BRUSSELS/DUBLIN Ireland is in talks to receive emergency funding from the European Union and is likely to become the second euro zone country after Greece to obtain an international rescue, official sources said on Friday.
Irish borrowing costs have shot to record highs this week because of concern about the country's ability to reduce a public debt burden swollen by bank bailouts, and worries that private bond holders could be forced to shoulder part of the costs of any bailout by taking "haircuts" on their holdings.
Government officials in Dublin have denied repeatedly that they plan to tap EU funds, and an Irish finance ministry spokesman said after the Reuters story was published that there were "no talks on an application for emergency funding from the European Union.
Euro zone sources told Reuters that aid discussions were under way, however. One official said it was "very likely" that Ireland would get financial assistance from the EU facility set up after Greece obtained a 110 billion euro bailout in May.
"Talks are ongoing and European Financial Stability Facility (EFSF) money will be used; there will be no haircuts or restructuring or anything of the kind," one euro zone source said. A second source confirmed the talks.
Under the EFSF, the 16 states in the euro zone can provide up to 440 billion euros in emergency loans to crisis-hit members. The EU's rescue mechanism also allows for the provision of 60 billion euros (50 billion pounds) from all 27 EU members and 250 billion euros or more from the International Monetary Fund.
The sources did not specify how large any bailout of Ireland might be but analysts polled by Reuters on Thursday estimated it could be around 48 billion euros, less than half the sum pledged to Greece.
Irish bond yields fell slightly after the Reuters report but the euro barely moved. Analysts said market reaction was modest because of uncertainty over whether Ireland would get a bailout, and since an infusion of funds would not by itself solve the country's long-term problems.
"It may put to rest some of the immediate concerns. Longer-term, the question of whether Ireland in the end will have to restructure some of its debt won't go away. Secondly, the focus may shift to other potential bailout candidates, in particular Portugal," said Sarah Hewin, senior economist at Standard Chartered Bank.
Philip Poole, global head of macroeconomic and investment strategy at HSBC Global Asset Management, said a quick bailout would be taken very positively by markets, but the experience of the Greek bailout suggested that agreement on the conditions attached to emergency loans could take a long time.
Pressure on Irish bonds eased earlier on Friday after France, Germany, Italy, Spain and Britain, seeking to calm the markets, issued a statement confirming that holders of existing euro debt would not take a hit if the EU proceeded with plans to introduce a mechanism letting countries restructure their debt.
The spread between the Irish 10-year bond yield and the German benchmark, which rocketed to a high of nearly 7 percentage points on Thursday, narrowed to around 5.8 percentage points on Friday.
But borrowing costs for Ireland remain sky-high and pressure on Ireland's fragile banks may have forced the government to enter aid discussions, even though it is fully funded until mid-2011 and does not face the same liquidity crisis that confronted Greece earlier this year.
The EU, in turn, may be keen to calm investors with an Irish bailout to prevent contagion to other indebted countries such as Portugal and Spain.
Going to the EU for aid would represent a humiliating setback for Ireland, which posted some of the best growth rates in the euro zone during the bloc's first decade of existence.
The global financial crisis, weak regulation of the banking sector and a property bubble fuelled by rock-bottom interest rates eventually caught up with Ireland. This year its budget deficit is projected to total 32 percent of gross domestic product, by far the highest in Europe.
Jean-Claude Juncker, chairman of the group of euro zone finance ministers, said on Friday that the EU was following the situation in Ireland very closely but there was no immediate reason to think Ireland would ask for aid.
Earlier on Friday, Irish Prime Minister Brian Cowen blamed Germany for aggravating Ireland's woes by pushing the idea of asset value reductions for private bondholders in a future rescue mechanism that Berlin wants in place by 2013, when the EFSF facility expires.
"It hasn't been helpful," Cowen said of Germany's plan, speaking to the Irish Independent newspaper, "The consequence that the market has taken from it is to question the commitment to the repayment of debt."
German government sources told Reuters late on Friday that Berlin had largely agreed a plan for the mechanism. Under it, holders of euro zone bonds would have to accept "Collective Action Clauses" from 2013 that would allow a country to reschedule its debts if it suffered a debt crisis.
Such a rescheduling would involve investors holding bonds for longer, or having to accept reduced interest payments, or a "haircut" -- or writedown, the sources said.
Ministries in Berlin do not regard the plan as a final concept, the sources said. Instead, German officials now want to discuss the points that are important to Germany with the European Commission.
Irish Finance Minister Brian Lenihan said on Friday that the country did not need to ask for EU help because it was well funded into June of next year.
"Why apply in those circumstances? It doesn't seem to me to make any sense," he told RTE television. "It would send a signal to the markets that we are not in a position to manage our affairs ourselves."
(Additional reporting by Patricia Zengerle in Seoul, Carmel Crimmins, Jodie Ginsberg and Lorraine Turner in Dublin, and Jeremy Gaunt and Sebastian Tong in London; Writing by Noah Barkin; Editing by Ruth Pitchford and Andrew Torchia)