Greece yesterday rejected a German plan for it to surrender control of its tax and spending policies to a powerful European Commission official in return for a €130bn (£109bn) bailout.
The row between Greece and Germany put a question mark over the EU and International Monetary Fund plan to rescue the ailing Greek economy. However, hopes are rising that Athens will reach a deal with its private creditors to prevent a disorderly default on its massive debts, which could plunge the global economy into crisis.
Under the agreement, €206bn worth of Greek bonds owned by investors would be exchanged for new bonds worth 60 per cent less. An agreement could be announced today when EU leaders meet in Brussels to agree on a "fiscal compact" aimed at saving the euro by enforcing budgetary discipline.
Germany's demand for a "budget commissioner" to take unprecedented control over the economic policy of a member state reflected the EU's impatience with Greece's failure to resolve its debt crisis. But it provoked a backlash in Greece and failed to win the backing of the European Commission.
Anna Diamantopoulo, the Greek Education Minister, called the German plan "the product of a sick imagination". Pantelis Kapsis, a Greek government spokesman, insisted there was no need for such controls. "It's a matter of national sovereignty," he said.
At today's meeting of European leaders in Brussels, David Cameron's historic veto last month of a new EU-wide treaty to rescue the euro is in danger of unravelling. Some of the moves the Prime Minister claimed he had stopped look set to go ahead – such as allowing the 25 or 26 nations who form the "fiscal compact" to use EU bodies including the Commission and the European Court of Justice.
A draft summit agreement says the compact should be incorporated "as soon as possible" into the EU-wide treaties, to which Britain is a signatory – overturning the Cameron veto. Another option is for this to happen within five years.
EU sources said yesterday that Britain would face pressure to allow the move within two years. Nick Clegg, the Deputy Prime Minister, who was furious about Mr Cameron's veto, hopes the compact can be included in the treaties before the next general election. Mr Clegg is sending a "minder", a foreign affairs official from his office, to today's summit so he can be kept abreast of Mr Cameron's moves.
The Liberal Democrats are pleased Mr Cameron has dropped his ban on the compact signatories using EU bodies and hope the Prime Minister will build bridges at the summit.
But they expressed concern after Iain Duncan Smith, the Work and Pensions Secretary and a leading Eurosceptic, said yesterday: "The fact is that the Prime Minister vetoed them [other EU countries] using the institutions because we had no guarantees that what they were proposing would not damage the single market or ... cause problems in the financial sector."