Athens:  Increasing fears that Greece could be forced out of the Eurozone, as it heads for new elections, deepened the debt crisis yesterday dragging down Spain and renewing the dangers of contagion.

European stock markets opened lower after heavy losses in Asia overnight, with Madrid in a surprise bounce — a sign of extreme volatility as the crisis whiplashes investors who want safety above all.

Funds flowed again into German debt instruments, seeking safety from risks over Greece and contagion to Spain, pushing down the German government's borrowing costs to record low levels.

The German government sought to reassure yesterday, saying it had no reason to doubt that Spain can help its banks without aid.

World leaders met US President Barack Obama late Thursday, with Greece top of the agenda at a two-day Camp David summit as the debate rages over the best way forward — whether to go for growth or more austerity.

Greek voters dramatically rejected painful spending cuts in a May 6 poll and are expected to do so again in the June 17 election, raising concerns about the fate of the latest ¤240 billion (Dh1.1 trillion) EU-IMF bailout package.

Room for movement

Many EU leaders insist that there can be no change to the terms of the accord but have also begun to allow some room for movement, especially as new French President Francois Hollande won power this month on a growth pledge.

The Eurozone crisis deepened late on Thursday when Moody's downgraded 16 Spanish banks as figures showed that the country had slid into recession.

European parliament chief Martin Schulz warned that any Greek exit from the Eurozone could see its economy collapse in days, with untold consequences.

"Many people believe that it would be the end of a negative cycle but for me it would be the beginning of an even more negative cycle," Schulz told German radio from Athens where he is due to meet President Carolos Papoulias.

In marked contrast, a former German economic minister and close ally of Chancellor Angela Merkel, said the Eurozone could absorb a Greek euro exit.

"Unlike two years ago, the Eurozone today could cope with a Greek exit," Rainer Bruderle told German business daily Handelsblatt.

"It would cost a lot of money but it would be manageable. The decision, however, lies in Athens and not in Berlin.

In Athens, a caretaker government took office on Thursday after the May 6 vote left Greece in limbo but the June 17 poll offers no guarantee it will produce a viable government able to implement the divisive EU-IMF bailout.

Orderly exit

Since there is no provision for an orderly exit from the 17-nation currency bloc, the prospect is for chaos if Athens cannot stick to the tough terms of the latest bailout deal.

Panagiotis Pikrammenos, the head of Greece's top administrative court and caretaker premier, told his colleagues: "We must not forget that all of Europe is watching us... We must all work to steer the country to a safe harbour.

"The country must honour the obligations it has undertaken. It cannot abrogate its obligations without reason and cause a major crisis," he added.

Spain was hit on Thursday by rumours of a run on deposits at its fourth largest bank, Bankia, and then the dramatic Moody's downgrade added to the problems of a country caught between weak public finances and the need to boost growth to cut soaring unemployment of above 24 per cent.

Spanish shares tumbled at the open but after 90 minutes were in positive territory as Bankia soared nearly 20 per cent despite news that bad loans in the country's banking system hit were at an 18-year high.

German Finance Minister Wolfgang Schaeuble, a consistent hardliner on austerity and on Greece sticking to its bailout terms, said yesterday that "in 12 to 24 months we will see a calming of the financial markets".

The EU and the International Monetary Fund have warned that no new funds will be released from the latest bailout if progress on pledged reforms and tough austerity measures falters.

However European leaders appeared to move on Thursday towards resolving an emerging split over how to deal with the crisis, agreeing in a videoconference that both growth and cutting budget deficits are needed.