Europe Wrangles Over Greece

European finance ministers meeting Sunday in Luxembourg moved toward approving a fresh quarterly installment of Greece's €110 billion ($157 billion) bailout loan, but they remained divided over the details of a far harder task—extending Greece a giant new package that would support it for years to come.

Meanwhile, finance ministers and central bankers from the Group of Seven industrialized countries held a conference call late Sunday to discuss the crisis, according to people familiar with the matter. Natalie Wyeth, a spokeswoman for the U.S. Treasury Department, confirmed a G-7 conference call was held but declined to provide any details. A senior euro-zone official said the U.S. urged a fast resolution of the Greek issue.

n Athens, Prime Minister George Papandreou said his country was negotiating a new deal of roughly the same size as the one granted just last year—about another €100 billion—and urged his parliament to back him in a vote of confidence scheduled for Tuesday. The Greek premier, fresh from a cabinet reshuffle meant to lift his political fortunes, will travel to Brussels on Monday for talks with European Union leaders.

Europe thought it had put Greece's troubles to rest last spring with a mammoth bailout that rewrote the contract among the euro's member countries. Now, Greece needs more help, and there's fatigue all around.

Voters in stronger countries—Greece's new creditors—are watching in anger as the costs rise. Greeks are rebelling against their leaders' determination to press the searing budget cuts that are the price of their rescue.

Greece will run out of cash in the middle of next month unless funds earmarked under last year's bailout are released. Unwilling to let that happen, finance ministers are likely to approve disbursement of €8.7 billion; the International Monetary Fund, which is also contributing to the bailout, would likely agree to pay out €3.3 billion in the coming weeks.

Approval of the loan installments should be routine: EU bureaucrats check Greece's progress, and finance ministers sign the check. But nothing is routine about Greece. Amid concern that the country was veering too far off track, the IMF had been hesitant to pay. The EU monitoring mission spent weeks in Athens.

The ministers' meeting stretched past midnight Sunday. In the early hours of Monday morning, they released a statement saying they would decide on the "main parameters" of a new bailout package in July. The statement said the new bailout would include "informal and voluntary" arrangements with creditors that would produce a "substantial reduction" in the amount of new funding necessary—but without casting Greece into default.

European officials, however, have struggled without success for weeks to find a solution that fits those criteria. Rating agencies have made clear that any action that harms creditors—even if dubbed voluntary—is likely to trigger a default.

The statement also said discussions with Greece were continuing over the terms of its compliance with last year's bailout; the completion of those talks "in the coming days"—along with the passage of more budget cuts by the Greek parliament—would "pave the way" for the payment of the next installment.

The meeting will continue on Monday. But agreeing to dole out money approved last year is the easy part. Planning for a future in which Greece needs much more money, for much longer, is another matter.

The big problem ahead is the likely inability of Greece to repay its debts—which have only mounted as the EU and the IMF pile on more loans. Europe doesn't yet have a strategy for dealing with that reality, as shown by Germany's failure to convince others in Europe to begin restructuring Greece's debt.

If the first year of the euro crisis was about fighting a liquidity crisis, the second year is likely to center on how to cope with Greek insolvency—a prospect made more likely by Greek leaders' declining ability to cut an outsize budget deficit in the face of popular frustration.

The great fear among euro-zone governments and at the European Central Bank is that a debt default by Greece could undermine bond markets' trust in other cash-strapped euro members. Ireland and Portugal are already struggling to rebuild investors' confidence, despite rescue loans from the European Union and International Monetary Fund. If panicked investors flee from Spain, a $1.6 trillion economy, the country could prove too big to save.

A new loan package for Greece, as before, will be tied to ever-deeper fiscal cuts by the Greek government. Also as before, it will have as its aim to cover Greece's borrowing needs until it can balance its books and return to bond markets.

That strategy is losing credibility, many economists say. It always relied on Greece's cutting its huge budget deficit so radically that tax revenues far exceed public spending. Only then would Greece be able to bring down its government debt to a sustainable level. (Last year, the Greek government spent a quarter more than it took in.)

"Euro-zone governments are still pretending that they are dealing only with a liquidity problem, and that Greece and Ireland will emerge creditworthy from their programs," says Thomas Mayer, chief economist at Deutsche Bank in Frankfurt.

"But what happens if these countries can't return to the capital markets? If more austerity programs are needed, will voters rebel? The message is missing that a country that can't pay its debts must restructure," Mr. Mayer says.

A country's solvency depends not just on its debt and growth, but also on its politics: Can its government maintain support for painful fiscal measures for long enough to stabilize its debt level? The political mood in Athens has soured noticeably—changing the already knotty calculus of negotiations. European leaders have said both the current quarterly payment and any new bailout are contingent on the Greek parliament's agreeing to fresh budget cuts.

But Mr. Papandreou has faced a revolt inside his ruling Socialist party over those cuts. Last year, many Greeks accepted the tough measures that accompanied the first bailout as a necessary step on the path to reform, and European authorities were able to craft a bailout plan with solid political backing.

That backing is slipping away. A mass protest and strike last week in Athens made plain the public discontent, and weakening support from Mr. Papandreou's party's deputies precipitated the cabinet reshuffle—which sidelined George Papaconstantinou, the finance minister who was seen as the architect of the unpopular austerity measures.

Mr. Papandreou's Socialists hold just a five-seat majority in the 300-member Parliament, and one Socialist deputy has said he will vote against the new package of budget cuts.

The new finance minister, Evangelos Venizelos, is in Luxembourg meeting his counterparts. A Greek government official said Mr. Venizelos would be "pragmatic" on what further measures are possible, and "tell his counterparts to refrain from public criticism of Greece or push for unrealistic targets, because the government in Athens is facing a lot of public anger."

One year into its multiyear fiscal program, Greece is running out of steam. The budget is off target thanks to a tanking economy and persistent tax evasion.

In Germany, politicians have worried for months that Greece will end up defaulting in a couple of years. By then, the European taxpayer would have replaced the bond market as Greece's main creditor, thanks to the loans euro-zone countries are now giving Athens to pay bondholders. German taxpayers would stand to lose the most when Greek debt is written off.

Germany's finance ministry hatched a plan this spring to extend the maturity dates of Greece's bonds, so that international aid to Greece doesn't go straight into the pockets of private investors. A maturity extension would have been a soft kind of default by Greece—and preparation for major debt forgiveness, known as a "haircut," at a later date. The ECB fought the German plan vigorously, arguing that it would spark massive contagion. The central bank made clear that it wouldn't accept Greek debt as collateral in its lending operations—a calamity for Greek banks—if Greece were to default, soft or hard.

Friday, Ms. Merkel dropped Germany's demand to extend the maturity dates, saying a looser gentleman's agreement by banks to maintain their lending to Greece would be "a good foundation" for a new Greek aid package. Her concession eases the way to a deal to continue funding Greece.

The negotiations, said Dutch Finance Minister Jan Kees de Jager, whose country is a key ally of Germany in bailout talks, could be "very difficult."