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UPDATE 3-Greece confounds euro zone, Spain not seen seeking bailout

* Euro zone, IMF hold "robust" debate on next steps onGreece

* Germany, others say Spain does not need financial help * No progress on Greece likely until troika report completed * Permanent, 500 bln euro rescue fund formally inaugurated

(Releads following Eurogroup news conference)

By Robin Emmott and Jan Strupczewski

LUXEMBOURG, Oct 8 (Reuters) - Euro zone finance ministersand the International Monetary Fund held a "thorough and robust"debate on Greece on Monday, but failed to make significantprogress in deciding how best to get the country back on trackwith its bailout programme.

Ministers spent more than two hours discussing an upcomingreport by the European Commission, the European Central Bank andthe IMF - known as the troika - on Greece's debt-reductionprogramme, with divergences emerging inside the eurozone andwith the IMF over how best to proceed, officials said.

While Jean-Claude Juncker, the chairman of the eurozone's 17finance ministers, and IMF Managing Director Christine Lagardeboth said they were pleased with Athens' progress, they saidmore still needed to be done. Further discussion will take placeonce the troika report is published, probably next month.

"It was a thorough and robust debate," one euro zoneofficial said describing in diplomatic terms a meeting thatothers said was at times intense and ultimately inconclusive.

One point of contention was whether to grant Athens up totwo more years to meet its budget and other targets. While theIMF is believed to favour leeway, countries such as theNetherlands and Finland have concerns about offering more time.

"We were happy to learn that substantial progress has beenmade over the last weeks," Juncker told reporters after afive-hour meeting which also discussed Portugal, Spain, Cyprusand issues related to tighter banking supervision in the eurozone.

"We called on the troika and Greece to finalise theirnegotiations and agree on ways to close the fiscal gap for 2013and 2014 as soon as possible," he said, adding that before anymore money could be paid to Greece, it needed to "demonstrateits strong commitment" to its austerity programme.

In March, the troika agreed on 89 "prior actions" thatGreece must take to get its budget deficit down and overhaul itseconomy. Most have already been achieved, but Juncker saidAthens now had only until Oct. 18 to complete the task.

"We will of course continue to monitor the situation closelyand are ready to reconvene once the review process by the Troikahas been completed," he said.

Lagarde also struck a positive note, saying Greece hadclearly stepped up its efforts, but she said further applicationwas needed if the country was going to bring its debt down fromaround 170 percent of GDP to a manageable level.

"More needs to be done on all fronts - fiscal, structuralreforms, financing, debt - clearly we will be working on thatthat," she said, adding that the discussion would continue at aG7 and IMF annual meeting in Tokyo later this week.

NO BAILOUT FOR SPAIN

While Greece, the country where the eurozone debt crisisbegan nearly three years ago, remains the most complicatedpuzzle to unlock and perhaps the greatest source of contagionrisk for the region, Spain is a deepening problem.

The eurozone has already set aside 100 billion euros forSpain to recapitalise its banks, only around 40 billion of whichis expected to be used in the coming weeks, but there are alsoexpectations in financial markets that Madrid will also have torequest a government bailout in the coming weeks or months.

German Finance Minister Wolfgang Schaeuble said as hearrived for the meeting that Spain was not asking for help anddid not need it, a message reiterated by other ministers. ButPrime Minister Mariano Rajoy has said he may have to requesthelp if Spanish borrowing costs remain too high for too long.

Spanish 10-year bond yields are currently at around 5.75percent, a level that is sustainable for the government. But aborrowing cost substantially above 6 percent for an extendedperiod of time could force Rajoy's hand.

"I think we should deal with such a request when it comes,but so far the Spanish government is undertaking reforms whichgo in the right direction," Luxembourg Finance Minister LucFrieden said as he arrived at the meeting.

Juncker said there had been no discussion about Spainneeding a sovereign bailout on top of its banks.

As well as Spain's broad financial needs, Monday's meetingtouched on the budget goals presented by Rajoy's government lastmonth, which the European Commission has yet to endorse.

The Commission will publish its twice-yearly economicforecasts on Nov. 7 and some officials have said it may concludeSpain can't meet its budget targets, which are based on theeconomy contracting by an optimistic 0.5 percent next year.

The IMF forecast of a 1.2 percent recession may be revisedfurther downwards on Tuesday.

With the euro zone countries involved in a lengthy processof trying to define how best to overhaul the monetary union thatbinds them, meetings of finance ministers increasingly involvebroad discussions rather than specific decision-taking.

However, the one firm action taken on Monday was theunveiling of the European Stability Mechanism (ESM), a 500billion euro rescue mechanism for the 17 euro zone countries.

The ESM, which replaces the temporary EFSF, will be used tolend to distressed euro zone sovereigns in return for strictfiscal and structural reforms that aim to put economies thathave lost investor trust back on track.

"The start of the ESM marks a historic milestone in shapingthe future of the European monetary union," the fund's chiefexecutive, Klaus Regling, told reporters

"The euro area now is equipped with a permanent andeffective firewall, which of course is a crucial component inour strategy to ensure financial stability in the euro zone."

The fund's lending capacity will be based on 80 billioneuros of paid-in capital and 620 billion of callable capital,against which the ESM will borrow money on the market to lend iton to governments cut off from sustainable market funding.

From Monday it has a capacity of 200 billion euros. It willreach its full capacity gradually by 2014.

(Additional reporting by Eva Kuehnen, Annika Briedthardt, JohnO'Donnell, Leigh Thomas and Luke Baker in Luxembourg, writing byLuke Baker, editing by Paul Taylor)

((jan.strupczewski@thomsonreuters.com)(+32 2 287 68 37)(ReutersMessaging: jan.strupczewski.reuters.com@reuters.net))

Keywords: EUROGROUP/