Negotiating in eurozone hell

Although global markets staged a rally overnight on fresh hopes of Chinese stimulus, many observers are wary of the growing fractures that are emerging in Europe.

Berlin's austerity plans will come under brutal attack tomorrow night, with French president Franois Hollande due to outline his growth initiatives, including a plan to introduce eurobonds, at a summit of European leaders in Brussels.

Hollande wants to reduce borrowing costs for debt-laden countries such as Spain and Italy by allowing them to issue eurobonds that would enjoy a guarantee provided by all eurozone countries. His eurobond proposal is expected to be backed by Italian prime minister Mario Monti and British prime minister David Cameron.

Hollande's plan represents a direct challenge to German chancellor, Angela Merkel, who has fiercely resisted the idea of eurobonds because she fears that countries such as Spain and Italy will relax their efforts to cut their budget deficits if they are able to borrow at lower interest rates. She is also worried that Germany's own borrowing costs could rise sharply if the country is forced to guarantee the debts of heavily indebted countries.

Merkel's own plans for rescuing the eurozone revolve around countries making stringent spending cuts to reduce their budget deficits. This puts her at odds with Hollande who wants to put more emphasis on boosting economic activity in the eurozone. Hollande, who is seen as the hero of the southern eurozone countries which have seen their economies plunge into recession as a consequence of savage spending cuts, is also expected to outline a proposal to allow the European Central Bank to lend directly to debt-strapped governments. Again, this idea is anathema to Berlin.

Meanwhile, Greece's rising political star, Alexis Tsipras, has embarked on his own tour of European capitals, in order to explain why his country is rebelling against the "barbarous” austerity plan that Athens agreed to in exchange for its latest €130 billion ($US166.5 billion) bailout.

Government officials in Paris and Berlin have declined to hold meetings with Tsipras, whose radical left Syriza party surged into second position in Greece's election earlier this month, and who is expected to emerge as the winner in fresh elections to be held next month. Instead, Tsipras has scheduled meetings with Jean-Luc Mlenchon from the Left Front in France, and with officials from the left-wing Die Linke party in Germany.

At a press conference in Paris overnight, Tsipras said there was no point in renegotiating the austerity plan, because "one doesn't negotiate with hell”. Instead, he said, fresh discussions were needed on Greece's debt.

But Europe's patience with Athens is wearing thin. According to the German publication der Spiegel, eurozone finance ministers turned on the Greek representative, Filippos Sachinidis at a meeting in Brussels just over a week ago. The head of the eurogroup, Jean-Claude Juncker told Sachinidis that if they were to hold a secret vote on whether Greece should remain in the eurozone, "there would be an overwhelming majority against it”.

Juncker added that new elections on June 17 would be Greece's last chance. If the country was unable to come up with a government capable of implementing the austerity measures that Greece agreed to in exchange for receiving financial aid, "then it is over".

At the same time, the European Central Bank is becoming increasingly worried about the increasing risks it faces as it struggles to keep Greece's banking system afloat, even though Greece's deposits are evaporating, and a desperately needed recapitalisation of Greece's banks has been delayed.

Most Greek banks are now unable to borrow from the ECB because they don't have enough collateral to use as security for their loans. Instead, they rely on emergency loans from the Greek central bank, which has relaxed the standards on the collateral it will accept in exchange for loans.

According to der Spiegel, at its last meeting, the ECB's governing council gave it permission for Greece's central bank to increase the amount of money it lent to the country's banks from around €90 billion up to €100 billion.

But the ECB is deeply worried that its risks are rising. Greece's latest bailout package set aside €50 billion to recapitalise Greece's financial sector, and half of this money has already been transferred to Athens.

The money is crucial, because the recent restructuring of Greece's debts put a €24 billion hole in the balance sheets of the country's four largest banks.

As part of the restructuring plan, Greece's banks were supposed to raise fresh equity from private investors, or face nationalisation. With investors reluctant to inject fresh funding, and in light of the political instability, the issue has been shelved. This means that the urgent recapitalisation of two struggling Greek banks – which was to have been finalised by the end of month – has been delayed.

The head of Belgium's central bank, Luc Coene, has publicly signalled his dissatisfaction, warning that emergency loans from the Greek central bank must "absolutely” be stopped if Greek banks are bankrupt, rather than merely short of liquidity.