BERLIN/ATHENS (Reuters) - German Chancellor Angela Merkel may fall short of a majority in her own coalition for a crucial reform of the euro zone rescue fund meant to stop a sovereign debt crisis spreading, in what would be a severe blow to her authority, a test vote showed.
Talk of proposals to leverage up the 440 billion euro ($598.5 billion) bailout fund to multiply Europe's financial firepower lifted global stocks on Tuesday but made it harder for Merkel to unite her fractious center-right coalition.
The Bundestag (lower house) is sure to approve a widening of the scope of the European Financial Stability Facility to aid weak states and banks, agreed by European leaders in July, since the opposition Social Democrats and Greens say they will vote for the measure on Thursday.
But a revolt by Euro skeptical backbenchers hostile to further bailouts in Merkel's conservatives and their liberal Free Democratic coalition partners may leave her without a majority in her own camp.
In an internal vote on Tuesday, 11 deputies from Merkel's CDU/CSU group voted against the motion and two abstained. Coalition sources said they expected between 2 and 5 FDP lawmakers to vote against and up to 6 to abstain.
If more than 19 coalition lawmakers vote against or abstain, Merkel will be dependent on opposition votes in a political humiliation that could weaken her ability to push through future rescues.
European shares surged by 4.3 percent in the biggest one-day percentage gain since May 2010 and safe-haven German bonds fell on reports that policymakers were preparing decisive action to tackle the debt crisis.
The cost of insuring Italian, Spanish and French debt against default also fell on hopes of a bold solution, which appear to have little grounding in immediate political reality.
German Finance Minister Wolfgang Schaeuble was forced to deny that any increase in the volume of the bailout fund is planned in a bid to calm irate center-right lawmakers.
"We do not intend to increase it," Schaeuble told n-tv.
That did not directly address the question of whether the EFSF fund could be leveraged to raise more money to prevent contagion spreading from Greece to Italy and Spain, the euro zone's third and fourth economies.
Leverage would make it possible to borrow more, probably from the European Central Bank, for financial firefighting without increasing the EFSF's size, but critics say it would also raise German taxpayers' liability for any losses.
Some lawmakers are concerned that EU officials are just waiting for them to approve what they were assured would be the final increase before pressing ahead with bigger bailout plans.
French Finance Minister Francois Baroin made clear there were tactical reasons to avoid discussing how to boost the fund's firepower before the German decision.
"It is out of the question to put forward, three days from the Bundestag (lower house) vote, the issue of whether we should increase the fund... Let's not open Pandora's box on something that is a red flag for Germany," he said.
Prime Minister Francois Fillon told parliament France would set out proposals to step up the battle against "speculative attacks" on the euro zone once the German vote was over.
The fund's status was bound to evolve but it was premature to say whether it might work "like an equity fund with a lever effect," Baroin added.
Merkel assured Greek Prime Minister George Papandreou at a meeting on Tuesday evening in Berlin that Germany wants a strong Greece and would do everything necessary for that. She also said she was confident her coalition would have the votes on its own to pass measures boosting the euro zone rescue fund.
Papandreou told Merkel that Greece needed Europe's solidarity. "It is very important to receive a signal of support from our European partners," he said.
Earlier, Papandreou had promised German industrialists that Greece would meet its commitments under its EU/IMF bailout program despite missing key fiscal targets so far.
"I can guarantee that Greece will live up to all its commitments," Papandreou said.
Merkel told the same forum: "We will provide all the help desired from the German side so that Greece regains trust." However, some of her ministers have openly questioned the country's ability to avoid default and stay in the euro zone.
The Greek parliament approved a deeply unpopular new property tax on Tuesday, one of several extra austerity measures the government is rushing through to plug a budget hole uncovered by EU/IMF inspectors earlier this month.
Ordinary Greeks, exasperated by pay and pension cuts, mass unemployment and tax rises, staged new strikes and demonstrations outside parliament on Tuesday. [ID:nL5E7KR0FY]
German and French government economic advisers urged in a joint article on Tuesday that Greece be allowed to write off around 50 percent of its debt and called for support for banks with large Greek holdings. [ID:nL5E7KR0JX]
Greek Finance Minister Evangelos Venizelos, back from talks with the International Monetary Fund, said speculation on default scenarios was harming his country and it was crucial to stick to the July 21 agreement on a second rescue for Greece.
Venizelos said the so-called troika of senior EU/IMF inspectors would return to Athens this week and Greece would receive the next 8 billion euro instalment of aid in time to avoid bankruptcy next month. A source close to the team said they would probably return on Wednesday to complete a review of compliance with the bailout program. [ID:nP7E7II01Z]
Most analysts expect Greece to get the cash but default anyway within a few months, perhaps early next year.
European Central Bank board member Lorenzo Bini Smaghi fueled expectations of a larger bailout pool by saying on Monday that policymakers were working on "how to leverage the money out of the EFSF in a more innovative and efficient way."
Citing U.S. programs to rescue banks during the 2008-9 financial crisis, he said EFSF funds could be used as collateral to borrow from the central bank, making more money available for crisis fighting. His ECB colleague Ewald Nowotny also said an increase in the funds available was being discussed, though it might not be as high as some expected.
But German Bundesbank chief Jens Weidmann, the leading hawk on the ECB's governing council, poured scorn on such options, saying they would discourage politicians from taking tough decisions to cut budget deficits and weaken faith in the euro.
The European Investment Bank, the 27-nation EU's soft-loan project finance arm, denied a U.S. television report that it might get involved in leveraged finance for euro zone bailouts, which diplomats said was legally impossible. [ID:nB5E7KL004]
Credit ratings agency Standard & Poor's was quick to warn when talk of leveraging the EFSF became public last week that such a move could potentially trigger ratings downgrades for leading euro zone countries Germany and France. [ID:nW1E7JU02F]
A senior EU official said many ideas for how to leverage the rescue fund were being floated but it would take time to check the legality of such options and build political consensus in the 17-nation euro zone for any change.
"Nobody wants to talk about this before Thursday night," he said in a reference to the German parliament vote. "It cannot be discussed formally before the Bundestag (lower house) and maybe all other national parliaments have voted."
Slovak lawmakers will be last to vote on the widening of the EFSF's powers on October 11, leaving little time to agree on further measures before the bloc's next summit on October 17-18.
In Bratislava on Tuesday, the junior government party rejected a proposal made by its larger partner aimed at winning joint coalition support in parliament for plans to strengthen the bailout fund.[ID:nL5E7KR2IR]
Additional reporting by Alexandra Hudson, Brian Rohan and Sarah Marsh in Berlin, William James and Ana Nicolaci da Costa in London, Nigel Davies in Madrid, Nicholas Vinocur in Paris; Writing by Paul Taylor; Editing by Janet McBride