The International Monetary Fund's threat to pull out of bailouts for Greece unless European partners grant Athens massive debt relief poses a stark challenge to Germany, the biggest creditor, which insists on IMF involvement in any future rescue.
The global lender has made itself unpopular with both sides in the Greek debt saga by playing its role as a teller of inconvenient truths without excessive diplomacy.
Its latest intervention, saying in essence that Greece will never be able to repay its debt mountain, is bound to sharpen debate when the German parliament meets on Friday to decide whether to authorise negotiations on a third bailout for Greece since 2010 that could cost an extra 85 billion euros.
It sharpens an unadmitted rift between Chancellor Angela Merkel, who wants to hold the euro zone together, and Finance Minister Wolfgang Schaeuble, who thinks Greece needs to leave the currency area, at least temporarily.
Merkel can count on a big majority in favour of opening loan talks with Athens due to her grand coalition's near monopoly of seats, although she may face an embarrassing revolt among her own conservatives.
But the IMF's debt sustainability analysis may force her within months to choose between two far more unpalatable options: grant massive debt relief or see the IMF walk away.
The report's conclusion that Greece needs debt relief “on a scale that would need to go well beyond what has been under consideration to date” makes it harder for her to argue that Germany will ever get much of its 57 billion euro exposure back.
The IMF released its findings late on Tuesday after Reuters had reported exclusively the study showing Greek debt rising to 200 percent of economic output in the next two years and staying at “highly unsustainable” levels for decades.
To avoid big writedowns – “deep upfront haircuts” in IMF-speak – Greece would have to be given either a 30-year grace period before it starts servicing or repaying all European loans, present and future, or large fiscal transfers by the eurozone.
The European Commission issued its own, less stark forecast on Wednesday, which said the Greek debt-to-GDP ratio would be 165 percent in 2020 and 150 percent in 2022 if Athens made reforms.
It accepted that Greece needs “a very substantial re-profiling, such as a long extension of maturities of existing and new loans, interest deferral and financing at AAA rates”, but gave no figures.
Commission Vice-President Valdis Dombrovskis, presenting the EU executive's study, said what mattered was not the size of the debt stock but the annual debt service cost, which is already lower in Greece than in most euro zone countries because of an existing 10-year holiday on most interest payments.
No ‘classic haircut’
Germany is by no means alone in opposing any outright write-off of Greek debt to European governments. Countries like Spain, Portugal and Ireland that went through their own programmes successfully and paid towards Greece's bailout do not want to take any loss.
Slovakia and the Baltic states, which carried out wrenching fiscal adjustments, are just as tough, as are the Netherlands and Finland under pressure from anti-bailout Eurosceptics.
Merkel has stated publicly that there cannot be a “classic haircut” because that would be illegal under the EU treaty.
By adding the adjective “classic”, she may have been preparing Germans for a gradual acceptance of the inevitable – the money won't be coming home in her lifetime or theirs.
True to her “step by step” mantra, after Monday's last-ditch agreement with Greece in Brussels, the chancellor played down the eurozone's pledge to look at lengthening loan maturities, already extended to 30 years on most European loans.
The statement merely repeated a 2012 commitment by Eurogroup finance ministers, she said, and would be considered only once Greece passed a first quarterly review by bailout monitors of its compliance with a new programme.
Her easiest course would be to salami-slice the issue, giving a little loan extension at a time in return for strict conditionality, so no one in Germany could spot the moment when a “Schuldenschnitt” (debt cut) actually happened.
But the IMF is signalling that more drastic debt relief is needed, and Merkel is desperate to keep the Fund involved, both to retain parliamentary confidence in the programme and because she doesn't trust the Commission to be tough enough on Greece.
Enter Schaeuble with a much simpler-sounding solution: Greece takes “time-out” from the eurozone for, say, five years initially; its debt to eurozone countries gets a real haircut, which by now looks likely to be a short-back-and-sides; and a healthier Greek economy returns eventually to the currency area.
EU officials say that would be illegal. Many economists say it would be impractical, not least because the billions of euros in cash stashed under Greek mattresses would drive out any new currency.
The finance ministry plan which Schaeuble said on Tuesday that several cabinet ministers in Berlin still saw as the best solution for Greece shows he is seriously thinking about the need to write off large amounts of Greek debt.
Stepping back from an earlier comment that a debt reprofiling must not lower the net present value of the European loans, Schaeuble's spokesman said on Wednesday that the value should not be reduced by too much, otherwise it would be a haircut via the backdoor. Each day the goalposts shift a little.
Merkel's strategy, which debt-restructuring lawyers often call “extend and pretend”, seems likely to prevail for now.
But if problems continue to pile up for the Greek economy and Athens falls behind in implementing the tough conditions just to start the new loan negotiations, the IMF's insistence on debt relief will grow more compelling.