Greece insisted on Tuesday any restructuring of its debts would be a disaster for the economy, but financial markets continue to view it as likely and are betting that the euro zone debt crisis will worsen.
A year and a day since the EU and IMF agreed to extend Greece 110 billion euros ($163 billion) in loans in exchange for deep structural adjustments to its economy, the finance minister again dismissed growing suggestions that Athens will have to restructure its debts, which are set to hit 150 percent of annual output, or around 340 billion euros, this year.
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"A restructuring, haircuts on debt, would be a huge mistake for the country," Finance Minister George Papaconstantinou told state television as EU and IMF inspectors began a new visit to assess if the government's austerity plans are sufficient.
"It would have a very big cost and we would not have the benefit, we would stay out of markets for 10-15 years, the wealth of Greek pension funds would suffer writedowns, we would have problems in the banking system and hence the real economy."
Despite the minister's insistence, two German government advisers said last week a restructuring of the debt pile, which is only increasing as Greece's output contracts, was now inevitable, and markets hold the same view.
European Central Bank policymaker Nout Wellink said on Monday he was open to the idea of extending maturities on Greek debt, becoming the first senior ECB official to admit that possibility publicly.
JP Morgan said the likelihood of a Greek restructuring this year was rising, although it was not guaranteed.
"We are not yet ready to forecast that a debt restructuring will occur this year, but we have to recognize that the risk has risen relative to our baseline assumption that any decisions about debt restructuring would be delayed until 2013," it said.
Yields on Greek 10-year government bonds now stand at 15.5 percent, nearly 12 percentage points higher than equivalent German bonds, a stark measure of the extra risk investors take on by holding Greek sovereign debt.
An even clearer illustration that some form of debt restructuring is inevitable can be seen in the two-year bonds, which are yielding 25.7 percent -- an unsustainable figure that implies Greece cannot but reschedule some repayments.
Under the umbrella term "debt restructuring" there are various options, ranging from writing down the value of the debt by a set amount, known as a haircut, to rescheduling when the debt will be repaid, which is a softer form of restructuring.
While Greece is adamant that there will be no haircuts, a move that would alarm bondholders including many of Europe's biggest banks and the European Central Bank, some form of rescheduling is a possibility, euro zone sources have said.
"It's very difficult to imagine what else Greece can do," a euro zone finance official said last week. "Without growth, its debts just keep growing. If it's going to get back on top of them, it's got to reschedule at some point."
PORTUGAL BAILOUT GROWING?
In Portugal, EU and IMF experts are expected to conclude nearly three weeks of negotiations over Lisbon's bailout in the coming days, sources have said.
Officials have said Portugal is likely to need about 80 billion euros of assistance, but Portuguese newspaper Diario Economico reported on Tuesday the figure could be greater than 100 billion euros ($148 billion), including up to 10 billion euros in aid for Portugal's banks.
The newspaper did not cite any sources but said the banking sector needed at least 5.3 billion euros to cover a hole left by the failure of BPN, a bank nationalized in 2008, as well as additional funds to help banks raise their capital ratios.
Officials in Brussels have described Portugal's bailout as more complicated than either that of Ireland, which received 85 billion euros last November, or Greece, which received agreed its 110 billion euro program on May 2, 2010.
The problem for Lisbon is that it has high public sector debts, banking problems and structural economic shortcomings, including rigid labor markets and a costly state pension system, all of which require attention in the same package.
At the same time, the country is to hold a parliamentary election on June 5 following the resignation of the previous government, which collapsed when its plans for austerity measures were voted down by the parliament.
The political impasse means the EU and IMF are negotiating with caretakers -- at a time when politicians are thinking about voters and their own re-election. The caretaker government will have to win the endorsement of major opposition parties before agreeing to any euro zone bailout deal.
But even then, there is the risk that any package will not be approved by all 17 countries in the euro zone.
Finland, where the eurosceptic True Finns party came third in a parliamentary election last month, would likely find it impossible to back the bailout if the True Finns end up being in the next governing coalition.
Jyrki Katainen, whose right-leaning party came top in the polls and who is expected to be the next prime minister, began preliminary talks with potential coalition partners on Tuesday.
The True Finns have said definitively that they will not support a bailout of Portugal, a position that may rule them out of government. But it is still unclear whether Finland will be able to form a government that backs Portugal's bailout in time for Lisbon to receive the money it needs by a June 15 deadline.
(Writing by Luke Baker, editing by Rex Merrifield/Mike Peacock)