Luxembourg warns Germany a Grexit would be catastrophic

By Paul Carrel

BERLIN (Reuters) - Luxembourg warned Germany on Sunday of a "catastrophe for Europe" if it pushed for Greece to leave the euro zone as the idea of a temporary exit gained traction with some of Chancellor Angela Merkel's conservatives.

Luxembourg Foreign Minister Jean Asselborn's comments came after Germany argued that Greece could take a five-year "time-out" from the euro zone and have some of its debts written off if Athens fails to improve proposals it has made for a bailout.

"It would be fatal for Germany's reputation in the EU and the world if Berlin does not now seize the chance that there now is with the Greek reform offers," Asselborn told Germany's Sueddeutsche Zeitung newspaper.

"If Germany pushes for a Grexit, it will provoke a profound conflict with France. That would be a catastrophe for Europe," he added in an advance release of an interview to run in the Sueddeutsche's Monday edition.

In a paper reviewing an offer of reforms from the Greek government in return for a three-year loan, German Finance Ministry officials wrote: "We need a better sustainable solution."

TEMPORARY EXIT?

The paper, seen by Reuters and first reported by Germany's Frankfurter Allgemeine Sonntagszeitung, offered "two avenues": either tighter conditions binding the Greek government to its new promises or a temporary exit from the euro.

The temporary exit idea resonated with Hans-Peter Friedrich, deputy parliamentary floor leader for Merkel's conservatives and a member of her Bavarian allies, the Christian Social Union (CSU).

"What is necessary is to restructure and strengthen the Greek economy in its own currency," Friedrich told German daily Die Welt.

Friedrich's comments highlight Merkel's dilemma.

The chancellor is trapped between fierce domestic opposition to going soft on Athens, and intense international pressure to grant Greece debt restructuring if it delivers convincing reforms in a deal to keep the country in the euro zone.

Merkel is due to take part in a euro zone summit on Sunday.

"Germany's responsibility is enormous," Asselborn said. "Now this is about not evoking the ghosts of the past."

German private sector economists told Reuters a temporary euro exit for Greece would be a bad idea.

Deutsche Bank's Nicolas Heinen said that under such a scenario euro cash circulating in Greece would still dominate in a dual currency system.

"A chaotic cash economy like in Cuba or Lebanon would further weaken the attractiveness of Greece," Heinen added.

Berenberg bank economist Holger Schmieding said a temporary euro zone exit for Greece would effectively be a 'Grexit' as Athens would have to qualify again to rejoin the currency union and likely face an extremely stern examination in doing so.

"In practice, it is really Grexit -- with the chance in five years to apply for admission again," Schmieding said of the Finance Ministry's temporary exit idea.

(Additional reporting by Rene Wagner; Editing by Ralph Boulton)