue of whether the countries that use the euro should spread the risk and borrow money jointly - issuing so-called "eurobonds." This would mean every country could borrow funds at the same rate, substantially lowering the costs for the more indebted countries.

Hollande has pushed for them as an important way to ensure such a crisis never happens again, but Merkel has rejected them, fearing they would reduce the pressure on heavily indebted governments to heal their finances and force Germany to borrow at higher rates.

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Don Melvin contributed to this story.