–Adds more detail to story sent at 17:00 GMT

FRANKFURT (MNI) – The Greek government needs to cut an additional
3.5% of GDP from its 2011 budget in order to reach its deficit target,
the staff of the International Monetary Fund reported Wednesday.

Greece’s reform program is, however, gaining ground, the staff
reported, adding that it supports the conclusion of the third review, a
necessary prerequisite for the embattled Mediterranean country to
receive IMF funds.

The country’s debt is seen peaking in 2013, but it could still
spiral to 200% of GDP were there to be a shock to the banking system,
the IMF staff cautioned.

The Greek government passed a “tight” budget for 2011, the IMF
staff noted, targeting a general government deficit of 7.5% of GDP,
consistent with the country’s reform program, which was agreed to last
May as a condition for E110 billion in combined lending from the IMF and
the Eurozone.

“Due to continued recessionary headwinds, some 3.5 percent of GDP
in net new measures will need to be implemented to achieve the target,”
the IMF staff wrote. It elaborated, however, that most of the new
measures have either already become law or are being considered.

The staff wrote that the country’s reform program “is slowly
gaining traction, but more work is needed to deliver the necessary
critical mass of reforms.”

“The program remains at a crossroads. The authorities need to
achieve a shift from stabilization of the fiscal and financial sectors,
to a full set of structural reforms that set the stage for higher growth
and strong job expansion,” the staff assessed.

Policies to bring about such a transformation are in the design
phase and implementation this year is realistic, the staff concluded.
From the Greek perspective, they had better be, since the staff wrote
that these reforms “will be a key subject for future reviews.”

Under the reform program’s base scenario, “debt remains
sustainable,” the IMF staff wrote, “although large risks remain.”

“Debt is expected to crest at high levels and to begin to decline
in 2013,” the IMF staff predicted. “This outcome continues to hinge
crucially on sustained fiscal and structural adjustment.”

“The updated sustainability analysis highlights the risk from
banking system problems given the government guarantees that have been,
or are likely to be, extended,” the staff added.

Were there to be a banking shock, excluding second-round impacts,
debts could rise to over 200% of GDP before retreating “although asset
recovery by the government could provide some benefit,” the staff wrote.

“In the financial sector, time must be provided to allow the banks
to deleverage and restructure in an orderly fashion,” the IMF staff
wrote.

“The banking system needs to extricate itself from the exceptional
liquidity support being provided by the Eurosystem. This will take time,
since the fragile macroeconomic and fiscal situation cannot bear the
additional impact that accelerated deleveraging would have,” the staff
added.

Credit and liquidity conditions are still tight, the staff
assessed. “The main constraint to credit growth appears to be funding
constraints and weakening credit quality, and indeed lending surveys
show that banks continue to tighten lending terms and credit standards.”

“The economy is expected to bottom out in the second half of 2011,”
the staff said. “Keeping projected quarter-on-quarter growth rates for
2011 unchanged (given the better than expected performance in Q4 2010),
suggests that the -3 percent projection remains well within reach.”

Inflation is expected to ease to nearly 1% by the end of 2011 and
“to remain around 1 percent for some time, as structural reforms put
downward pressure on prices via strengthened competition and expanded
supply.”

The staff said that Greece should aim to implement medium-term
policy reforms in the second half of this year, adding that this is
“critical” to the reform program’s sustainability.

“Technical work to design public personnel policy reforms, tax
reforms, and reforms to better target social spending should be
completed by the middle of the year,” it added.

“Implementation should begin immediately, both to support
achievement of the 2011 fiscal target – there is no room to continue to
eliminate a projected shortfall by again under-executing the budget –
and to support the planned 2012 adjustment,” the staff urged.

“To make these reforms effective the government must in parallel
continue to make progress with combating tax evasion and tightening its
control over spending. The government will have to show determination in
the face of what undoubtedly will be strong resistance from vested
interests,” the staff emphasized.

–Frankfurt bureau, +49-69-720142, tbuell@marketnews.com

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