G20 finance chiefs and central bank heads from the world's biggest economies meet in Paris on Friday needing to find a solution to a deepening euro zone debt crisis that has fanned fears of a global recession.

Underlining the challenge for European policymakers, Standard and Poor's cut Spain's long-term credit rating, citing the country's high unemployment, tightening credit and high private sector debt.

This meeting takes place in a context where the absolute priority for the success of the G20 is to find the elements for the stability of the euro zone, a source at the French finance ministry said.

French and German officials are battling to flesh out the bones of a crisis resolution plan in time for a European Union summit on October 23.

Fears about the damage a default by Greece -- and possibly others -- could inflict on the financial system have driven a confidence-sapping bout of market volatility since late July, with global stocks falling 17 percent from their 2011 high in May.

With impatience growing over the crisis, and its implications for the rest of the world, finance chiefs from outside the bloc are expected to speak frankly.

This meeting is an important staging point before (a G20 summit in) Cannes and a valuable opportunity to put pressure on the euro zone, said a non-euro zone G20 delegate.

Canadian Finance Minister Jim Flaherty set the tone late on Thursday, telling reporters before leaving Ottawa that euro zone actions were short of what is needed.

Japan would urge its European partners to support the continent's banks, Finance Minister Jun Azumi said.

RISK OF DIVISION

Unlike in 2009 when the G20 launched a coordinated stimulus to pull the world out of crisis, the forum is at risk of division as the rest of the world chafes at Europe's dithering over a debt crisis that started two years ago in Greece, and as Washington and Beijing spar over the yuan currency.

Paris and Berlin are taking time to agree on how to recapitalize banks and while Germany favors a second round of losses for Greek bondholders, Paris is reluctant. The two euro heavyweights also differ on the idea of joint bond issuance for the euro zone, with Germany loath to see its debt costs rise.

The Franco-German crisis plan is likely to ask banks to accept big losses on their Greek debt and should lay out a system for recapitalizing troubled banks, whose shares have been pounded by fears about Greek exposure.

At its core will be an agreement on how to increase the firepower of the EFSF rescue fund, and it should also set out a timeframe for ramping up economic coordination, with closer governance and explicit national laws on balancing budgets.

A key concern has been that, whilst the EFSF has the resources to cope with bailouts for Greece, Portugal and Spain, it would be overwhelmed by the need to rescue a bigger economy such as Italy or Spain.

The latter two countries, the bloc's third and fourth biggest economies respectively, have seen their bond yields pushed up by markets worried at high public and private debt levels and weak growth.

In Spain, some banks are seen as vulnerable after the bursting of a property bubble, and the country is still struggling with labor market reforms.

Despite signs of resilience in economic performance during 2011, we see heightened risks to Spain's growth prospects due to high unemployment, tighter financial conditions, the still high level of private sector debt, and the likely economic slowdown in Spain's main trading partners, S&P said.

The agency's downgrade of the nation's long-term rating to AA- from AA mirrored a similar move last week by rival Fitch.

The G20 may refer to the euro crisis in its communique and in closing news conferences on Saturday evening, but little else of substance is likely to be inked in.

CHINA MAY OFFER GROWTH, NO YUAN SHIFT

This week's talks may give the green light to regulators for new rules on banks deemed 'too big to fail', including capital surcharges, due to be officially approved in Cannes.

Yet any concrete progress on bigger goals such as setting parameters to measure global imbalances and reining in commodity market volatility and speculative capital flows is unlikely to come before a November 3-4 summit in Cannes, where France passes the G20 baton to Mexico.

The finance ministry source said that for Cannes, France hoped to have two or three measures agreed for countries showing imbalances: consolidation measures for those with high deficits and stimulus measures for those with surpluses.

We are going to try to make some progress and obtain, perhaps not tomorrow or Saturday but by Cannes, a list of measures country by country which corresponds to what is needed to relaunch global economic activity, he said. These must be measures which will have an impact on the real economy.

A separate G20 source said after preparatory talks late on Thursday that China would commit in Paris to boost its consumption through a five-year plan, via households and companies as well as infrastructure, as the G20 seeks tough fiscal commitments from the euro zone and the United States.

The G20 countries make up 85 percent of global output.

An April G20 meeting placed seven large economies under review -- the debt-burdened United States, export-rich China, France, Britain, Germany, Japan and India. Officials have said privately the aim was to get Beijing to discuss the yuan, and China's cooperation is essential to the success of the process.

France has dangled the prospect of the yuan entering the basket of currencies making up the IMF's Special Drawing Right (SDR) in a bid to divert the debate away from its value and onto the criteria of free usability required for this.

But the euro zone crisis has derailed French President Nicolas Sarkozy's hopes of using his G20 presidency to launch a fundamental rethink of the global financial system and its reliance on the U.S. dollar.

China and the United States sparred this week over a U.S. Senate bill to press Beijing to raise the yuan's value, and the issue is likely to create a sideshow at the G20 talks, even if the euro zone crisis pushes it off center stage.

(Additional reporting by Randall Palmer, David Milliken, Francesca Landini, Kevin Yao and Abhijit Neogy; Editing by Louise Ireland and Alex Richardson)

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