ANALYSIS:TENSION ESCALATES by the day. As rumour and speculation swirl about the fate of Greece, its besieged government and international sponsors are struggling to hold back talk of a crippling sovereign default.

For all the denials that anything of the sort is in prospect, the outlook for the country and its place in the euro zone seems increasingly uncertain. This raises alarming questions as to whether Europe’s leaders can prevent an agonising national tragedy from morphing into catastrophe for the single currency.

The stakes are that high. This helps explain the turmoil in markets and pressure on Europe from the global community to step up the political response to the crisis and expand the euro zone bailout fund. It hasn’t happened yet, however.

Hand-in-hand with all of this comes an unstinting push from the IMF and other bodies for new bank recapitalisations in Europe, something that points to an implicit realisation that the prospect of Greece avoiding some form of default is fading fast.

Sources in the official world say as much in private conversation, but political real time moves at a much slower pace.

Still, the clamour for an alternative solution from the junior coalition party in the German government speaks volumes about current debate in Berlin. Chancellor Angela Merkel continues to rule out default, but the sense of drift is palpable.

In an interview published yesterday, Dutch central bank chief and European Central Bank governing council member Klaas Knot stuck his neck right out and said default could no longer be ruled out. “It is one of the scenarios,” he said, according to Dutch daily Het Financieele Dagblad.

“All efforts are aimed at preventing this, but I am now less certain in excluding a bankruptcy than I was a few months ago.”

This was no small thing to say, given the ECB’s dogged resistance to default and its fear of the contagion that might ensue.

In Athens, meanwhile, the government spent the day trying to play down reports that finance minister Evangelos Venizelos had told MPs an “orderly” default was one option under discussion.

No matter that Venizelos dismissed such talk as an unhelpful distraction. The force of the political and fiscal pressure on the Greek government is so great that it is no longer possible to dismiss the risk of default.

As a result, it is not possible to rule out the threat of contagion bearing down on Italy, Spain and supposedly secure countries like France and Belgium. In such a pernicious cycle, the threat to Ireland’s difficult recovery effort would indeed be grave.

Hanging over this scene is the creeping sense that the Greek rescue plan is simply not viable.

The immediate danger here is that Greek premier George Papandreou may lose the battle to keep his government’s majority intact, triggering an election in which voters refuse to back the austerity drive.

When Germany pressed for private creditor involvement in the second Greek bailout during the summer, the convoluted deal that emerged was predicated on a 21 per cent “haircut” for investors.

That was sufficient to protect the French banks, who are heavily exposed to Greece, but it failed to convince the doubters that the country’s debt was being brought down to a sustainable level.

All of this amplifies the sense of uncertainty and woe.

The haircut would have been increased long ago if the problem was that simple, but it is not. In this crisis, the domino effect is everywhere. The greater the losses borne by the banks that hold Greek debt, the greater their need for fresh capital and the greater the requirement for public aid from distressed exchequers.

Nor would it stop there. If Greece did capitulate, it seems clear enough the precedent would weigh heavily on other weakened countries, with dire consequences.

In Europe there is no end of anger and frustration with Greece over its foot-dragging and its failure to implement promised reforms. But that won’t solve anything. As the country slips deeper and deeper into the mire, time is running out rapidly.

Default scenario Irish bank exposure to Greek debt minimal

THE ONLY Irish bank with an exposure to Greek sovereign debt is Allied Irish Banks, which has €41 million of the country’s bonds – so the direct effect of a Greek default on Irish lenders would be minimal.

AIB, which is 99.8 per cent publicly owned following a €20.7 billion injection of public funds, has the biggest exposure of the Irish banks to the most indebted euro zone countries.

The bank has €816 million of Italian government bonds, €335 million of Spanish debt and €243 million of Portuguese state bonds.

Irish government debt is the biggest sovereign exposure for the Irish banks. Bank of Ireland has €5.57 billion of Irish government bonds on its books, followed by AIB with €5 billion and Irish Life Permanent with €1.85 billion.

The State’s sovereign wealth fund, the National Pension Reserve Fund, holds no Greek sovereign debt.

The fund had €46 million worth of Italian government bonds at the end of 2010, €3 million of Spanish government debt and €327,000 of Portuguese state bonds, according to its annual report for 2010.

The fund had shares in 35 Greek public companies at the end of last year which were valued at €14.3 million at that time, and €19.4 million worth of stock in Portuguese companies. SIMON CARSWELL