Germany softened its position on giving Greece more help by agreeing with France on Friday that private investors would be involved only on a voluntary basis, a move that boosts hopes the debt-ridden country will get another rescue package.
Chancellor Angela Merkel and French President Nicolas Sarkozy announced they had reached common ground on the delicate topic of involving Greece's bondholders, calming fears Germany wanted to see losses forced on private creditors.
Eurozone finance ministers earlier this week failed to reach a deal on a second set of rescue loans necessary to save Greece from defaulting on its massive debts amid divisions over the role of banks.
Merkel told reporters that Germany had agreed that "participation of the private creditors, on a voluntary basis, and I stress that," was needed in order to swiftly secure a new rescue package for Greece and ensure the stability of the common currency.
In recent weeks, Merkel had backed her finance minister's calls for banks and other private bondholders to give Greece an extra seven years to repay its bonds. Rating agencies as well as the European Central Bank, however, warned that such a moved would likely count as a "credit event," a partial default by Greece that could spread panic on financial markets and hurt Greek banks.
After the meeting, Merkel indicated she now favored a so-called "Vienna-style" agreement, which had previously received support from the ECB and France.
Under such a deal, banks and other private investors would commit to maintaining their exposure to Greece by buying new bonds as old ones expire and keeping their Greek banking subsidiaries afloat. That type of bond roll-over would likely have to come with some tweaks, as market interest rates on Greek bonds are currently way above what the Greek state could afford.
"It is about a voluntary participation of the private sector, and for that the 'Vienna-style,' as it is called, is a good basis and I think that we can use it to move forward," Merkel told reporters.
Sarkozy said "relatively precise principles" for the private-sector involvement would now have to be fixed, adding that "this can be put into place relatively quickly."
Merkel also ruled out the idea of triggering anything that could be counted as a default. "We do not want that," she stressed. "This is about a voluntary participation."
J.P. Morgan wrote in a research note that "Germany appears to have backed down" and welcomed the move as the clearing of a key obstacle to a solution for Greece.
Joerg Kraemer, chief economist at Commerzbank, dismissed the Vienna-style option, saying that asking creditors to renew their holdings with fresh bonds at the lower, pre-crisis interest rate would lead to a default rating.
"I think we will have private sector involvement, but only in two years or so when the other peripheral countries have stabilized more and are in a situation where there is no longer a risk of contagion," Kraemer said.
"If you do the Vienna initiative in this way, you cause a default," Kraemer said. "So we do not even expect a Vienna initiative, only a vague appeal to investors to stay invested, nothing more."
European finance ministers meet Sunday and Monday to discuss the crisis.
A decision to extend the maturities of Greek bonds without the creditors' consent or a haircut on the value of the debt would have been an immediate hit to banks, with the biggest fear being that of contagion _ a difficult-to-predict chain reaction that could roil markets and make it harder for other indebted countries to cope with their debts, with the result being higher borrowing costs for eurozone countries.
The European Central Bank has been very hostile to seeing private creditors sharing a part of the burden for fear it would be considered a credit event that would erode trust in the 17-nation currency.
Merkel therefore stressed that any solution must be found in accordance with the ECB.
"This should be worked out with the European Central Bank. There may be no contradictions here," she said.
The EU's top financial official, Olli Rehn, indicated Thursday that Greece will likely get its next financial lifeline in July if Prime Minister George Papandreou's government can pass new budget cuts and privatizations before the end of the month. The next euro12 billion ($17 billion) injection would keep the country afloat until September.
In Athens, Papandreou replaced his finance minister Friday as part of a broad reshuffle in an effort to calm criticism and meet the requirements to get the fresh aid injection.
The Franco-German announcement on private creditors was reminiscent of a similar bilateral deal last fall, when the two leaders set out the cornerstones of new pan-European fiscal rules and a permanent bailout mechanism.
"I believe that this meeting ... again shows the power of the Franco-German couple," Sarkozy said.
Gabriele Steinhauser in Brussels and David McHugh in Frankfurt contributed to this report.