“GM faces the same overcapacity situation with Opel, and that’s why PSA is trying to convince them to merge the two,” said one of the people, who asked not to be identified because the talks are confidential. “The Peugeot family has now accepted that they’ll lose control, so this is no longer an issue.”

The family, which founded Peugeot in 1810 as a coffee mill manufacturer, holds a 25.4 per cent stake commanding 38.1 per cent of voting rights in a company now struggling for survival.

Peugeot and GM both declined to answer questions about their frequent discussions. “We don’t comment on speculation or rumours,” Peugeot spokesman Jonathan Goodman said.

Before injecting more cash, GM would need assurances that it had a free hand to cut production capacity as it took control of integrating Peugeot and Opel, sources said in recent days.

Peugeot, its sister brand Citroen and Opel are among those worst-hit by a European car sales slump that put a US$1.8 billion dent in GM’s last year earnings. The market is on course to contract for a sixth straight year, taking sales to a two-decade low.

For Peugeot, heavily dependent on its home region, the threat is existential. The company burned 3 billion euros (HK$30.3 billion) in operating cash last year, and asset writedowns swelled its net loss to 5 billion euros (HK$50.5 billion).

Shares in Peugeot closed 5.5 per cent higher at 6.50 euros after the Reuters story was published, while GM shares closed 1.7 per cent higher at US$33.10 in New York.

Peugeot’s stock has plunged 77 per cent over the past two years, compared with a 1.4 per cent slide for the STOXX Europe 600 autos & parts index. Its debt has been classed as junk by all of the main rating agencies since early last year.

Chief executive Varin has responded by cutting 10,000 more jobs, selling 2 billion euros in assets and negotiating a 7 billion-euro (HK$70.7 billion) state guarantee for financing arm Banque PSA.

The company aims to cut more costs by pooling future car programmes with GM under their existing alliance - cemented by a 1 billion-euro share issue when the US auto giant acquired its Peugeot stake in March last year.

Earlier talks on a full combination were halted late last year as a French government bailout of Peugeot and its worsening cash position stirred misgivings at GM’s headquarters in Detroit.

Peugeot will need another capital injection and must lay the groundwork this year, people familiar with the matter said, even if the company sticks to its goal of halving operating cash consumption to 1.5 billion euros this year.

Exploratory discussions about selling a 30 per cent stake to a consortium led by Dongfeng Motor Group were inconclusive, the sources said, and would anyway have taken too long. Dongfeng declined to comment.

“PSA will need to present a new industrial plan for people to underwrite a capital increase, and the only hope is GM,” one said. “They (GM) are ready to inject more money if they can control the business, integrate Peugeot and Opel and rationalise production.”

GM is “playing hardball” by holding out for assurances that it would be able to cut plants and jobs at reasonable cost, another person said, adding that no plan is likely to surface before German elections in September.

The US carmaker has drawn criticism from some shareholders over the initial Peugeot investment. GM halved the book value of its stake in a February writedown.

GM has no plans to put in more cash, Chief Executive Dan Akerson said last week, while leaving the door slightly ajar.

“We don’t have any intention of investing additional funds into PSA at this time,” Akerson told reporters in Shanghai. “If we see something changes, we’ll evaluate that.”

The US Treasury, which owns just under 14 per cent of GM common shares, declined to comment through a spokesman.

“PSA’s situation has only deteriorated since the alliance was formed,” Barclays analysts Michael Tyndall and Brian Johnson said in a note on the Reuters story, concluding that an expanded relationship was “unlikely.”

“A further cash infusion could be viewed as throwing good money after bad,” they added. Opel should “search for global synergies with GM operations in regions such as China, where opportunity is abundant, rather than France”.

Still, walking away might not be an easy option for GM. Its own European turnaround plan draws on technology from vehicles such as the Peugeot 208 and Citroen C4 Picasso for future versions of the Opel Corsa small car and Zafira minivan.

But approval for sweeping cuts seems unlikely in Germany or France - where the government last year condemned Peugeot over plant and job cuts that President Francois Hollande described as “unacceptable.”

As one of its rescue conditions, the French government appointed civil servant Louis Gallois to Peugeot’s board. Gallois, a former CEO of Airbus parent EADS, declined to be interviewed for this story.

Ministers understand that Peugeot needs a fuller combination with GM or another industry partner and now expect Varin to present a new plan within months, a French official said.

While not “dogmatically” opposed to foreign control, the government remains determined to preserve Peugeot’s French sites and jobs, he added.

The government or a state-owned investment vehicle could end up taking a Peugeot stake if necessary, officials have also suggested.

In the past five years, GM has scrapped a Belgian car factory and earmarked another for closure in Germany, where it has about 20,000 employees.

Peugeot, which employs 77,000 workers in France, is shuttering its Aulnay plant near Paris and scaling down another domestic site. Its five French assembly plants ran at 71 per cent capacity last year, according to IHS Automotive data, while GM’s three main German sites were at 66 per cent.

Combining their European operations would require deep cuts to draw benefit from the considerable overlap between similarly sized and priced cars. GM sold 9.3 million vehicles globally last year and its French partner 3 million.

Peugeot also ended last year with cash of 6.67 billion euros, excluding listed subsidiary Faurecia SA, and is expected to consume 2 billion euros this year after restructuring costs.

Together with 2.4 billion euros in undrawn credit lines, that will leave about 7 billion euros in available reserves - but the real cushion is closer to 4 billion because Peugeot needs the difference just to operate.

“The minimum level of liquidity they need is 3 billion,” said a London-based auto analyst with a major US bank. “You never want to use that up.”

At Peugeot’s current market value of 2.2 billion euros, raising another 1 billion in equity would dilute current shareholdings by at least one-third. The immediate effect could be reduced by issuing convertible bonds along with shares.

“The only way it works is with a family dilution,” said one source.

Such an upheaval for the company would reduce Europe’s remaining trio of car dynasties to a pair: BMW’s Quandts and the Agnellis still reigning over Fiat.

Chairman Thierry Peugeot and his cousin Robert, who heads the family holding company FFP, both declined to be interviewed.