Europe scrambles to avoid Greek default, but S&P downgrades

European finance ministers are expected to announce a further extension of the IMF/EU loan arrangements to Greece as it seeks to avoid a restructuring on the money markets.

The European Central Bank (ECB) and European Commission are privately briefing that they see a debt restructuring as a 'must avoid' event. However, Standard & Poor's last night cut its rating on Greek debt by a further two notches. It reflects growing market certainty bondholders will ultimately be called upon to share the pain as Athens' fiscal consolidation plans become ever more delayed and compromised.

The agency said it saw a further bail-out as a trigger for a debt restructuring in order to appease public opinion in Germany. 'Such private sector burden sharing would likely constitute a distressed exchange...for which we assign a rating of selective default'.

Such sentiment was reflected today by Erkki Tuomioja - a senior member of the Finnish Social Democratic Party - which has become a significant threat to further bail-outs with the threat of a veto. He said: 'My personal view is that if Greece applies for any additional benefits, it's time for restructuring their sovereign debt.'

Despite keenness to avoid a default European policymarkers are insisting on fresh evidence Athens can make its fiscal cuts and privatisation program stick.  This morning Ewald Nowotny a member of the ECB governing council became the latest figure to seek to put pressure on the struggling Greek government.

'The first step has to be on Greece's side. Only when we have a clear view here can we consider whether the existing programme must be rounded out, but that is something one can judge only in the weeks ahead,' Nowothy said.

However, he acknowledged it now looks unlikely Greece will be able to return to public markets next year to raise the needed €25 billion to €30 billion. 'It was assumed this could be financed on the markets next year. Now there are strong indications that this cannot happen in this form,' the economist argued. 

So far, the mood music from Berlin has been less dramatic with figures close to chancellor Angela Merkel suggesting that while evidence of progress is needed this could be in the form of public commitments that on the face of it the Greek government could easily make.

The key risk of a debt restructuring in the eyes of the ECB remains the impact on the Greek banking sector according to Nowotny. JP Morgan has estimated that Greek banks would lose some €25 billion in the event of a 50% haircut.

Nowotny said: 'This is something that is ruled out by the EU, the ECB and also in the interests of Greece. You have to be aware that this would immediately have massive consequences for the Greek banking system and for the banking system overall. That would only heighten the crisis.'

The yield of Greek debt has continued to rise precipitously in recent days. It now costs the Greek government 22% to borrow money for two years.