"We have seen a very substantial improvement if you look at where we were in November and where we are now in terms of risk for example of France, Belgium, Italy and Spain," Orphanides told a conference in Cyprus.

"But you realize we have not solved the problem yet, because the risk is a lot greater than the risk we started off with two years ago."

He said a defining moment for the euro zone was when Europe's leaders abandoned the concept of private sector involvement (PSI) as a means of handling debt crises, leaving it in place only in the case of indebted Greece.

Orphanides, governor of the Central Bank of Cyprus, has frequently argued that the PSI, which imposed a writedown in the value of Greek sovereign debt held by creditors, triggered contagion throughout the euro zone.

"By abandoning the PSI (concept) in December, essentially we improved the framework up to a point," he said. "Unfortunately it didn't reverse the haircut on Greece, so we had them (European leaders) on the one hand saying "we won't do it again" but on Greece, imposing a loss.

"We had a situation where declarations were not consistent with deeds and that is one reason why, in my view, European leaders did not manage to fully restore the confidence of the markets," he said.

A "fiscal compact" enforcing more financial discipline on euro zone states which was agreed to by Europe's leaders in December was an important step forward in building a mechanism to fight future crises, Orphanides said.

(Reporting By Michele Kambas; editing by Keiron Henderson)

• A Permanent Economic Emergency