SOVEREIGN DEBT CRISIS:GERMANY IS trying to revive plans for a Greek debt swap as Europe battles to find a way of ensuring private creditors take part in a new bailout for the country.

The development comes weeks after Berlin withdrew its proposal in light of warnings that it would result in a default rating on the debt. An alternative French initiative emerged last week, but it is now subject to a similar default warning even though it was softer on financial institutions.

Euro-zone officials are known to be examining whether such ratings could be viewed as “temporary” if they are reviewed immediately afterwards on the basis that the position of investors was guaranteed.

This is still seen to be a step too far, and euro-zone finance ministers resolved at the weekend that the ultimate solution should not involve a selective default. Such a manoeuvre would be viewed as inherently risky, with unpredictable market consequences.

However, a well-placed European official said discussions were under way to assess whether default ratings might be imposed “only for a day” and lifted immediately afterwards on the basis that there was no haircut on the investors’ receivables.

The key element of uncertainty was the likely response of markets.

“One can try to predict but it’s not something we can forecast with accuracy, what the reaction would be at this point,” the official said.

Central to the discussion is whether any such action would trigger payouts on credit default swaps, a form of insurance against sovereign default. The authorities do not want to go down that road for fear of prompting contagion in markets.

Still, it is acknowledged that these talks may provide a new opening for the debt-swap plan first mooted by German finance minister Wolfgang Schäuble.

A further consideration is that the authorities are no longer pushing for a deal next week. With no agreement likely before September, sources say this might provide a new opportunity to advance the debt-swap proposal.

Mr Schäuble saw potential to produce a “quantified” private-sector contribution to a new Greek bailout by urging banks which hold the country’s bonds to swap them for new paper with maturities seven years longer.

Credit-rating agencies made clear their distaste for the plan, saying it would result in a credit event. Berlin relented, but it now sees scope to revive the proposal as a result of a negative assessment of the French initiative by Standard Poor’s.

“The model put forward by some French banks is still a good base for discussions and we are currently working on this,” German deputy finance minister Jörg Asmussen said yesterday.

“But since rating agencies have signalled that they will consider modalities [such as] the French proposal as a selective default – that means a rating event – we can also put other options like a bond exchange on the table.”

German chancellor Angela Merkel wants to maximise the private creditor contribution to a new Greek bailout to ensure political support for the endeavour within her own government.

The more banks contribute to the new bailout, the less guarantees would be required from euro-zone governments.

Although German institutions agreed in principle last week to participate in a bail-in scheme similar to the French plan, there was disappointment in Berlin that their likely contribution would be no more than €3.2 billion.

Mr Asmussen said the French plan may involve incentives for private creditors to participate which were “too clear”. While work was under way to amend the proposal, he said other options including the bond swap would also be considered.

“First, one has to look how can one modify the French proposal in a way that it is still attractive to financial institutions,” he said.

One key element of the equation was the interest rate that Greece paid because higher rates had more negative implications for its debt sustainability.

If a “rating event” was not avoidable, however, Mr Asmussen said it should be limited to a short period.

“Then the question is, ‘can we limit the period of this rating event to a very short period of time?’. This is the key: what can we do to limit this period to probably a few weeks or even days?”

Private investor support: French and German plans for Greece

Germany and France are behind the main plans to enlist private investor support for a second Greek bailout.

Details of the German plan are sketchy, but German finance minister Wolfgang Schäuble set out his thinking in letter last month to his fellow ministers.

“The process has to lead to a qualified and substantial contribution of bondholders to the support effort,” he wrote.

“This can best be reached through a bond swap leading to a prolongation of the outstanding Greek sovereign bonds by seven years, at the same time giving Greece the necessary time to fully implement the necessary reforms and regain market confidence.”

There are two options to the French proposal, which is considered softer on investors but is now the subject of a default warning from Standard & Poor’s.

The first, which is the more detailed of the two, would see French institutions invest at least 70 per cent of the proceeds of their maturing Greek bonds in newly-issued 30-year Greek government bonds.

They would bear interest at 5.5 per cent plus a margin equal to the percentage of real annual growth of the Greek economy, capped at 2.5 per cent and floored at 0 per cent.

Athens would be required to apply a portion of the issuance proceeds to the purchase of zero-coupon 30-year “AAA” -rated bonds issued by one or more sovereigns or European agencies, with the principal and interest from such debt calculated to repay in full the principal amount of the new 30-year bonds.

In the second option, French institutions would invest at least 90 per cent of the proceeds of their maturing Greek bonds in newly-issued five-year Greek government bonds. ARTHUR BEESLEY