Euro zone summit aims to keep Greece in single currency

A draft statement seen by Reuters said Greece must pass laws to change its value added tax and pension systems, reform bankruptcy rules and strengthen the independence of its statistics office before bailout talks can even start.

"The Eurogroup... came to the conclusion that there is not yet the basis to start the negotiations on a new programme," the draft said.

"Only subsequent to legal implementation of the above mentioned measures can negotiations on the memorandum of understanding commence, subject to national procedures having been completed," it said, in a reference to authorisation by national parliaments in countries such as Germany.

The draft said Greece needed 7 billion euros by July 20, when it must make a crucial bond redemption to the European Central Bank, and a total of 12 billion euros by mid-August when another ECB payment falls due.

It did not say how those needs would be met. A source said the statement would be handed over to the euro zone leaders and might not be issued before they meet.

Several hardline countries voiced support for a German government paper that recommended Greece take a five-year "time-out" from the euro zone unless it accepted and implemented swiftly much tougher conditions, notably by locking state assets to be privatised in an independent trust to pay down debt.

Argument became so heated that Eurogroup chairman Jeroen Dijsselbloem decided to adjourn at midnight and resume talks at 11 a.m. to allow tempers to cool.

"The main obstacle to moving forward is a lack of trust," Italian Economy Minister Pier Carlo Padoan told reporters.

The ministers agreed in principle to seek ways to ease Greece's debt burden by extending loan maturities and other steps stopping short of a "haircut" or writedown, provided Athens first implements reforms.

GREEKS SEE HUMILIATION

European Commission Vice-President Valdis Dombrovskis, who is in charge of the euro in the EU executive, doused Greek hopes of an immediate agreement on Sunday to start loan negotiations.

"It's utterly unlikely the European Commission will get a mandate to start formal negotiations as regards a third programme or ESM programme today," he said, referring to the European Stability Mechanism bailout fund.

Greece's new finance minister, Euclid Tsakalotos, was silent in public but the reaction among some lawmakers in Tsipras' radical leftist Syriza party, still smarting from having to swallow austerity measures they had opposed, was furious.

"What is at play here is an attempt to humiliate Greece and Greeks, or to overthrow the Tsipras government," Dimitrios Papadimoulis, a Syriza member of the European Parliament, told Mega TV.

With banks shuttered for two weeks, cash withdrawals rationed and the economy on the edge of an abyss, some Greeks in the streets of Athens vented their anger on German Chancellor Angela Merkel and Finance Minister Wolfgang Schaeuble.

"The only thing that I care about is not being humiliated by Schaeuble and the rest of theme" said Panagiotis Trikokglou, a 44-year-old private sector worker.

Greece has already had two bailouts worth 240 billion euros from euro zone countries and the International Monetary Fund, but its economy has shrunk by a quarter since the crisis began, unemployment has soared above 25 percent and one in two young people is out of work.

Athens defaulted on an IMF loan repayment last month and faces state bankruptcy if it cannot make the bond redemption on July 20, which would likely force the ECB to cut emergency funding for Greek banks.

German sources said Schaeuble, Merkel and Social Democratic Vice Chancellor Sigmar Gabriel had agreed on a division of labour to force Greece to accept tougher conditions or leave the currency area temporarily.

However economists said the idea of a temporary exit was likely to mean ejecting Athens from the European monetary union in the end.

Paul De Grauwe, a Belgian economist at the London School of Economics, compared it to a couple having a trial separation.

"Temporary Grexit is like temporary divorce. Most if not all end up being permanent," he said in a Twitter message.

Holger Schmieding, chief economist of Berenberg Bank, was even more categorical, saying: "Temporary Grexit is Grexit."

Analyst Nicolaus Heinen of Deutsche Bank told Reuters that billions of euros withdrawn by Greeks before capital controls were imposed would crowd out any new currency in a cash economy similar to Cuba or Lebanon, where the dollar is king.

There would be political conflict over a date for Athens' return to the euro zone, and "tension between Greece and the rest of Europe would be bound to grow if Greece was sent to stand outside the classroom like a naughty schoolboy," Heinen said.

Merkel is under mounting pressure from her own conservatives not to give any more money to Greece, but she has so far said she wants to hold the euro zone together, and that will require a third programme for Athens.

She requires the assent of the German parliament to agree to the opening of loan negotiations, so diplomats expect her to commit to calling a special session of the Bundstag to give her that mandate if Greece enacts prior reforms this week

The United States has added its voice to calls for a deal this weekend, concerned at the geopolitical consequences if Greece were to be cut loose and become a failed state in the fragile southern Balkans, adjoining the Middle East.

"No one wants to see a North Korea in southeastern Europe," a European Commission official said.