Greece set for temporary default as second bailout agreed

Greece is to get a second financial bail out in an attempt to protect the euro and try to avoid the single currency zone going into free fall.

An emergency summit of the 17 Euro zone leaders agreed on a second rescue package for debt stricken Greece but it risks triggering a temporary default so measures were also discussed to limit the damage.

If, as is expected, ratings agencies declare Greece is in temporary default, the first such time in the 12 year history of the euro, the financial rescue fund will have broader powers to try to prevent market instability spreading through the region.

Leaders agreed another €109 billion of government money, plus a contribution by private sector bondholders estimated to total as much as €50 billion by the middle of 2014.

The package boosted stocks and the euro because it suggested for the first time since the Greek debt crisis erupted early last year that the euro zone was taking a comprehensive, long term approach to the problem, rather than simply lending Greece more money to avoid disaster in the near term.

‘We have thus sent a clear signal to the markets by showing our determination to stem the crisis and turn the tide in Greece, thereby securing the future of the savings, pensions and jobs of our citizens all over Europe,’ said Dutch Prime Minister Mark Rutte.

But some of the details remained sketchy and doubts linger about whether the plan went far enough to assure not only Greece's debt sustainability but that of Ireland, Portugal and other debt burdened nations.

If market conditions deteriorate and a larger European economy, Italy being the most likely at present, struggles to shoulder its debt burden, the rescue fund could be quickly wiped out, analysts are warning.

French President Nicolas Sarkozy said measures agreed at the summit, the fifth this year on the crisis, would together reduce Greece's debt by 24% of gross domestic product from about 150%.

Greek Prime Minister George Papandreou said the deal would cover his country's funding needs until 2020 and make its debt sustainable, but analysts questioned whether the reduction would be enough to avoid a restructuring in the medium term.

The second bailout of Greece, details of which are likely to be set formally in September, will supplement a €110 billion rescue plan for the country launched by the European Union and the International Monetary Fund in May last year.

Among other steps, the leaders agreed to ease terms on bailout loans to Greece, Ireland and Portugal. Maturities will be extended to 15 years from 7.5 and interest cut to around 3.5% from 4.5 to 5.8%. Banks and insurers will voluntarily swap their Greek bonds for longer maturities at lower interest rates to help Athens.

Acknowledging that the swap scheme may lead to Greece being declared in selective default, Sarkozy said euro zone nations stood ready to protect Greek banks from the fallout, by providing credit guarantees if needed to ensure they can still obtain liquidity from the European Central Bank.

The region's rescue fund, the European Financial Stability Facility, will be allowed to buy bonds in the secondary market if the ECB deems that necessary to fight the crisis.

It will also be allowed for the first time to give states precautionary credit lines before they are shut out of credit markets, and lend governments money to recapitalise banks, both moves which Germany blocked earlier this year.

The expanded EFSF role is designed to prevent bigger euro zone states such as Spain and Italy from being excluded from markets because of fears of a weaker country defaulting.

‘We have agreed to create the beginnings of a European Monetary Fund,’ Sarkozy said of the EFSF's new powers.

The European leaders also promised a Marshall Plan of European public investment to help revive the Greek economy, which is in a deep recession due to draconian austerity steps imposed by the EU and the IMF. They did not give details.

The expansion of the EFSF's role will have to be endorsed by national parliaments in the euro zone, but diplomats said critical lawmakers in Germany, the Netherlands and Finland were likely to back it since the private sector will share the burden of the new Greek rescue.

But unless Greece returns quickly to strong economic growth, which analysts believe is unlikely, a tougher decision may have to be made down the road on writing off more of its debt.

Some analysts also believe Ireland and Portugal may eventually have to restructure their sovereign debt, although EU officials insisted that the Greek bond swap would not be used as a model for those two countries.

Many economists believe the only way out of the euro zone's debt crisis in the long run may be closer integration of national fiscal policies, for example, a joint euro zone guarantee for countries' bonds, or issuance of a joint euro zone bond to finance all countries. Germany has opposed this.