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Greece passes key EU/IMF test but long road ahead

By Dina Kyriakidou and Ingrid Melander

ATHENS (Reuters) - International inspectors on Thursday applauded Greece's efforts to exit its debt crisis, endorsing a fresh 9 billion euro payment from an EU/IMF bailout scheme, but urged reforms in energy, banking and the public sector.

In their most positive assessment so far that offered an antidote to market skepticism, IMF, ECB and European Commission officials said Athens would likely meet this year's deficit cutting target, though risks remained.

"This was a very ambitious programme with a lot of front-loading, and the good news is that it is being implemented as agreed," the IMF's mission chief for Greece Poul Thomsen told Reuters in an interview.

Officials from the so-called 'Troika' told reporters at the end of an inspection visit ahead of the release of the second tranche of the 110 billion euro ($145 billion) programme in September that they now sought reforms in energy, banking and the public sector.

"Despite considerable progress on a very vast array of areas, key challenges and risks remain," said Servaas Deroose, deputy director general for economic and financial affairs at the European Commission.

Commenting on the assessment by the international inspectors, European Central Bank President Jean-Claude Trichet said at a news conference in Frankfurt, "It doesn't mean that a very hard job should not continue to be done."

Reforms were crucial to restore investor confidence and allow Greece to return to international bond markets some time next year as planned.

Deroose said Athens must come up with a plan to free up the energy market by the end of the year, adding the banking sector also needed restructuring. He said he government was preparing a strategic review of lenders in September.

MARKETS WARY

Greece's debt crisis has shaken the euro zone and effectively blocked Athens from markets, with the cost of borrowing briefly hitting 1,000 basis points over German bunds. Spreads have been relatively steady at around 750 basis points since Prime Minister George Papandreou asked for aid in May.

Five-year credit default swaps were at 712 basis points at 1030 GMT versus 130 for Italy, the benchmark for the euro zone's peripheral economies. This means it would cost 712,000 euros to insure 10 million euros of Greek debt against default.

Analysts said Greece now may actually come close or even meet a target to cut its budget deficit from 13.6 percent of GDP in 2009 to 8.1 percent this year, thanks to bigger than expected spending cuts offsetting low revenues.

"People were fearing that the programme was not succeeding just a few months ago. So, it's definitely a positive development," said Giada Giani of Citigroup. "It does not mean that the challenges are not there anymore.

Finance Minister George Papaconstantinou said Greece may actually do better than expected on the deficit target despite lagging revenues.

"On the basis of GDP development and higher than expected inflation ... we will have a deficit below 8.1 percent by the end of the year," he told reporters.

Inspectors said the biggest spending risk areas are state hospitals, municipalities and state-owned companies, which have long burned holes in the budget.

A weak economy was also a challenge. Despite the government's more optimistic views of a milder than expected recession, the IMF and the EU said there was no reason to revise a 4 percent GDP decline. Greece plunged into its first recession in 16 years in 2009 after years of booming growth.

Inflation has jumped to over 5 percent in May and June, much higher than the euro zone average, partly due to value added tax (VAT) and other tax hikes, showing weak competitiveness and highlighting the need to open up professions and markets.

The EU and the IMF revised their inflation forecast for this year to 4.75 percent from an earlier 1.9 percent projection but said they expected the pace to slow to 1.5-2 percent next year.

CHALLENGES AHEAD

After a slow start, Papandreou's socialist government has bitten the bullet and imposed draconian austerity measures, cutting public salaries and hiking taxes.

It has launched long-delayed pension and labor reforms, despite strikes and protests that have disrupted tourism, transport and services, and eroded its popularity.

On Thursday, the finance ministry was briefly evacuated due to a bomb hoax just as the minister was due to begin a news conference on the 'Troika' visit.

Opposing the reforms, seamen blocked ports at the start of the key tourist season in May and truckers went on strike for a week affecting fuel and goods supply, but the government stood its ground and ordered them back to work.

Thomsen welcomed the government's firm stance: "What this has shown to me is that this government is serious about reform. It is not going to back off just because a special interest group is opposing reforms," he said.

But analysts say the next clash with workers, expected to be with the powerful union at the state PPC <DEHr.AT> utility opposing liberalization, will be much tougher.

Analysts said they would be eyeing longer term reforms to assess if Greece is making real progress.

"Bringing the deficit below 3 percent of GDP (by 2014) is obviously going to take a long time, so the risk is whether the strength of the reforms and the strength of the fiscal tightening remains in place over the coming years," said Diego Iscaro of IHS Global Insight.

"Especially because the political situation is likely to deteriorate ... if unemployment remains high and people are more unwilling to make sacrifices," he added.

(Additional reporting by Ruth Pitchford in London)

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