The International Monetary Fund wants euro zone finance ministers to agree to cut Greece's debt by 20 percent of GDP now and commit to further debt reduction in the future to get the country's finances back on a sustainable path, a source familiar with EU-IMF talks said on Monday.
An immediate 20 percentage-point cut, equal to 40 billion euros, could mostly be achieved through lowering interest rates and extending maturities on loans to Greece, the source said.
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Finance ministers from the 17 countries sharing the euro, the European Central Bank and the IMF were locked in a third round of talks on Monday to decide how to make Greek debt, expected to rise to 190 percent of GDP next year, more sustainable by reducing it to 120 percent or below by 2020.
The IMF and the ministers are at odds on how to achieve the goal, with the IMF pushing for a bolder reduction of Greek debt through the forgiveness of some of the official loans to Athens which now make up the bulk of the country's obligations.
Greece's biggest creditor, Germany, opposes any debt forgiveness for Athens.
Without additional debt-cutting measures, Greek debt is likely to fall to only 144 percent of GDP in eight years - substantially above the 120 percent target. Many policy-makers see even the 120 percent as too high for Greece, which is in its fifth year of recession and set to contract again in 2013.
The IMF argues, the source said, that if there is no debt reduction up front, the Greek economy will not grow, nobody will invest and Greeks themselves will not spend, derailing other macro-economic assumptions of its adjustment program.
But Germany has said debt forgiveness would be illegal and the European Commission has said that a haircut on the principal lent to Athens is a red line for euro zone ministers.
The key to a compromise may be in keeping the principal intact.
One idea discussed by ministers is to keep the principal untouched but lower the interest on the official loans, either extended bilaterally or through the temporary bailout fund EFSF, to below market rates, and to extend maturities.
This could produce a reduction in debt big enough to make Greek debt sustainable, or close to sustainable.
Other available options include the European Central Bank forgoing profits on its Greek bond portfolio, a 10-year moratorium on debt servicing and a buy-back of privately held debt at a deep discount.
The source said the IMF insisted on a package of steps that would slash 20 percent of GDP off the debt pile up front to give the plan credibility and the Greek economy a chance to grow.
But it also expected the euro zone to promise a further reduction to a level well below 120 percent of GDP at some point in the future as a reward for keeping Greek reforms on track, the source said. That would have to involve debt forgiveness.
The IMF had made clear that it would not walk away from Greece, the source said, but also that it would not endorse a debt reduction deal that did not guarantee debt sustainability.
The IMF insists that any measures the ministers agree on, as well as assumptions in the Greek reform program, have to be credible enough for investors to see them as realistic, otherwise Greece would not be able to return to markets.
(Reporting By Jan Strupczewski; editing by Luke Baker)