REUTERS

European leaders will probably ask private investors to shoulder losses of around 50 percent on holdings of Greek government debt, the top end of a range suggested by euro zone officials last week, a Reuters poll of economists showed.

With a European Union summit looming this weekend that could mark a major step towards resolving the euro zone's debt crisis, the survey's respondents gave strong backing for other means of protecting the region.

A majority - 28 of 44 economists - thought the market for Italian government debt, which has come under attack by speculators, could be stabilised through a plan to leverage the euro zone's bailout fund (EFSF) by allowing it to guarantee a portion of newly issued euro zone debt.

With Spain suffering a double-notch downgrade to its credit rating on Wednesday and pressure mounting over France's stretched budgets, G20 leaders have urged bold action from Europe to prevent a new global financial crisis.

“The size of the EFSF cannot be too big, it can only be too small,” said Dawn Holland, senior research fellow at London's National Institute of Economic and Social Research.

In line with the consensus, she said leaders should allow or enforce a 50 percent loss - or “haircut” - on private holdings of Greek debt.

Forcing investors to write off half of their holdings of Greek debt would be significant for two reasons.

Firstly, that would be the high end of a 30 to 50 percent range suggested by euro zone officials last week, and more than double the 21 percent agreed in the July Greek bailout, which now is clearly not enough.

Indeed, six economists thought those losses could be 60 percent or higher. Not one of them thought investors would get away with the 21 percent loss agreed in July.

Secondly, while Greek banks could endure a loss of up to 30 percent on domestic government bonds, banking sources told Reuters that a 50 percent haircut would inflict losses that would necessitate strong support for the economy.

Additional support for Athens may be a forgone conclusion in any case - the poll showed the 109 billion euro ($150 billion) euro zone bailout arranged for Greece in July will likely fall short by a median 50 billion euros.

A separate Bank of America-Merrill Lynch monthly survey of fund managers showed 85 percent expect Greece to default with only 8 percent saying the country would meet its obligations.

THE ITALIAN JOB

Italy has fast become a new target for the euro zone debt crisis.

While its budget deficit, under 5 percent of gross domestic product, is modest compared with several euro zone peers, financial markets have become increasingly alarmed about Italy's dire economic growth prospects, as well as a fractious political situation.

The Italian 10-year government bond yield has risen around 100 basis points since June, and on Wednesday stood at 5.88 percent. Analysts say 7 percent represents a threshold where borrowing costs become unsustainable.

Twenty-eight out of 44 economists said leveraging the EFSF through first loss insurance guarantees would be an effective way of calming the Italian bond market.

But they added that it would have to insure investors against 25 percent of any losses resulting from a potential default of newly issued euro zone debt.

Gernot Griebling, head of bond and economic research at German bank LBBW, said the EFSF insurance plan could stabilise the Italian market - but perhaps only in the short term.

“As it would take pressure from Italy to consolidate its public debt it is likely that the total volume of Italian government would continue to climb instead of shrinking,” he said.

Overall, the poll showed around 150 billion euros in the EFSF would be earmarked for bond insurance, 132 billion for bond purchases, and another 100 billion for bank recapitalisations.

A CAPITAL IDEA

A big majority of economists - 36 out of 39 - said the proposed 9 percent core Tier 1 capital ratio for European banks would be enough.

Last week banking and regulatory sources told Reuters Europe's banks would have to achieve much stronger capital positions under a new quick-fire regulatory health check, with some citing a range of 7-10 percent for the pass mark.

All but one of the 39 said the new threshold should be implemented within a year to be effective, with 23 of them saying it should be within six months.

Several respondents concluded that ultimately, only the full fiscal integration of the euro zone would end the crisis.

While that looks a far stretch for this Sunday's meeting, analysts hope new measures will at least give countries time to see fiscal reforms bear fruit and restore market confidence.

“Europe needs to buy this time,” said Christian Schulz, senior economist at Berenberg Bank.

“In a best case, the measures to be agreed on Oct. 23 (will) suffice to calm markets immediately or are able to fend off any further turmoil arising, for instance from more sovereign and banks ratings downgrades.”

But it is more likely the European Central Bank will need to make even bigger interventions in markets to buy this time, he said. - Reuters