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BL: "Europe Failed" Greece Will Default `at Some Point,' Hurt Euro, UBS Economist Donovan Says

By James G. Neuger and Brian Parkin

March 24 (Bloomberg) -- Germany and France, paving the way for a European Union plan to aid Greece, agreed to involve the International Monetary Fund in any potential EU package for the debt-burdened nation, a German Finance Ministry official said.

The shift toward an IMF role before the start of an EU summit tomorrow came a week after finance ministers agreed to a European framework. German Chancellor Angela Merkel, who says her taxpayers shouldn’t pay for the region’s biggest budget deficit, then pushed for IMF involvement. The reversal put her at odds with French President Nicolas Sarkozy, who backed an EU solution. The euro fell to a 10-month low against the dollar.

“It seems like a U-turn but it’s a sensible solution,” said Julian Callow, chief European Economist for Barclays Capital in London. “The IMF brings credibility and transparency and anything that gives investors a degree of comfort is good. The situation has been from the outset that there is no European mechanism in place to deal with a situation like this. This is what the IMF is there for.”

Franck Louvrier, a spokesman for Sarkozy, wasn’t available to comment and didn’t respond to e-mails.

With allies dropping their resistance to IMF involvement, Merkel agreed to sign on to a statement at the Brussels summit March 25-26 to create a mechanism to aid indebted members, including Greece, Die Welt reported yesterday. A government spokesperson denied that Merkel had agreed to an EU plan.

Euro Weakens

The euro dropped to a 10-month low against the dollar and declined to a record against the Swiss franc as news of an IMF role was seen as undermining the credibility of the single currency. The euro slipped as much as 1.1 percent to $1.33354, the lowest since May 2009.

Renewed concern that Greece’s financing woes could spread also hurt the currency. Fitch Ratings cut Portugal’s credit grade today one step to AA-, calling a budget deficit that swelled to 9.3 percent of GDP last year, three times the EU limit, a “sizeable fiscal shock.”

Greek bonds declined after the Fitch announcement, paring gains on news of a possible aid agreement. The yield on the country’s benchmark 10-year note rose 1 basis point to 6.35 percent, after falling to 6.19 percent earlier.

The need to bring in the IMF was a failure for Europe, and Greece would likely eventually default even with aid, UBS Investment Bank deputy head of global economics Paul Donovan told Bloomberg Radio.

Europe ‘Failed’

“The problem that we’ve got here is Europe has failed to clear its first serious hurdle,” he said. “If Europe can’t solve a small problem like this, how on earth is it going to solve the larger problem, which is the euro doesn’t work. It’s a bad idea.”

Greek Prime Minister George Papandreou has been urging EU allies to give details of an aid package to shore up investor confidence and bring down borrowing costs. Greece’s 10-year bonds now yield twice comparable German debt. That financing premium led Papandreou to say on March 19 that Greece, which needs to sell about 10 billion euros ($14 billion) of bonds in coming weeks, is a step away from not being able to borrow and may need to turn to the IMF if European aid isn’t forthcoming.

Merkel set three conditions for supporting EU assistance, another German official said yesterday on condition of anonymity. Aid would be made available only if Greece couldn’t raise funds in financial markets, the IMF makes a substantial contribution and EU sanctions against deficit-limit violators are stiffened.

‘This Mess’

“The euro area’s ability to impose the rules that it already has have been inadequate,” David Mackie, chief European economist at JPMorgan Chase & Co said. “In some sense you have to bring someone in who does a better job of it. The existing rule book has failed otherwise we wouldn’t be in this mess.”

Some European officials have resisted calling in the IMF, saying it undermines the credibility of monetary union and the single currency. European Central Bank Executive Board member Lorenzo Bini Smaghi said in an interview with Germany’s Die Zeit newspaper that IMF involvement would be “detrimental to the stability” of the euro.

“The image of the euro would be that of a currency that is able to survive only with the external support of an international organization where the Europeans are not in a majority and the U.S. and the Asians are increasingly influential,” Bini Smaghi is quoted as saying.

Van Rompuy’s Role

The agreement on the IMF role came as EU President Herman Van Rompuy pushed to bridge the differences an aid to Greece and after Sarkozy called for a meeting of euro-region leaders before the Brussels gathering to take up the issue.

Van Rompuy pursued a similar strategy last month, when he delayed the start of the Feb. 11 summit to broker an accord in principle “to take determined and coordinated action” to safeguard the euro area.

Greek Finance Minister George Papaconstantinou said that he expected “positive” results from the summit and preferred a European solution for any potential aid. “We want to borrow with better rates and believe this will happen with the implementation of the deficit plan,” he said at a conference in Athens yesterday.

Greece is banking on wage cuts and tax increases to shave the deficit to 8.7 percent of gross domestic product this year from 12.7 percent in 2009, the highest in the euro’s 11-year history. Papaconstantinou said that target is reachable even if the economy shrinks as much as 2 percent this year.

To contact the reporter on this story: James Neuger in Brussels at [e-mail]; Brian Parkin in Berlin at [e-mail]

Last Updated: March 24, 2010 07:12 EDT