Germany and France pressed on Monday for a rapid deal between Greece and its private creditors that returns its soaring debt to sustainable levels and said they remained committed to a new bailout that is needed by March to avert a disastrous default.
Euro zone finance ministers are due to decide later on Monday what terms of a Greek debt restructuring they are ready to accept as part of a second rescue for Athens.
Ahead of that meeting, French Finance Minister Francois Baroin said an elusive deal to convince the banks and investment funds that own Greek debt to accept deep losses on their holdings appeared to be "taking shape."
But his German counterpart Wolfgang Schaeuble warned that any deal must help Greece cut its debt mountain to "not much more than 120 percent of GDP" by the end of the decade, from roughly 160 percent today, something many economists believe will not be achieved by the existing plan.
"The negotiations will be difficult, but we want the second program for Greece to be implemented in March so that the second tranche can be released," Schaeuble told a news conference in Paris with Baroin and the heads of the German and French central banks.
"Greece must fulfill its commitments, it is difficult and there is already a lot of delay," Schaeuble said.
After several rounds of talks, Greece and its private creditors are converging on a deal in which private bondholders would take a real loss of 65 to 70 percent on their Greek bonds, officials close to the negotiations say.
But some details of the debt restructuring, which will involve swapping existing Greek bonds for new, longer-term bonds are unresolved.
Charles Dallara, the Institute of International Finance chief who is negotiating on behalf of the private debt holders, left Athens over the weekend saying banks had no room to improve their offer.
Sources close to the talks told Reuters on Monday that the impasse centered on questions of whether the deal would return Greece's debt mountain, currently over 350 billion euros, to levels that European governments believe are sustainable.
"There will likely be an updated debt sustainability analysis that will be discussed at the Eurogroup," a banking source in Athens said, requesting anonymity. "Talks will continue this week. The aim is to have an agreement by late next Monday."
In Brussels, European Economic and Monetary Affairs Commissioner Olli Rehn said talks had been "moving well" and expressed confidence a deal could be sealed this week.
But German Chancellor Angela Merkel said there was no question of extending Greece a bridging loan if talks with the private sector dragged on further.
The euro pushed up to its highest level against the dollar in nearly three weeks on hopes for a successful debt swap.
Speaking in Berlin not far from Merkel's Chancellery, IMF chief Christine Lagarde urged European governments to increase their financial firewall to prevent Greece's troubles from ensnaring bigger countries like Italy and Spain.
She also called on European leaders to complement the "fiscal compact" they agreed last month with some form of financial risk-sharing, mentioning euro zone bonds or bills, or a debt redemption fund as possible options.
Berlin opposes those steps and Merkel told a news conference with the Belgian prime minister that it was not the time to debate an increase in the euro zone's bailout funds -- the European Financial Stability Facility (EFSF) and its successor, the 500 billion euro European Stability Mechanism (ESM).
"I don't think it is right to do one new thing then do another, let's get the ESM working," Merkel said, reiterating that Germany was prepared to accelerate the flow of capital into the ESM ahead of its planned introduction in mid-2012.
Italian Prime Minister Mario Monti, who has complained openly that his reform efforts have not been recognized by the markets, is reportedly pushing for the rescue fund to be doubled to 1 trillion euros. Lagarde stopped short of advocating that, saying: "I am not saying double it."
The more immediate worry is Greece. Without the second bailout from the euro zone and the International Monetary Fund, Athens will not be able to pay back 14.5 billion euros in maturing bonds in March, triggering a messy default that would hurt the entire euro zone and send tremors beyond the 13-year old single currency bloc.
Euro zone leaders agreed in October that the second bailout would total 130 billion euros, if private bondholders forgave half of what Greece owes them in nominal terms.
But Greek economic prospects have deteriorated since then, which means either euro zone governments or investors will have to contribute more than thought.
A key sticking point is the coupon, or interest rate, the new Greek bonds would carry. Officials said the new bonds are likely to be 30 years in maturity and carry a progressively higher coupon, which would average out at around 4 percent.
"The euro zone ministers will examine the proposal and say whether we have a deal. If they say we don't, we're back to the negotiating table," a banking source close to the talks said.
Progress will be presented to euro zone ministers by Greek Finance Minister Evangelos Venizelos.
After dealing with Greece, euro zone ministers will choose a replacement for European Central Bank Board member Jose Manuel Gonzales Paramo, whose term ends in May.
The 17 ministers of the euro zone will then be joined by 10 ministers from the other European Union countries to finalize a treaty setting up the euro zone's permanent bailout fund, the ESM.
The 27 EU finance ministers will also prepare the final draft of another treaty to sharply tighten fiscal discipline in the euro zone, called the "fiscal compact," that is designed to ensure another sovereign debt crisis cannot happen in future.
EU leaders are to sign off on both treaties at a summit on January 30, allowing the ESM to become operational in July.